Over the past three decades, regulatory reform and industry consolidation have driven banks away from corporate lending activity. To fill the gap, “private direct lending” 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, about three-quarters (see chart below) of which was in the United States, where its market share is nearing that of syndicated loans and high-yield bonds. 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—and so should individual investors.
Performance Of Public Versus Private Credit
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 CDLI and CDLI-U-NOF return, has been about 2% per year while the cost of public credit, the difference between the Morningstar LSTA US Leveraged Loan 100 Index return and BKLN return, has been about 1% per year. Note also that the volatility of private credit has been lower.
To examine the returns to live investments, versus the CDLI Index, we will take a look at my choice for investing in private credit, Cliffwater’s fund (CCLFX). The fund is an interval fund which provides daily pricing, and quarterly liquidity of a minimum of 5% per quarter. The reasons for the choice include the broad diversification of the fund (with almost $22 billion in assets, it is highly diversified across 12 industries and more than 20 private lenders, with more than 3,700 underlying credits, with an average loan size of only about $5 million, representing a small fraction of the underlying loan size), credit quality (the fund’s investments are almost exclusively in senior secured loans to companies backed by private equity sponsors, with about 95% first lien exposure), and the management fee and other expenses (excluding interest on borrowed funds) is 1.58% (with no incentive fee)—in the 2024 edition of its annual fee survey of 66 of the largest middle market direct lenders, managing $1.1 trillion in direct lending assets, Cliffwater found that the average total fees and administrative expenses for private debt funds was 4.12%.
In addition, CCLFX’s fee is charged only on net, not gross, assets. Considering the leverage the effective fee on gross assets is about 1.25%). From inception in June 2019 through August 2024 the fund outperformed the Morningstar LSTA US Leveraged Loan Index return of 5.58% by 4%, returning 9.58%. 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% over the period. That is about the same premium as equities have historically provided though with a small fraction of their volatility.
Investors can find a complete list of interval funds that invest in private credit here. The table below shows the largest funds, including their structure, returns, AUM, and expense ratios.
Given the credit risk involved when deciding on a fund investors should perform strong due diligence on the manager’s historical credit record to ensure that the focus is on quality and not achieving the highest returns.
Summary
It is my experience that more investors don’t allocate to private credit because of their singular focus on expense ratios, buying what is cheaper. With that in mind there is an old expression that there are millions of people who know the price of everything and the value of nothing. This applies to investors who only focus on a fund’s expense ratio, rather than considering the value added relative to the expense ratio.
Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future: The Keys to Successful Investing.
The table below documents the performance comparison between the Cliffwater Unlevered, Net-of Fee Direct Lending Index (CDLI-U-NOF) and public credit benchmarks. The CDLI-U-NOF was created to provide one-half of an apples-to-apples private-public credit comparison. Private loan performance is pulled from the CDLI series, which is unlevered and gross of fees. CDLI-U NOF is different from CDLI in that management and administrative fees are deducted from CDLI returns based upon quarterly BDC disclosures. The resulting quarterly return series parallels the after-fee, unlevered returns reported by public bank loan funds, ETFs, and separate accounts, though not the Morningstar LSTA indices where returns are formulaic and without fees and transaction costs.
Given the choice of private and public credit, the data strongly points to investors allocating most, if not all their credit allocation to private solutions. Personally, all of my credit exposure is private and includes Cliffwater’s CELFX). From inception in July 2021 through August 2024, the fund returned 13.17%, outperforming the 6.25% return of the Morningstar LSTA US Leveraged Loan Index by 6.92 percentage points, and the return of 3.25% of Treasury bills by 9.92 percentage points.