The Price of Opacity in Private Credit
Private credit's booming but are investors paid for opacity risk, not just credit risk?
The private credit market continues to take the spotlight; with the market AUM approximately at $3.5tn USD, expanding at very consistent double-digit pace YoY. Large asset managers and funds like Apollo, Blackrock and KKR continue to push capital into the space, whereas investor sentiment remains mixed. The key question going forward is whether private credit compensates for credit risk or if the absence of continuous price discovery reflects a weakness in the market.
The bull case for this is genuine, direct lending has filled a real financing gap, making credit more accessible for IG corporates accessing private markets and conversely, for institutional and UHNW individuals allocating capital and filling the gap, despite bank retrenchment and rate cuts. CEO of Apollo, Marc Rowan, earlier this week had floated the prospect of the potential opportunity that private credit could grow to $40tn USD as a suggested potential long-term TAM expansion.
Yet, despite the smooth returns and traction gained, cracks are appearing. BlackRock reported a 13% redemption request with the stress triggered by the Fed’s rate cuts. The bankruptcies of both Tricolor and auto parts First Brands Group raised questions about underwriting quality. Alongside this, manager-determined valuations underscore the opacity of this asset class, and this is precisely what makes the risk profile structurally hard to read.
Nonetheless, these stress points have not yet been enough of an indication as to a structural breakdown – though it is vital to note that investors in 2007/8 sat in the same seat when facing CLOs and CMBSs, echoing some of the concerns observed in pre – 2008 structured credit markets. Whilst the opacity itself wasn’t the cause of losses, it delayed price discovery until the damage was already done.
Private credit has proven resilient through the rate cycle more than critics anticipated, with credit performance holding better up than expected. However, the liquidity mismatch and limited price transparency raises the possibility that risk is not accurately reflected. Therefore, the central question is not whether private credit “works,” but whether investors are being adequately compensated for bearing both credit and opacity risk.Those are two separate risks and markets only price one of them.