On Tuesday July 22nd, I spoke at Opal Group’s Public Funds Summit 2025 on “Private Credit,
Debt, and Direct Lending: A Developed Asset Class For Pension Funds” alongside Reid
Bernstein [Amerin Partners], Mike Fang [Maryland State Retirement and Pension System],
and Molly Whitehouse [Newmarket Capital], moderated by Lindsay Powers [NEPC]. A big
thank you to Opal Group for bringing this very talented panel of private credit experts
together, to speak to the many public pension plan officials attending this Summit.
Assessing credit strategies has always been one of my favorite professional endeavors, and
the variety of private credit strategies now available offers institutional investors many ways
to seek attractive returns. Like many of my peers, I have found some compelling private
credit strategies that I think are relatively insulated from most economic downturns. We
have analyzed many of these strategies for our clients, and they have helped my diligence
clients achieve excellent results.
Knowing what to look for is important for analyzing any alternative investment strategy, and
particularly so for private credit strategies. The laws of economics did not evaporate when
investors started making allocations to private credit: Investors would be misleading
themselves to target returns of 10% to 20% net-of-fees, expenses, and borrowing costs,
while overlooking vexing operational risks, illiquidity premia, credit and leverage exposures,
and structural considerations. Apparently smooth return streams in private credit also belie
its nascent volatility: Publicly traded BDC analogs of private credit strategies [like one of
my favorites, GBDC] often exhibit annualized volatility as high as equity market volatility,
albeit with much more mean reversion. Record-low spreads on high yield bonds are
encouraging institutional investors to allocate more into private credit, helping to compress
returns, so the return outlook presented by managers to investors today may not be what
they can achieve in the future, even if credit performance is strong.
One of the gravest oversights I have seen is investors not fully appreciating that many of the
protections present with other strategies are simply ineffective for private credit strategies.
I will highlight one key consideration: we cannot rely on auditors to assess valuations of
private credit holdings reliably, much less validate that the assets even exist. In many cases,
no clear comparables exist to help value debt of private borrowers, and auditors often rely
disproportionately on the honesty of the private credit manager to mark their holdings
appropriately. While auditors should take an additional step of assessing the
creditworthiness of a private credit fund’s underlying borrowers, this onerous step is often
missed or glossed over. The example of the $2 billion failure of Bridging Finance is
impressive not just for the brazen misuse of investor capital causing losses of about 65%,
but also for the apparent oversight of KPMG and E&Y as auditors to uncover this major
fraud over many years:
https://canadianbusiness.com/ideas/what-happened-to-bridging-finance-david-natashasharpe/.
We always encourage investment consultants and OCIOs to take a deep dive in private credit
fund diligence, and to allocate proportionately more resources to review these managers’
individual investments. Private credit managers should offer, subject to a reasonable NDA,
full access to review their investment memoranda, and means to validate the existence and
performance of their funds’ assets from original, independent sources—including by
conducting verification calls with some borrowers directly. Relying on audit reports is not
suicient, but using a sensible sampling approach to help validate asset valuations and
existence could be sufficient. If you encounter resistance, then I would advise you not to
pursue an investment with that manager. I’ve had many very successful diligence reviews of
very talented private credit managers, and I’ve also had a small number of opaque private
credit managers terminate my reviews of them because I insisted on reviewing sufficient
information, for which I am very proud.
When we evaluate investment consultants and OCIOs, we are particularly focused on
whether these advisers have committed sufficient talent and resources to evaluate the
private credit strategies they recommend to their clients. If your analysts recommend SRT
[structured risk transfer] strategies, we expect that they’ll have a firm understanding of
correlation trading models and that they at least review the SRT reference credit portfolios,
steps we often have seen investors skip. If you invest in trade credits, bridge loans, or
litigation financing, we want to know that you understand enough about those businesses to
ensure that the loan terms make sense for them, as well as validating the existence of these
assets.
While we are very pleased with the development of private credit markets, we do raise
concerns about the rapid growth in private credit allocations. Mistakes in making private
credit investments can be very unforgiving: a portfolio of ten private credit managers
earning 10% net of fees could easily see several years of alpha vaporized by one
meaningful blowout. We would like to see institutional investors take steps to avoid
unpleasant surprises. We would also like investors to develop more rigorous opinions of the
performance of the underlying borrowers and industries selected by their managers. U.S.
middle market companies have yet to recover to their pre-COVID performance. Higher
interest rates, slower private equity exits, weaker earnings and sales growth outside of the
technology sector are harbingers of future performance challenges for private equity
investments.
What do we like? We have helped our clients to source and invest in several interesting
private credit strategies. Right now, we see a few excellent private credit managers lending
to sponsor-backed companies focused on “growth equity” companies, mostly in technology.
We expect that they will earn 10% to 15% per year, with one turn of leverage, provided that
they continue to uphold their underwriting standards. We are concerned about
compromising of credit underwriting standards at the very large “asset gatherers” in
private credit; we avoid them. Conversely, we are interested in seeing upcoming private
credit fund launches by very large insurance companies, which have decades of experience
in this market.
We also like some private credit strategies focused on securitization markets in residential
and commercial real estate markets, but we strongly advise that any investors have
resources to understand securitization markets before approaching this sector. We see
returns there ranging from 10% net with very little leverage, to 15% tax-free for one very
unusual but highly leveraged strategy. On the more conservative end of the markets, we
have seen AA-equivalent consumer securitization strategy that earns well over 2% above
SOFR.
Sophisticated investors have been embracing private credit markets for many reasons. We
encourage all participants to maintain exceptional standards of diligence when examining
private credit strategies. Doing so will help ensure that your institution is getting what they
think they are getting, while also reinforcing good conduct in this important market.
Chris Cutler CFA
President
Manager Analysis Services, LLC
cutler@manageranalysis.com
August 4, 2025