Over the past 20 years, a quiet corner of Wall Street has become a pillar of the global financial system. It recently crossed $1.6 trillion in assets. BlackRock estimates that the total addressable market could be $4.5 trillion in the U.S. alone by 2030, or more than 15% of American GDP.
The assets within this ecosystem are some of the most prestigious and sought-after in the market. They’re almost exclusively owned by ultra-high-net worth investors, pensions, and sovereign wealth funds.
And I can virtually guarantee you’ve never heard of it…
While everyday investors are distracted by tariffs, trade wars, and tech stocks like Nvidia, these elites are extracting double-digit yields from this hidden sector. And not just during the good times. These investments have not missed a beat during the recent stock market crash, and the pandemic didn’t phase them either.
Today, the secret is coming out.
I’d like to show you how the growth miracle of Wall Street came to be, and exactly how you can join the most privileged institutions and mega-wealthy in realizing unbelievable levels of income. And with a lot less risk than you think.
If you’re skeptical, I wouldn’t blame you.
But just take a few minutes to read today’s essay. Because I intend to prove it to you.
Paltry to Powerhouse
Something very interesting happened after the Great Recession of 2008/2009.
Regulators dropped the hammer on traditional banks. New legislation like Dodd-Frank meant their ability to loan to huge parts of the economy disappeared.
While the punishment was supposed to be aimed at the big banks, they hurt Main Street instead. Small- and medium-sized businesses lost their ability to get loans almost overnight.
The stated goal was to prevent a situation like 2008 from ever happening again. If you look at the data though, the big banks are larger and more powerful than ever thanks to what the regulators did. But it did have plenty of negative consequences. Lending to smaller, private businesses was now disincentivized, even though it was mortgages and reckless derivatives that caused most problems… The Big Banks, for the most part, moved on. After all, there was still plenty of business to be done with larger, public companies – the type of companies that wouldn’t draw regulatory scrutiny.
But the demand for lending from private companies of all sizes didn’t go away. In fact, the restrictions created even more demand for capital. Plus, fewer and fewer companies wanted to go public. That meant even more private companies that needed lenders.
And so, these “main street” companies did the only thing they could – they turned to a corner of the market that, up until then, had mostly been a niche.
That would be the private credit markets.
At a high level, you can think of private credit as a collection of companies that lend directly to businesses that have trouble acquiring financing from the big banks for all the reasons I listed above.
Businesses in need of financing turned to private credit in the aftermath of 2008. But so did institutional investors. College endowments and pension funds were desperate for income in a zero-interest rate environment.
I actually played a part in that story. One of my first jobs on Wall Street was as a due-diligence officer for a major broker/dealer. My job was to evaluate these funds on behalf of our clients. And I saw firsthand how eager they were to get a piece. I even analyzed many private credit offerings that become stocks (they had initial public offerings years later) you may know today. That includes Bain Capital Specialty Finance (BCSF), Blue Owl Capital (OBDC), Morgan Stanley Direct Lending (MSDL), among others.
Supply and demand collided, and the rest was history.
Source: Pitchdeck Data
Why Private Credit Is Better
When regular people hear fixed income, the first thing that comes to mind is “boring.” And the second is “not enough yield.” Experienced investors also know that most traditional fixed income, like corporate bonds and Treasurys, carry significant duration risk. That’s Wall Street jargon for interest-rate risk.
If inflation rises, fixed-rate bonds suffer. That’s exactly what happened in 2022 when long-term bonds fell by more than 30%. Not so “risk-free” after all.
Private credit is better all around.
First, most private credit issues floating rate loans. That means if inflation or interest rates go up, so does their income. That’s huge for fixed income investors worried about their money losing its value over time.
Second, private credit managers usually underwrite each loan carefully, and that includes strict covenants on the borrower. This might require the borrower to maintain certain levels of cash or avoid taking on too much debt. Corporate bond investors can only dream of that power.
Third, these loans are much more lucrative. Today, the typical rates charged by private credit managers is 8% to 15% depending on the quality of the borrower and collateral. This means investors have the potential to earn double the income from investment-grade bonds, and 50% more than high-yield bonds.
If that sounds too good to be true, I’d understand. Brad is always encouraging investors to be wary of “sucker yields.” But that’s not what these are.
I’ve been recommending private credit assets in the pages of High-Yield Advisor for nearly three years. As I write, the current yields on some of our private credit assets are 11%, 11.5%, and 13.1%.
You might think this makes them inherently riskier. And, yes, there is some risk. Because there always in. But for all the reasons I shared above, these yields are more reliable, more resilient than you might think.
Another statistic: During the entire history of High-Yield Advisor, we have recorded a roughly 95% win rate. Our biggest-ever loss was less than 10%. About a third of those trades were the publicly traded version of private credit that I’ll tell you about next.
One of the Few Avenues Open
The major players in private credit today include the likes of Ares Management (ARES), Blackstone (BX), Golub, and Blue Owl (OWL). Unless you have millions to invest, getting into their institutional funds won’t be easy. Fortunately, you don’t need to.
As I mentioned, I was a due diligence officer at some of the largest broker/dealers in the country for many years. These managers were desperate to access the hundreds of billions of client capital that I guarded. So, to get my vote of confidence, they had to pull back the curtain and show me every detail about their portfolios, strategies, mistakes, and successes. This experience taught me how to analyze private credit funds very well.
And I can say with complete confidence that there is an equally good, and much simpler way to tap into the rapidly growing private credit market: publicly traded business development companies (“BDCs”).
BDCs are a tax-advantaged similar to real estate investment trusts and master limited partnerships. They are forced, by law, to invest in at least 70% U.S. small- and medium-sized businesses. Even better, they must distribute at least 90% of their profits to investors. These aren’t small businesses like your neighborhood corner store. Most BDC target companies earn at least $25 million in pre-tax profit annually. And, yes, at least for now, they tend to provide double-digit dividend yields like I mentioned above.
Now, it does take skill to evaluate BDCs. Not all are created equal.
Knowing which are best is critical and so is getting in at an attractive valuation. That’s why I walk through subscribers to my High-Yield Advisor service exactly how to do it.
We’ve invested in Golub Capital BDC (GBDC), Ares Capital (ARCC), Blue Owl Capital (OBDC), Blackstone Secured Lending (BXSL), and several others. On average, they yield over 10%. And everyone has maintained or increased their hefty distributions for many years. As just one example, we earned a total return of over 45% on our first GBDC trade.
Traditional fixed income can be boring, but intelligently investing in private credit certainly isn’t.
Regards,
Stephen Hester
Chief Analyst, Wide Moat Research