(Bloomberg) — A trio of academics have a bold take on the booming $1.7 trillion private loan market: After accounting for additional risks and fees, the asset class delivers virtually no additional return for investors.
In a new study published by the National Bureau of Economic Research, the professors argued that direct lenders as a whole hardly produce any alpha — or additional compensation over broad market benchmarks.
That conclusion is sure to be controversial in a market that has more than doubled in size over the past five years thanks to the lure of higher and more stable returns compared to publicly traded debt.
Read more: Why is private credit booming? How long can it last?: QuickTake
“It's not a panacea for investors where they can earn 15% risk-free,” said Michael Weisbach, a finance professor at Ohio State University who co-wrote explorative with Isil Erel and Thomas Flanagan. “Once you adjust for risk, they're essentially getting what they deserve, but no more.”
Behind the research is complex mathematics to try to sort out the alpha part of a return that depends on skill, and the beta part that can simply come from stalling in a bull market. While benchmarking stock pickers against a market benchmark like the S&P 500 is standard by now, it's not clear what the right metric is for private loan funds, which make niche and obscure loans for a wide range companies.
To be clear, the study covers industry broad returns rather than any particular fund, and Weisbach is quick to add that the asset class can still be a welcome source of diversification as long as investors can tolerate the liquidity of his lowest.
The three economists analyzed MSCI data on the cash flows of 532 funds, covering their capital inflows and distributions to investors. They compare industry performance to portfolios of stocks and loans with similar characteristics, whose fluctuations end up explaining most of private credit returns. The study shows that these private credit funds also carry an equity risk, as about 20% of their investments contain equity-like features, such as guarantees.
After accounting for these risks, they find that there is still alpha left on the table—which only disappears after the fees paid to these managers are deducted.
“It's really the first attempt to my knowledge of trying to look at private credit using credit and equity benchmarks,” said Tobias True, a partner at Adams Street Partners who applies data analytics to building portfolios. private. “There is so much variety and diversity in loan structures with equity components and different levels of leverage. That's what makes it really challenging for us to separate alpha and beta.”
The paper's conclusion may resonate with some investors, or limited partners, who are beginning to question the steep costs as interest rates rise and competition for their dollars intensifies. Meanwhile, default risks are also rising as tighter monetary policy squeezes corporate borrowers. With fund growth now slowing after several years of rapid growth, some private equity funds have begun waiving fees for lead investors.
Read more: Private credit funds depend on “no fee” offers to valued investors
As private markets thrive, some quants — notably Cliff Asness of AQR Capital Management — have suggested that investors are being misled by returns that mask volatility and may be less impressive than they appear.
True to Adams Street Partners, which co-wrote one of the first letters on the performance of private credit, warns that until the industry faces its first downturn, it may be difficult to determine real alpha. But he says the NBER study is a good step toward digging beneath the surface of private loan returns.
“It's not going to give anybody a magic formula where they can come in and say, you haven't delivered any alpha,” he said. “Maybe it just raises awareness that there is additional risk and the overperformance was not worth it in some cases.”
bids
- Thryv Holdings Inc., the software company that owns the Yellow Pages, has held discussions with private lenders for $350 million in financing to refinance its existing debt
- Private credit funds are working on plans to provide up to $2.5 billion to finance the sale of US packaging firm Trivium Packaging
- Credit arm of BC Partners agreed to provide $400 million for football helmet maker Riddell, in a deal that will give shareholders, including private equity firm Fenway Partners, a long-awaited payout
- Oak Hill Advisors served as joint lead arranger for the private equity financing to support HGGC's acquisition of Rimcus Consulting Group