In this blog, Stuart McKinnon warns those being attracted to the abundance of new style private credit funds to be careful.
It is possible to earn attractive returns but it can be difficult to assess risk and some approaches are unduly complex.
Before the global financial crisis, UK institutional investors such as pension schemes typically provided loans, or credit, only via traded bond markets, with banks providing much of the (very considerable) rest.
But the crisis has brought about real change to this system. Banks have had to shrink, by lending less, and have had to reconsider the types of lending they do. As economic recovery continues, demand for loans has increased and this has given rise to opportunities for others to step in to the gap left by banks.
For the “man in the street”, peer-to-peer lending websites have become the subject of dinner party discussions and articles in personal finance sections of newspapers. But for institutional investors, specialist fund managers now provide stronger and more direct links to those companies and projects needing loans. The result is a multitude of funds, across a wide spread of opportunities, but often under a common label of “private credit”, “direct lending” or “illiquid credit”.
Whilst the forecast returns being publicised by managers would probably attract most investors, great care is needed. Lending is a specialist area, where risk is difficult to assess and some of the approaches are highly complex. The challenge for investors is multi-faceted. It may be tempting to seek double digit returns reliant on complex financial engineering, but if something sounds too good to be true then be wary.
Rather, focus on understanding who you are lending to, what protections are in place should problems arise and, more broadly, how lending can help you achieve your investment goals.