In 2024, forward-thinking investors are gearing up for what figures to be a banner year in credit asset management. Investment titan KKR is not alone in predicting ideal conditions for lenders and borrowers, which should lead to bigger and better loans reaching companies on conditions good for them, their lenders, and all savvy investors who take part in credit asset management.

So, what does it mean to engage in the credit market in 2024—and to manage credit assets?

Below, we’ll define credit asset management by explaining what credit assets are, how they’re managed, and the benefits that come along with investing in this lucrative approach. We’ll also touch on some of the potential downsides or drawbacks and how to prevent or mitigate them.

Understanding credit as an asset class

Companies and individuals seeking funding often find it in credit from banks and non-bank lenders. The sum total of these opportunities is referred to as the credit or debt market.

There is a spectrum of credit assets investors can target, including but not limited to:

• Bonds and loans issued on the public or private markets
• Securitized bundles of loans (i.e., mortgage and auto payments)—
  • Agency, non-agency, and commercial mortgage-backed securities (MBS)
  • Asset-backed securities (ABS) and specialty ABS including niche assets
• Collateralized loan obligation (CLO) debt from leveraged buyouts (LBO)
• Residential (personal) and commercial real estate (CRE) lending

Investing in credit or debt assets related to publicly traded companies is trading in public credit or debt. And tapping into the same kinds of assets but for companies off of the public market is trading in private debt or credit. For our purposes, we’re focused mainly on the private side.

Private credit vs private equity

Private credit is similar to private equity (PE) in that both approaches involve investors providing funds to companies via private market transactions with the goal of generating  a return when exiting that investment later on. However, the mechanism by which the return is generated is completely different.

In private debt, the primary return driver is interest on the line of credit, although credit assets may also be sold at a profit. In individual deals, issuers and borrowers negotiate interest based on the risk and size of the loan, among other factors. In aggregated deals, dividends or similar payments might be distributed, but these are calculated based on the underlying interest.

By contrast, in private equity, investors are purchasing ownership of the companies they invest in. Rather than being paid in interest, PE assets drive returns through dividend recapitalization and, more importantly, a PE fund’s exit strategy—often an IPO, LBO, or strategic sale.

Despite their differences, PE and private debt can coexist in a diversified portfolio; some firms focus on one or the other, but many pursue both (and other approaches) simultaneously.

How credit asset management works

Credit asset management is the process by which funds and firms raise capital from investors and direct it toward select credit (and other) assets. According to the Federal Reserve, most investments in private credit come from institutional investors, such as pension funds and insurance companies. Other big players are high-net-worth individuals and family accounts.

However, these high-value investors typically aren’t managing the investments themselves.

Managers pool funding from sources like these and, through a careful selection process, pick individual lending opportunities or curated bundles thereof to invest in. For a management fee and a portion of the carried interest (“carry”), firms and funds handle the legwork of selecting and managing portfolios and chasing optimal returns. Traditionally, these fees sit at around 2% and 20%, respectively, but recent studies in private credit have seen lower medians (1.5%, 15%).

Variations in credit asset management

There are many different approaches to managing credit assets and firms or funds focused on them. Morgan Stanley breaks down most private credit management into four distinct focuses:

• Senior capital – Investment managers may elect to provide direct funding to companies, whether or not they are deemed “investment grade.” Lending to more mature elements in portfolio companies’ capital structures lowers risk and provides consistent income.
• Junior capital – Credit assets such as mezzanine, preferred equity, and second-lien debt subordinate the debt structure without securing credit against assets. The relatively high risk is often offset by incentives, such as “equity kickers,” which function as a backup.
• Distressed debt – Investors may seek out loans to disadvantaged companies with the hope of helping them turn their operations around and capitalize on the profits. These assets carry higher risk and are adjusted accordingly (i.e., better rates or lower prices).
• Special situations – These are unique financial circumstances that require bespoke conditions for the loan or other line of credit to make sense for all parties involved; common examples include complicated restructurings or mergers and acquisitions.

Some firms set up shop in just one or two of these, and others mix and match across all of them. And, as mentioned above, some funds choose to specialize in just credit assets (or just public or private debt specifically), while others diversify across other asset classes as well.

Benefits of credit asset management

Investors in debt assets, especially private credit, enjoy remarkable success. Per the Federal Reserve, private credit assets generate “higher returns than most other comparable asset classes,” even as “year-to-date default rates have generally been low.” In short, these investments make lenders and managers optimal returns with relatively low risk. 

In large part, these benefits for investors are driven by companies’ demand for private credit.

Private credit especially makes funding available for companies that otherwise might not be able to secure it. This is why they’re willing to pay a premium for the capital in question.

In a recent Bloomberg interview, Blackstone’s head of credit Dwight Scott explained how private credit funds’ certainty and confidentiality are appealing to companies. In particular, Scott notes that private credit has an advantage in take-private deals, which can be difficult to complete because of how long they can take and how many factors can change throughout the process.

Spotlight: Bigger deals, bigger rewards

In a recent conversation between Blackstone executives published in Private Debt Investor, the experts highlighted how bigger credit asset deals outperform smaller ones. Although investors might be skeptical about the risk exposure that comes along with large loans to bigger and more mature companies, these assets consistently perform better in terms of risk-adjusted returns.

The Blackstone executives note that some of this phenomenon can be chalked up to inertia.

For instance, larger companies looking for bigger loans are often in that position because of their high-quality products and services. That, in turn, may speak to other strong underlying factors, like strong management and diversified (yet focused and complementary) offerings.

However, with the caveat that there is great value to be found in deals and companies of all sizes, both experts agreed that larger companies are among the least likely to default.

Downsides of credit asset management

Investing in credit assets does not guarantee optimal returns; no singular investment strategy can. And, while public and private credit as a whole have relatively small risk profiles, they are still subject to market fluctuations. A bet that companies will make good on loan payments (or that the threat that they won’t have been adequately accounted for) is, ultimately, still a bet.

And, as recent years have shown, the market can take just as well as it can give.

Exiting 2022, experts were near-unanimously warning that 2023 would slow down or even halt the growth of private debt. Reuters’ reporting highlights consensus around warning signs like:

• Surges in redemption requests in select assets like real estate income trusts
• Rising corporate default risks, leading to investors second-guessing risky debt
• Relatively high chances of recession-like conditions, causing debt restructuring

These risks aren’t unique to credit assets; they abound across the asset management landscape.

Overall asset management first broke the $100 trillion mark on the heels of 2020, but the industry has been on a slight downswing more recently. Boston Consulting Group’s 2023 estimates saw the market falling back down to $98T after global turbulence in 2022.

These are all reasons that, moving forward, credit asset managers and investors of all stripes will need to leverage technological tools and data analytics to optimize their portfolios.

Getting the most out of credit asset management

At Allvue, we see great potential in private credit and are optimistic about its prospects for investors. We’re dedicated to providing the support and resources needed to navigate this promising area, ensuring you’re well-equipped to make the most of these opportunities.

 To that effect, we’ve built a comprehensive CLO solution that consolidates the data managers need to optimize their operations from end to end. From research assistance to investment accounting and pipeline management, our software is designed by and for investors. 

To learn how effective artificial intelligence (AI) and machine learning (ML) can be for credit asset management, get in touch today—or request a demo to see our platform in action.

 

Sources: 

Bloomberg. Private Credit Funds’ Certainties Offer An Edge, Says Blackstone’s Scott. https://www.blackstone.com/wp-content/uploads/sites/2/2023/09/Bloomberg_Dwight-Scott_Private-Credit-Funds-Certainties-Offer-An-Edge.pdf

Boston Consulting Group. The $100 Trillion Machine. https://www.bcg.com/publications/2021/global-asset-management-industry-report

Boston Consulting Group. The Tide Has Turned. https://www.bcg.com/publications/2023/the-tide-has-changed-for-asset-managers

Callan. Our First Private Credit Fees and Terms Study: What We Found in 2023.  https://www.callan.com/blog-archive/private-credit-fees-2023/

Federal Reserve. Private Credit: Characteristics and Risks.  https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-characteristics-and-risks-20240223.html

KKR. 2024: A Credit Vintage to Remember?. https://www.kkr.com/content/dam/kkr/insights/pdf/2024-a-credit-vintage-to-remember.pdf#page=4

PIMCO. Across the Spectrum: Understanding Public and Private Credit. https://www.pimco.com/en-us/resources/education/across-the-spectrum-understanding-public-and-private-credit/

Private Debt Investor. Why bigger deals can drive better returns.  https://www.blackstone.com/wp-content/uploads/sites/2/2023/10/Blackstone_PDI_Why-Bigger-Deals-Can-Drive-Bigger-Returns.pdf

Reuters. Private debt markets face reality check as companies grapple with rising rates, recession.  https://www.reuters.com/markets/rates-bonds/private-debt-markets-face-reality-check-companies-grapple-with-rising-rates-2022-12-20/