Private Credit Investing in Rising Rate Environments
The increase in prices is pervasive and persistent across a range of sectors of the US economy — and investors now face upward pressure on interest rates that has spread globally. Private credit, which generally consists of floating rate loans, may be resilient in a rising rate environment.
Several upward pressures on interest rates
- Persistent supply-chain issues, pent-up consumer demand, and price swings related to the war in Ukraine have each injected inflationary pressure into a US economy already experiencing pandemic-era inflation.
- The Federal Reserve has clearly adopted a new, more hawkish posture in an effort to contain these trends.
- The 60/40 portfolio of equities and bonds turned in one of its worst starts to a year ever in 2022 — reflecting uncertainty associated with the war in Ukraine, commodity price shocks, more hawkish central banks around the world, and pressure on traditional fixed income that is unlikely to abate.
At this point, it may make sense to take a fresh look at assets with resilience in the face of rising rates and inflation, such as those with variable cash flows and/or floating-rate coupons.
Figure 1: Inflation-Adjusted Returns for Aggregate Bonds (2021-Q2 2022)1
Figure 2: Returns When 10-Year US Treasury Increases by 0.75%+ (2016-2022 YTD)2
Note: Past performance is not indicative of future results. The information herein is provided for educational purposes only and should not be construed as financial or investment advice, nor should any information in this document be relied on when making an investment decision. Opinions expressed reflect the current opinions of Blackstone as of the date hereof and are based on Blackstone’s opinions of the current market environment, which are subject to change.
- Source: Morningstar, as of 6/30/2022. Federal Reserve, as of 6/30/2022. Morningstar calculates nominal return using trailing yearly/quarterly returns Real Return is calculated by subtracting inflation from the Nominal Return. Inflation is represented by the US Bureau Labor of Statistics CPI All Urban Seasonally Adjusted Base Period 1982-1984 Index. Aggregate Bonds is represented by the Bloomberg US Aggregate Bond Index. City Average. Public Fixed Income is represented by the Bloomberg US Aggregate Bond Index.
- Source: Morningstar, as of 6/30/2022. Federal Reserve, as of 6/30/2022. Includes periods of rising rates over the past 5 years, beginning in 2016. Private Credit is represented by the Cliffwater Direct Lending Index.
What makes private credit an attractive consideration for investors in an inflationary and rising rate environment?
Floating Rate Loans may Benefit from Rising Rates. In a cycle of rising interest rates characterized by persistent inflation, fixed income investors may struggle to earn satisfactory yield on their long-duration investments. In a rising rate environment, we believe floating rate loans such as those in private credit are highly attractive, as income can increase with rising interest rates.
Privately Negotiated Terms and Structure. Private transactions are negotiated directly between the lender and the sponsor/borrower, with an extensive focus on due diligence and downside protection. Private lenders aim to negotiate stronger structural protections, including covenants and higher call premiums. Private credit deal flow remains robust as borrowers seek certainty of terms, flexibility in structuring, and a more efficient process than the public market.
Less Volatility, Duration, and Correlation. Private assets are valued based on the fundamentals of the underlying companies and are not subject to mark-to-market volatility. Floating rate loans are often benchmarked to 3-month reference rates and they are among the lowest-duration investments available to investors today. Less volatility and lower correlation are expected in private assets because these investments are not traded in public markets.
Scale and Sector Focus Matter. Blackstone’s scale and size allow the firm to commit to large-scale transactions in changing market environments. Blackstone seeks to offer protection from inflation by focusing on sectors the firm believes exhibit high growth trends and strong cash flow profiles, such as software and healthcare.
Access Private Credit Investing in Rising Rate Environments
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