Barings’ Jon Bock discusses the biggest mistakes investors make when allocating to private credit—and shares his views on why last cycle’s playbook won’t work this time around.
It’s human nature to overweight proximity. Think about your to-do list today. How many tasks center on reaction to current news, new perspectives, or whatever you’ve seen on your LinkedIn or Instagram feed? If you’re intellectually honest, the answer is probably a lot. Be it life or investing, it’s important to understand how proximity to the information of the day influences our attitudes—and ultimately—our decisions.
The same is true when it comes to investing in private credit, an industry where credit asset managers (non-banks) provide loans to corporate borrowers with the goal of delivering attractive rates of return to clients. This industry takes on many different names: direct lending, non-bank lending, private credit, middle market lending and sponsored lending among the most common.
Like the proximity point mentioned above, the torrential news cycle in private credit remains almost as volatile as the revenues of the news industry itself, and investors, if not careful, can quickly get caught in a routine of reacting rather than investing. On one extreme, there is a view that this asset class is akin to James Milton’s Shangri-La—offering utopian risk-adjusted returns from lending to middle market borrowers who can smartly handle their debt. Such a view, unsurprisingly, leads to new capital being raised by managers happy to grow assets under management (AUM). The other extreme, of course, is dystopia—the view that substantial industry competition will lead to an eventual loosening of terms and a flood of future losses. This view, also unsurprisingly, tends to be widely reported in the investment press because—let’s face it—fear sells.
Whether your view falls at one extreme or somewhere in the middle, it’s hard to ignore the drama captured in headlines like: “High Yield was Oxy. Private Credit is Fentanyl” or “There is No End in Sight for the Private Credit Boom.” Imagine the influence on private credit investor decision-making when considering those titles.
Aside from the inherent hyperbole, one big concern with these headlines is that they tend to focus on the “fruit” issues rather than the “root” issues. Akin to treating symptoms as opposed to the actual sickness, too much time spent on the issues of the present day (the fruit) diverts investors’ focus away from the issues that drive market movements (the root).
This article, with (admittedly) a bit of dramatic flair, focuses on the root. It does so through a discussion of common investor mistakes—made by top institutional investors down to the smallest RIA. These mistakes are thematic, and our perspectives here are designed to offend both extreme views on private credit.
Mistake #1: Past Is Prologue
Ask any large institutional investor, and they will likely tell you that the primary reason they invest in private credit is their expectation that the asset class will offer attractive risk-adjusted returns in the future—like it’s done in the past.