Private equity and debt deals are attractive to wealthy clients for several reasons. For one thing, these asset classes give investors access to the deals the public markets can’t. Private investments also give investors a certain cachet if dinner party talk winds around to Wall Street.
And it’s never been easier for financial advisors to connect their clients to such investments. Thanks to regulatory changes in banking, new fund structures and advances in financial technology, deals that only institutions were privy to in the past have entered the mainstream for the very well-off.
“I would say private credit and private equity are appropriate for almost anyone,” says Jeff Sarti, CEO and partner at Morton Wealth in Calabasas, Calif. “Typically, most would say these private structures are only appropriate for the ultra-high-net-worth or the high-net-worth investor. I disagree. I think there’s tremendous opportunities outside of public stocks and bonds.”
Rob Young, senior investment analyst in the Chicago offices of Telemus, cites key reasons that he, too, is excited about private equity and debt being available to a broader range of advisory clients. “Private alternatives used to be out-of-bounds for high-net-worth individuals, largely because of the liquidity requirements,” Young says. “Now they’re becoming more semi-liquid, and they’re registered. So they’re a little more open to our type of clients. And it’s something that appeals to our clients because it gives them access to a greater universe of companies.”
At the same time, consider what’s happening in the public stock market. The universe of U.S. public companies has shrunk. Data companies tracking the space say the number of companies peaked at roughly 8,000 in 1996, only to drop to about half that, 4,100, by 2019. The reason? More companies were enjoying the privacy that kept their product development and business plans shrouded in secrecy, and they found all the financial support they needed through private investors.
At the same time, since the global financial crisis of 2008-2009, the traditional bank lending market has dried up as banks require more stringent capital ratios to satisfy regulators, Young says. “And they have to do that because the source of funds for that market is bank deposits. Whereas for private credit managers, their source of funds are institutional investors and high-net-worth individuals. The taxpayer is on the hook in the bank market [but not] in the private credit market.”
Historically, private equity has attracted more investor interest than private credit. Over the last 20 years, private equity funds returned 15.25% annually, according to Boston-based Cambridge Associates, although there is great dispersion between the worst performers and the best.
Private credit has always trailed behind, at least until the beginning of 2022 when its rate of return nudged ahead. Since then, private credit has had stronger returns in all but one quarter, says the State Street Private Equity Index, which monitors roughly 3,800 partnerships with about $4.6 trillion in capital commitments.
For the three quarters of data available for last year, the index paints a picture of private equity returns in decline, with buyout funds returning 2.73% to investors in the first quarter, 2.29% in the second quarter and 0.41% in the third. Venture capital’s performance was even bleaker, after it returned 0.00% in the first quarter, while losing 0.16% in the second quarter and losing 1.48% in the third.
On the flip side, private credit’s return to investors rose through the first half of the year—it gained 2.28% in the first quarter and 2.61% in the second—before it also dropped in the third, to 1.88%. But even that third-quarter decline was roughly 140 basis points better than private equity’s return, and with less risk.
That private equity has had it rough in the last couple of years is irrefutable, as rising interest rates have made borrowing for these deals expensive. “They’re not able to sell their portfolio companies, merge them with larger companies or whatever their strategy may be because the financial markets just haven’t been open to that,” says Jay Sammons, a private markets portfolio manager at Gratus Capital in Atlanta. “Meanwhile, private credit, or specifically direct lending to middle-market companies, is done on a floating-rate basis. As interest rates spiked, the returns to private credit right now are outpacing the returns to private equity. I do not expect that to persist, but at this moment in time, that’s what you’re seeing.”