Market Views

Private Credit Investing in Rising Rate Environments

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 early 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 Public Fixed Income
(2021-2022 Q1)1

Figure 2: Returns When 10-Year US Treasury Increases by 0.75%+
(2011-2021)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.

  1. Source: Morningstar, Federal Reserve, as of 3/31/2022. Nominal Return is calculated by Morningstar by using trailing yearly/quarterly returns. Real Return is
    calculated by subtracting inflation from the Nominal Return. Inflation is represented by the Consumer Price Index for All Urban Consumers: All Items in US
    City Average. Public Fixed Income is represented by the Bloomberg US Aggregate Bond Index.
  2. Source: Morningstar, Federal Reserve, as of 12/31/2021. Periods shown are of rising rate periods over the past ten years, starting in 2011.

What has made private credit more resilient in rising rate environments and therefore, we believe, an attractive consideration for investors today?

Floating Rate Loans. As we enter a new interest rate cycle characterized by higher 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 are highly attractive, as income can rise alongside interest rate increases. Private credit tends to be floating rate, which may limit both the rate risk and the duration risk that are inherent in traditional fixed income today.

Privately Negotiated Deals. Private credit transactions are bilateral in nature and are negotiated directly between the lender and the borrower, which is typically backed by a private equity sponsor. With private credit, investors can access a wide funnel of private transactions. Managers aim to invest in the best ones. Private credit managers generally aim to negotiate better protections, including a senior secured structure, covenant terms, call protection, each of which can make these credits more defensive.

Less Volatility. Less volatility is expected in private assets because these assets are not traded in public markets. Valuations are generally based on the fundamentals of the underlying companies. Managers generally are not forced to mark private assets to market during periods of volatility. Private loans have offered relatively low historical volatility, while still maintaining attractive returns, when compared with the public market.3

Credit quality improves with the economic recovery. Credit quality and fundamentals of issuers generally improve with economic recoveries, and today the performance of the US economy continues to be resilient in spite of inflation and related headwinds. In any economic environment, we think it is critical for investors to select private credit managers who carry out extensive due diligence, oversight of credit quality, and focus on downside protection.

Access Private Credit Investing in Rising Rate Environments

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.

  1. Source: Morningstar, Federal Reserve, as of 3/31/2022. Nominal Return is calculated by Morningstar by using trailing yearly/quarterly returns. Real Return is calculated by subtracting inflation from the Nominal Return. Inflation is represented by the Consumer Price Index for All Urban Consumers: All Items in US City Average. Public Fixed Income is represented by the Bloomberg US Aggregate Bond Index.
  2. Source: Morningstar, Federal Reserve, as of 12/31/2021. Periods shown are of rising rate periods over the past ten years, starting in 2011.
  3. Morningstar, over a 15-year period ending December 31, 2021. Volatility is measured using standard deviation. Morningstar computes standard deviation using the trailing quarterly total returns for the appropriate time period. All of the quarterly standard deviations are then annualized.

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