Blue Owl Capital’s struggling stock price and recent decision to offload $1.4 billion in loans while reshaping investor withdrawal terms have advisors debating the future of adding private credit to client portfolios.
And they are doing it quite publicly.
Ted Neild, chief executive officer and chief investment officer at Gresham Partners unabashedly points out that he does not carry exposure to private credit. His UHNW families have meaningful allocations to private equity, venture capital, and real assets. However, he has chosen to avoid private credit because he believes the forward risk/return profile, particularly on an after-tax basis, has been “unattractive” for several years.
“The asset class has delivered acceptable results in benign conditions in recent years but has not been tested at its current scale and structure through a full credit cycle. Today, pressures appear to be mounting,” Neild said.
Neild says he focuses first on ex-ante indicators, including spread compression, rising entry leverage levels, and deteriorating underwriting standards. The amount of capital entering this space has pressured many of these metrics and reduced the margin for error, according to Neild.
He adds that ongoing indicators like rising non-accruals and defaults, forced asset sales at discounts, and redemption pressures in semi-liquid retail vehicles can reveal stress that is not always apparent in reported marks.
“Whether recent developments represent isolated issues or early signs of broader stress remains to be seen,” Neild said.
Elsewhere, Jason Howell, president and family wealth advisor of The Jason Howell Company, assumes right off the bat that his clients are not ready for private credit.
“Our clients come to us for advice and our advice is to create a diversified portfolio that achieves a return they need with the least amount of risk. We evaluated private credit in 2023 and decided it was an unnecessary diversifier,” Howell said.
Right now, Howell says he is listening for whether the private credit borrowers are software companies.
“There's a lot of talk now about "re-rating" software companies in light of the AI revolution. If software companies are involved in the lending transaction, we're not recommending the investment,” Howell said.
Along similar lines, Noah Damsky, principal at Marina Wealth Advisors, has been avoiding private credit. That said, if he was faced with these conversations about troubled private credit loans, his message to clients would be to assume the worst.
“We need to treat whatever we get back and whenever we get it back as a portfolio cherry on top. It's not comforting, but there's simply not enough information to have more certainty. While I don't think a complete loss is likely, it's better to be pleasantly surprised than extra disappointed. However, clients need to be prepared to take their medicine and accept that it's going to taste bad,” Damsky said.
Damsky points out that credit investing remains complicated because there are tons of risk factors that can be structured in an infinite number of ways.
“The red flags today are the same as they were before: lots of unsophisticated capital flowing into a segment with more downside than upside that's loosely underwritten and loaded with leverage. Our clients will stick to private equity/buyout, venture, and infrastructure where the upside isn't so limited relative to risk,” Damsky said.
Damsky adds that the current troubles in the private credit arena reinforce his diligence process, which is to be prudent and disciplined. It also includes “not succumbing to FOMO or following the lemmings of the industry as they pile in.” In his opinion, investors chased high yields without understanding the extent of the risks they were taking.
“I didn't understand the risks fully, either, which is why I refused to invest. Peer or industry pressure to follow the herd in investing is real, and unless you're confident in your beliefs, you're at risk of leading your clients over the cliff with the rest of the lemmings. In the end, you owe it to your clients to be confident in your beliefs and stick to them,” Damsky said.
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