Private Credit in a Rising Rate Environment

Amid the higher than expectation 9.1% year-on-year inflation announced in the US on 13 July 2022, market is expecting even more aggressive measures taken by the Federal Reserve in the US. In this rising rate environment, the floating rate featured in private credit strategies could protect investors by offering an interest rate-linked yield.

As an asset class, private credit is an umbrella that include asset ranges from corporate debt, distressed lending, mezzanine loan, special situation to real-estate lending. Alternative funds that invest in these assets allows investors to hedge their risk exposed in traditional fixed income and equity investments.

Private credit strategy is not only an effective hedge against interest rate risk in the US. As year-on-year inflation rate hits a record-high 8.6% in Europe in June, the ECB is also raising rate by 50bps to tame inflation after maintaining a negative deposit rate since 2014. The Bank of England is also considering raising rate by 50bps in August after five consecutive hikes since mid-December 2021. Private credit investments in Europe could also provide a hedge for portfolios with exposure in the region under such market condition.

Apart from a floating rate hedge, private credit can also act as a mean of capital preservation. According to Pitchbook, in Q1 2022, when the market started to speculate and react to the rate hikes which resulted in a -4.6% QoQ return in the S&P 500, private debt continued to deliver a positive and reasonable 2.89% horizon IRR.

Investing in a private credit fund where the manager has an expertise in deal sourcing and selection allows investors to generate returns through the streams of repayments specified in the loan terms. The returns are therefore to a very small extent correlated to the public market which makes it an attractive strategy to diversify investors’ portfolio.

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