The booming $1.7tn (£1.3tn) private credit industry prides itself on offering higher returns to investors than public markets, but a bold new academic study has challenged that assertion.
Three academics have written a paper, released by the National Bureau of Economic Research, which claims that private credit funds barely offer any additional returns to investors, after accounting for additional risks and fees.
The professors analysed the risk-adjusted returns of private debt funds originated between 1992 and 2015, using the Burgiss-MSCI database. Their estimates suggest that the risk-adjusted return on $1 of capital invested in private credit funds is “indistinguishable from zero”.
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The paper notes that private debt funds charge substantial fees, usually a 1.5 per cent annual management fee and 15 per cent carried interest.
Since other non-bank lenders have much lower fees, private debt funds must lend at much higher rates and therefore they fund lower-quality borrowers who do not have other sources of capital.
“Our estimates indicate that once we adjust for fees and risks, private debt funds provide their investors with returns just appropriate for the risks they face, but not more,” the paper said.
Read more: Direct lending returns will “more than offset” higher defaults this year
However, it noted that private debt funds do in fact generate alpha, before it is eaten up by fees paid to managers.
“Overall, the results in our paper are consistent with the view that private debt funds charge rates to their borrowers that reflect their fees and also the risks involved in lending to these small and mid-sized, riskier firms,” the paper said.
“The return that borrowers pay in excess of the risk-adjusted interest rate approximately equals the fees that the private debt funds charge.
“Rents earned by the funds from making private direct loans accrue to the general partners, not the limited partners. These rents appear to reflect compensation for identifying, negotiating, and monitoring private loans to firms that could not otherwise raise financing.”
Despite the academics’ research, investors are maintaining confidence in the asset class.
A recent survey from Goldman Sachs Asset Management found that insurers expect private credit to be one of the asset classes that delivers the highest returns over the next 12 months, beating private equity for the first time.
