Private credit is a bit of a buzzword these days, according to Christian Stracke, managing director and global head of credit research at PIMCO.

Despite its overuse, however, there remains a lack of understanding about private credit — in fact, it is often conflated with other products, many of which involve a lot more risk-taking.

To set the record straight, Stracke explains that private credit emerged in the wake of the extensive global regulatory response to the financial crisis. With banks forced to curb lending and proprietary trading, private lending pushed into the space to pick up the slack.

Read: Global sovereign investors shifting down equities, ramping up alternatives: survey

“Private credit isn’t just corporate lending — it extends to multiple areas, including commercial real estate, consumer loans and residential mortgages.” In short, any type of lending that has been affected by the extending reach of regulators, he notes.

The question investors need to ask is whether or not they are gaining exposure to private credit or simply taking a lot of risk. “Is it a real opportunity or simply a reach for yield dressed up as private credit?” Stracke warns.

The real opportunity in private equity falls into two categories — an illiquidity premium and a complexity premium — which basically means that these assets are harder to manage and involve a lot of detailed assessment of loan portfolios. Together, these two premia mean that private credit is fundamentally uncorrelated with risk assets — a key advantage. It can also tread where banks are no longer able, such as residential mortgage lending, for example, where it’s getting harder in some segments to gain access, especially for small business owners.

“These mortgages are 30 per cent cash down, and you have to have a high FICO score. Line this up with normal mortgages and the credit quality is actually high,” Stracke explains.

Read: Are investors becoming cautious around private debt?

Consumer lending and commercial real estate are two additional areas banks have exited and where private credit now plays a role. However, it’s not just about the big deals; the real opportunities in private credit happen when you are able to pull together multiple smaller loans with higher credit quality. For example, in commercial real estate, small business owners like dentists and doctors are looking for capital to buy their buildings or expand their businesses.

It’s a richer and bigger field, says Stracke, and that’s compelling at a time when corporate debt is at all-time highs. Private credit provides access to far less crowded areas of the market, provided you have the time and expertise, he adds.

This article was originally published on Benefits Canada‘s companion site the Canadian Investment Review.

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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