Why are family offices losing interest in private credit funds?

It’s the hottest trade on Wall Street. Everywhere you turn, money managers have upped their investments in private credit, helping the asset class balloon into a $1.7 trillion industry. But there’s one group where interest appears to already be waning — the family office.

Managers of the fortunes of the world’s ultra-wealthy are searching out private credit funds at a slower pace this year than last, according to the latest data from Preqin, an analytics company that tracks the alternative investment industry. 

It bodes ill for direct lenders that are relying on the trillions of dollars that family offices oversee to propel the industry’s next growth phase. Amid a difficult fundraising environment this year, private credit funds have ramped up efforts to lure the world’s richest individuals. Still, overall family office allocations to private debt remain at roughly 2%, according to a recent report from UBS Group AG.

“We don’t need to invest through the sort of generic private credit fund managers,” said Grace Cheung, Chief Investment Officer and Founder of TGIM Assets Capital, a private markets investment group with capital allocations from family offices. “We have the resources, expertise and the network to do a lot of private credit-type transactions ourselves,” she said, adding that they sometimes co-invest alongside established private credit firms.

The Preqin report is based on fund searches that reflect active investment intentions of investors over the next 12 months, according to the company.

North American private credit fund searches have comprised 11% of the total this year, down from 18% last year and below the 39% of private equity and venture capital, and 45% of real estate. Hedge funds and infrastructure have made up the rest.

In Europe, private credit fund searches were down to 8% from 10% a year ago.

Among the top concerns among wealthy investors when weighing how much to invest in private credit is the potential for lower returns as the Federal Reserve and European Central Bank begin to cut interest rates, according to Preqin’s Rachel Dabora, lead analyst on the report.

Higher borrowing costs helped push returns into the double-digits last year for direct lending funds, data from Cliffwater LLC show. But given the floating-rate nature of the loans they provide, investors are concerned that rapid cuts to interest rates could weigh on future gains.

On the flip side, North American family office interest in real estate has surged as stress in the asset class fuels deep discounts, while in Europe three-quarters of searches have been for private equity this year, continuing the asset class’s dominance.

For Alex Chaloff, Chief Investment Officer for Bernstein Private Wealth Management, private equity may simply be a more natural fit for family offices given their risk tolerance and often long-term investing horizons.

This year’s global family office report from UBS showed that 39% of those surveyed wanted to increase their investments in private equity direct investments, compared with just 29% that wanted to boost allocations to private debt.

“If a private credit fund earns a 20% return, I think they may have taken too much risk,” Chaloff wrote in emailed comments. “When a private equity fund earns 20%, I look at how that fund compares to other peers. There’s no cause for alarm.”

The hunt for higher potential payouts is even more acute in regions with elevated benchmark rates like Russia and Latin America. 

“Historically, Latin American investors have been hesitant to invest in credit due to high domestic interest rates, often opting for higher-octane strategies like private equity,” said Philippe Stiernon, CEO of ROAM Capital, a Latin American alternative asset placement agent that works with high-net-worth individuals, family offices and institutional investors.

Nonetheless, a chunk of family offices appear keen to ramp up their private credit exposure. Citigroup Inc.’s global family office survey for last year showed that respondents bullish on private credit outweighed those that were bearish by more than 30 percentage points in Europe, the Middle and Africa as well as in North America. 

A number of private credit vehicles directed at rich individuals have had successful fund raises in recent months, too. 

For TGIM’s Cheung, however, avoiding private credit funds affords more flexibility in terms of both risk management and optimizing perspective returns.

“We’d rather be robust and focused on those direct and scaled private debt investments where we can have good control of the risk and return profiles as well as the flexibility to invest further across the respective capital stacks,” Cheung said.