What is private credit and what role can it play in portfolios?

Transcript

You know, private credit can be a deal just done by two people, if you come to me and ask me for a loan, that's private credit. If you come to me and ask me to advance you money, that's private credit. If I go buy a house and I take out a mortgage and it's too big for Fannie Mae or Freddie Mac to insure, that's a private credit instrument. That loan also, a distressed investment, to a failing company can be a private credit investment. So it really does span things that are risky and things that aren't risky. And hopefully the return you get accounts for that risk.

It really can just be a private negotiated transaction. And so smaller companies can issue debt, can have access to the debt markets without having to pay the large underwriting fees at a Morgan Stanley with charge. But to the deal that they can offer wouldn't be big enough for a large global bank to care about underwriting it. And so it allows more liquidity in the economy. It allows people to allows companies to optimize their capital structure, and it allows people who otherwise wouldn't have the ability to get loans to be able to get loans when they need it and potentially, plug short term liquidity gaps for them.

My favorite example of this is there's a company in New York that raised venture capital to build a robot to tie rebar for commercial construction. They didn't think they'd need an asset based loan, but when they went and met their first client that was a large municipality, they realized that they were going to have to have all this rebar in inventory. So they went to a supplier finance bank, thought they'd be able to get a loan. And the supplier finance bank was turned off by the kind of innovation that they were providing. So not only is this a group of construction workers tying rebar, it's a robot tying rebar. And I think that that was very scary to the bank until they knew that it would work. So we proposed giving them a loan against the rebar, not against the robot. And rebar is based off steel prices. And we were comfortable that at the loan-to-value of the steel that we were that we were lending at, that we would be able to - God forbid the company changed their what they were doing, went out of business, any of those things - we would be able to just sell the rebar.

You know, if you're a bank and you have all this capital, you can always guarantee transactions. But a lot of these new real estate, tech enabled real estate companies, tech enabled financial services companies sometimes have to be able to guarantee a product to their customer. And without the capital to do that, they're a little bit flying blind, maybe offering things that they're praying they'll be able to deliver but might not be able to. And so we can offer a guarantee product where as long as we know how they're underwriting, as long as we know how they are going to evaluate the offer they're giving to a customer, we can pre underwrite that as long as you stick to your underwriting guidelines, we can help you. Providing that guarantee product allows them to confidently be able to run their business. You know, the first one of these was created for a real estate company that was trying to buy classy buildings in classy cities. And individual investors don't normally have access to that type of real estate. Well, they wanted to syndicated to individual investors, but they couldn't contact the individual investors until they had the building under contract. And so because of that, they really wanted a solution. How do you get the building under contract if you can't contact the investors?And then how do you tell the seller of the building you're going to have the money if you can't contact? It's a very chicken and egg problem. And there are now creative solutions for that.

We underwrite loans to a mid-teens yield. And you could have a situation where that mid-teens becomes a 50 percent yield if one or two of those warrants, you know, kind of become a multibillion-dollar company. I have, I would say, at least 40 percent of my personal money in private credit and some of it lower risk, some of it medium risk, and some high risk. I mean, the opportunity cost is very severe, right, so rates are very low. The government borrows at around one percent for, I think, ten years. That's really low. You can't meet inflation. And so when the government bond curve is so far below the expected inflation, you're actually eroding your wealth every year. And that's a very scary thing over a 30 or 50-year time horizon. I would never be able to keep up with inflation, keep up the way you live if you, especially for retirees, if you own one percent debt, corporate bonds obviously yield a little more than that. They could yield two percent, three percent, four percent. But again, once you pay your taxes, you're really not beating inflation either. And so finding a constant stream of income that has downside protection and upside convexity I think is really important.