Mike Dowdall wants people to understand that private credit is far less complex than it may seem.
“Don’t be intimidated when you first hear of private credit. Private credit can be as simple as ‘you give me a loan,’” he shared. “I think the asset management and finance industry like to use jargon that makes it sound more complicated than it is, but oftentimes it can be quite simple once you boil it down.”
Nectar Head of Capital Markets Andres Sandate sat down with Dowdall to talk about the growing opportunities in the private credit space, as well as the top questions you should ask your advisor when considering this investment strategy.
At the most basic level, private credit is when a company or asset is financed with non-bank loans.
“When you look at the broader private credit market, most of the strategies that you see are what we call middle market direct lending. And so what that means is, when a private equity firm goes and buys an individual company, they do financing. So they’re not going to put all their equity up to buy it, they’re also going to take out loans,” Dowdall explained.
However, this is just one part of the private credit ecosystem that Alternative Fund Advisors is working to make accessible to financial advisors and their investor clients.
“Those middle market direct loans are fine,” he shared. “But we think that that’s just one part of this broader private credit ecosystem that investors should have access to.”
Until recently, most of the private credit strategies have functioned within the context of a bank. But as banks have consolidated, many of the institutions that focused on lending to mid-market businesses and newer, niche, or specialized segments of the economy have disappeared.
“These smaller banks that might have been lending to regional businesses or a real estate developer, a lot of those banks have really been gobbled up by the big guys,” Dowdall explained.
At the same time, the average loan size of banks has increased, because it’s more efficient for banks to complete large loans than small ones.
This has created a new space for investment sponsors and fund managers to fill the void left by banks. The supply and demand for private credit and investor allocations has exploded in response.
As with any financial strategy, it’s important to make sure you’re working closely with your advisor to understand the risks and opportunities before allocating to the private credit space.
Private credit will always include recession risk, so you should focus on learning as much as you can about how the manager manages risk in their portfolio. For example, AFA prioritizes conservative underwriting and diversified collateral.
AFA also utilizes an interval fund structure which provides investors with exposure to a diversified portfolio of underlying managers and strategies in a registered vehicle that has different liquidity features than many private funds.
“Each of the individual strategies that we invest into, they’re their own standalone business,” Dowdall explained. “So from that standpoint, we also like to be able to diversify that as well. It’s not like investing into a bunch of different mutual funds, these are truly standalone businesses.”
Private credit is relatively illiquid, and as a result, you should consider your liquidity needs and weigh whether a manager’s projected returns will compensate them fairly for the illiquidity.
“You’re taking on more complexity, you’re taking on less liquidity, so there should be a higher return,” Dowdall shared.