Private credit professionals had these advantages over bankers. They're disappearing
Private credit was the sexiest place to be in finance in 2022, in 2023, and 2024. But it’s 2025 now, and the world is changing. Are private credit’s people elite enough to withstand this new world?
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That depends. “An open question is to what extent private credit funds are better at originating, screening and monitoring loans,” says a recent research paper, published by the Bank of International Settlements and authored by a team led by senior economist Fernando Avalos.
The paper suggests that private credit professionals had a historic advantage over bankers because they focused on a few sectors: "Their specialisation in narrow market segments could provide informational advantages," suggests Avalos.
Avalos says that these specialisation-derived advantages were compounded by a lower cost of equity in the past. Unfortunately, both these advantages are now being eroded.
The charts below, taken from the report, show the extent to which private credit funds are specialised. Private credit started out with a focus on three key sectors: manufacturing, TMT, and industrials product sectors. These represented ~63% of its deals in 2010. In 2023, that was down to ~42% of deals.
Avalos' report also refers to Herfindahl-Hirschman indices (HHI), a measure used in portfolio management to determine how concentrated a portfolio is in a single sector. For US-based private credit funds, this went from approximately in 0.9 in 2000 to approximately 0.66 in 0.25.
Diversification is only likely to increase. As private credit funds pursue retail investors' assets, Avalos says it's inevitable. Private credit returns may fall as a result.
Avalos' report also says that private credit funds derived historic advantages from their lower cost of equity (CoE). Business Development Companies (BDCs), which are exchange-listed vehicles through which investors can put money into private credit firms, have had lower CoE than banks, but higher costs of debt; these differences are converging. Basically, it's becoming less financially advantageous to invest in private credit through a BDC.
Costs of equity and debt for BDCs and banks, and the convergence of cost of capital
The concern is that returns offered by private credit funds are not sustainable in the long term. “Private credit, being a fairly young asset class, has not yet gone through a full credit cycle,” Avalos et al say. “It remains to be seen whether the expected returns of private credit are commensurate with the risk-taking involved or whether lending standards deteriorate in the face of continued credit expansion.”
It doesn't help that the gains of private credit aren’t freakishly good anyway. A separate research paper written last year by Isil Erel and others for the US national bureau of economic research suggested that “the risk-adjusted abnormal return on $1 of capital invested in private credit funds is indistinguishable from zero.”
The implication is that private credit professionals might struggle to outperform lending bankers in the future. They had the upper hand, but it's being dragged lower and lower.
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