Publicly traded bank loans and high-yield bonds have offered some investors diversification in their traditional 60/40 portfolios. However, for investors willing and able to accept at least some degree of illiquidity, private credit offers returns that have been 3% to 4% higher (when adjusted for fees). That should be more than sufficient to compensate investors who don’t need liquidity for their entire portfolio (which is almost all investors).
Over the past three decades, regulatory reform and industry consolidation have driven banks to curtail corporate lending activity. To fill the gap, “private direct lending” has emerged, with independent asset managers funded by capital from institutional investors, replacing banks as providers of secured first-lien commercial loans. By 2024, the private credit market had grown to more than $2 trillion globally, with about three-quarters of that in the United States, where its market share is nearing that of syndicated loans and high-yield bonds. (See the chart on the following page.) Note that while the private market has grown rapidly, it still represents a small fraction of the total corporate debt market of about $14 trillion.
As the chart shows, the market has grown rapidly, and the speed, flexibility and certainty of execution that direct lenders provide have proved valuable to borrowers and their private equity sponsors. Though private credit is illiquid, institutional investors such as pension funds and insurance companies are attracted by the higher returns and reduced volatility. Individual investors should be too.
Public Versus Private Credit Performance
The table on the next page shows a performance comparison between the Cliffwater Direct Lending Index, as well as the version of the index that’s net of fees, next to the public credit benchmarks. The net-of-fees index was created to provide one-half of an apples-to-apples private-public credit comparison. It’s different from the regular Cliffwater direct index in that the management and administrative fees are deducted from returns (according to quarterly business development company disclosures). The resulting quarterly return series in the net-of-fees version parallels the after-fee, unlevered returns reported by public bank loan funds, exchange-traded funds, and separate accounts, though not the index of Morningstar LSTA, where returns are formulaic and without fees and transaction costs. (“LSTA” stands for the Loan Syndications and Trading Association.)
As you can see, investors are picking up almost 4% in added net-of-fee return from private credit (7.23% minus 3.31%) despite paying an additional 1% or more in higher expenses. The cost of unlevered private credit (the difference between the Cliffwater index and its net-of-fees index return) has been about 2% per year while the cost of public credit (measured by the difference between the Morningstar LSTA U.S. Leveraged Loan 100 Index return and the return of a fund that tracks it—the Invesco Senior Loan ETF (whose ticker is “BKLN”)—has been about 1% per year. Note also that the volatility of private credit has been lower.
When comparing returns against the Cliffwater Direct Lending Index, we will take a look at my choice for investing in private credit, the Cliffwater Corporate Lending Fund (whose ticker is “CCLFX.”) This interval fund offers daily pricing and quarterly liquidity at a minimum of 5% per quarter. One of the reasons I chose this fund is its broad diversification: It has almost $22 billion in assets across 12 industries and includes more than 20 private lenders with more than 3,700 underlying credits. Its average loan size is only about $5 million, a small fraction of the total underlying loans.
The fund also enjoys good credit quality (its investments are almost exclusively in senior secured loans to companies backed by private equity sponsors; about 95% have first-lien exposure). The fund further sports an attractive cost; its management fee with other expenses (excluding the interest on borrowed funds) is 1.58% (with no incentive fee). The average for this category was 4.12% (according to the 2024 edition of Cliffwater’s annual fee survey of 66 of the largest middle-market direct lenders, those managing $1.1 trillion in direct lending assets). The 4.12% figure includes the average of the total fees and administrative expenses for the private debt funds.
In addition, the Cliffwater fund’s fee is charged only on net, not gross, assets. Considering the leverage, the effective fee on gross assets is about 1.25%. From its inception in June 2019 through August 2024, the fund returned 9.58%, outperforming the Morningstar LSTA U.S. Leveraged Loan Index’s return of 5.58%. For most investors that is a more than sufficient premium for accepting some degree of illiquidity. The fund also outperformed Treasury bills by 7.3 percentage points over the same period. That is about the same premium as equities have historically provided (though with only a small fraction of their volatility).
Cliffwater lists the largest funds in this space as the Blackstone Private Credit fund (BCRED); the Blue Owl Credit Income fund (OCIC); the HPS Corporate Lending fund (HLEND); and the Apollo Debt Solutions fund (ACRED).
Given the credit risk involved, investors looking through private credit interval funds should perform strong due diligence on each manager’s historical credit record to ensure that the focus is on quality and not achieving the highest returns.
The Price Of Everything
Given the choice of private and public credit, the data strongly suggest that investors should assign most, if not all, their credit allocation to private solutions. My own credit exposure is all private and includes the Cliffwater Enhanced Lending Fund (CELFX). From inception in July 2021 through August 2024, this fund returned 13.17%, outperforming the 6.25% return of the Morningstar LSTA U.S. Leveraged Loan Index by 6.92 percentage points, while outperforming the 3.25% return of Treasury bills by 9.92 percentage points.
It is my experience that more investors don’t allocate to this space because they’re focused on the expense ratios and want to buy something cheaper. But keep in mind the old expression about knowing the price of everything and the value of nothing. That could well apply to focusing on an expense ratio instead of the value you get for your investment.
Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future: The Keys to Successful Investing.