Large investors return to private credit funds

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Investors return to private credit funds

Institutional investors return to the market

The data show that large investors remain willing to allocate capital to this segment of private credit despite several major defaults and concerns about the market’s excessive concentration in the software sector.

“Retail investors have pulled back from private credit as they have come to terms with the reality of lower return expectations on loans issued in 2021 and 2022,” said David Colla, global head of credit investments at Canadian pension fund CPP Investments.

At the same time, he noted that returns are still “respectable,” while the withdrawal of retail clients has “left a gap in private credit markets that institutional capital is now filling.”

Major investment groups, including Blackstone, Ares Management and BlackRock-owned HPS Investment Partners, are meeting with investors to raise money for new flagship funds.

According to a person familiar with the situation, Apollo Global executives brought forward fundraising for their new flagship direct lending fund by six months to take advantage of strong demand. The fund was presented to prospective investors last week.

Brad Marshall, co-head of Blackstone’s $45 billion flagship private credit fund, said many investors expect returns to rise. This is especially likely if outflows from retail-focused funds limit their ability to issue new loans.

According to him, periods of volatility usually become the best time to deploy capital because market participants are nervous, deal structures become more conservative, and the cost of lending rises. This refers to a wider credit premium, or spread, that lenders can charge above benchmark rates.

Why big players see an opportunity

Demand from institutional investors sharply contrasts with outflows from funds aimed at retail investors and wealthy clients. Investment groups from Apollo to Morgan Stanley have already limited withdrawals from such vehicles after facing more than $22 billion in redemption requests in the second quarter.

“Institutional investors seem to be approaching direct lending very pragmatically,” said one private credit executive. According to him, new deals now have slightly less leverage, tighter documents and higher pricing. This is exactly what institutional investors see: in their view, the market is getting better, not worse.

Maine’s state pension fund approved commitments of up to $375 million to Blackstone’s new direct lending fund in February, according to state disclosures.

New Jersey’s investment arm, which manages one of the largest pension plans in the country, proposed investing up to $600 million in funds managed by private credit specialist Golub Capital.

Institutional investors’ optimism is supported by the resilience of the U.S. economy and the possibility that interest rates could start rising if the Federal Reserve tries to contain inflation. Higher rates would boost returns on floating-rate private debt.

“They want more of these instruments,” Apollo Asset Management co-president John Zito said last month, referring to institutional demand for private credit. According to him, when investors see alarming headlines, they view them as an opportunity to earn additional spread and deploy capital on more favorable terms.

Why private credit funds are needed

Private credit funds have become an alternative to bank loans for companies that need fast and flexible access to capital. Unlike banks, such funds can approve deal terms more quickly, issue large customized loans and work with borrowers for whom standard bank financing is not always suitable. For businesses, this is a way to raise money for deals, growth, debt refinancing or operating expenses without entering the public debt market.

For investors, these funds are attractive because they allow them to earn income from corporate loans, often with floating rates and a higher risk premium. At the same time, the market remains less liquid and more closed than public bonds, so it is generally better suited to large institutional investors that are ready to commit capital for the long term and assess credit risks more carefully.

As a reminder, according to Morningstar DBRS, the private credit sector is shifting toward specialized strategies.

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