As investment markets and opportunities have evolved, many high-net-worth investors have turned to private market investments, including Private Equity. Private equity investments have long been a popular choice for sophisticated investors seeking high returns and portfolio diversification.
However, a lesser-known cousin in the private markets space, private credit investment, has been quietly gaining traction and attracting increased attention from investors looking for attractive yields in today's economic landscape.
Private credit investments, a subset of the broader alternative investment landscape, have gained significant traction among investors seeking higher yields and diversification.
Unlike public credit markets, such as taxable, municipal, or government bonds, private credit involves lending money to private companies, real estate projects, or other entities that do not typically have access to traditional bank loans or public debt markets.
These investments are generally made through private credit funds, offering investors access to unique opportunities with the potential for attractive risk-adjusted returns.
Example*: An example of a private credit investment is direct lending to a private company.
Scenario: A private mid-sized pharmaceutical company needs $20 million to expand its operations but does not want to issue public bonds or go through traditional banks. Instead, it approaches a private credit fund for a loan.
Investment Structure:
*This hypothetical example is for illustrative purposes only. This is not a prediction or guarantee of actual results. This example is not intended to represent the value or performance of any specific product.
For high-net-worth individuals, including retirees and doctors, private credit can be a compelling option. These investments often provide higher yields compared to traditional fixed-income instruments, such as government and corporate bonds. In a low-interest-rate environment, the ability to generate a stable income stream is appealing, particularly for retirees seeking to maintain their lifestyle without drawing down their principal. Private credit investments are also attractive due to their low correlation with equity and bond markets, which can enhance portfolio diversification.
For doctors and other professionals with significant income, adding private credit to their investment portfolio can reduce overall portfolio volatility. The relatively stable cash flows from these investments can complement the unpredictability of the stock market, providing a buffer during market downturns.
Despite their appeal, there are inherent risks when you invest in private credit.
One of the primary risks is liquidity. Private credit investment funds are typically illiquid, meaning investors may have to hold their investments for several years before they can be sold or redeemed. This lack of liquidity can be a disadvantage if an investor needs access to their capital quickly.
Credit risk is another significant factor. Since private credit involves lending to companies or projects that may not have access to traditional financing, there is a higher risk of default compared to investment-grade bonds.
Additionally, these investments are less transparent, making it challenging for investors to assess the underlying risk fully. Lastly, the lack of regulation in private credit markets can lead to variations in the quality of loan origination, underwriting standards, and risk management practices.
Another important consideration is related to the income distributions of private credit investments. For high-income and high-tax bracket investors, the level of taxable income generated from private credit investments can simply diminish the after-tax returns. The returns often sound appealing, but when considering state and federal taxes, the returns can often be reduced by 40% or 50% depending on the tax bracket and state income tax rate. As the adage goes, it’s not what you earn; it’s what you keep.
While a private credit investment strategy offers attractive benefits, potential investors, including retirees and doctors, must carefully weigh the risks and align these investments with their financial goals and risk tolerance.
Consulting with a financial planner with expertise in private credit is crucial for making informed investment decisions.
If you are interested in learning more about our investment philosophy or alternative investments, including private credit, please contact one of our financial advisors to see if this or other strategies align with your financial goals and risk tolerance.
Any discussion of taxes is for general information purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.
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As the Director of Planning & Strategy for Spaugh Dameron Tenny, Jordan applies his academic and practical experience in the creation and maintenance of the firm’s financial plans, as well as coordinating research efforts for products and strategies that may benefit clients. Originally from Canada, Jordan came to Charlotte on a golf scholarship where he attended Queens University of Charlotte. In addition, Jordan has a Master’s degree in Wealth and Trust Management.
