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Private credit can be a defensive asset class for investors’ portfolios, offering stability when uncertainty is increasing in the markets and the economy, according to James Reynolds, co-head of private credit for Goldman Sachs Asset Management.
The regular cash distributions that flow to investors can help to make private credit funds attractive when other assets may appear more vulnerable, Reynolds says on a Goldman Sachs Exchanges podcast. Investors “see private credit as being a good hedge against potential inflation as well, given that most of what we do when we lend to a borrower is exposed to a floating rate.”
Private credit loan portfolios tend to be relatively defensive, Reynolds adds. Lenders in the private markets are less likely to make loans to cyclical companies that are often more heavily impacted during volatile periods. There is less exposure to commodities in private credit than there is in the public high yield market, for example. And while private credit mostly lends to smaller, middle-market companies, they aren’t lower quality.
A lot of private credit investing is focused on market leaders with pricing power and strong cash flows, Reynolds says. At Goldman Sachs, this includes software services, certain parts of the healthcare industry, and other businesses that may be more insulated against a downturn. Reynolds points out that Goldman Sachs has had a private credit business since 1996 and the business has navigated multiple market cycles during that time.
While private credit is a relatively young market, it has grown quickly in the past decade and a half and now has about $2.1 trillion in assets under management. Its attraction as a place to invest during periods of volatility in public markets can be seen in the continued strong interest that pension funds, insurance companies, and sovereign wealth funds are showing in the asset class today, Reynolds says.
Private credit amid rising market stress
To be sure, the biggest part of the private credit market, direct lending, is a form of leveraged finance, and losses and defaults can be expected to rise when the economy faces strain or the prospect of a recession. Still, direct lending may have certain advantages when losses rise. There’s more flexibility in private credit relationships, and reduced friction, which can help to reduce costs in bankruptcy situations or facilitate coordination among creditors in a loan workout.
Reynolds points out that most private credit is senior lending, often characterized by more cautious underwriting. Senior direct lending sits at the top of the capital structure, meaning those creditors are the first to be repaid in a default, making it less vulnerable in periods of greater economic stress.
Aside from the positives for investors, private credit can also offer advantages for borrowers, as well as lenders, when markets are fluctuating. Perhaps a private equity owner needs to borrow to make a smaller acquisition but finds that market volatility has caused banks to make fewer loans. A private credit lender may be in a better position to get the deal done. “That certainty is going to be even more critical,” Reynolds says.
Generally, when banks are concerned about uncertainty or volatility and become more hesitant, it creates opportunities for private credit. This became apparent during the regional bank stress in 2023, which resulted in dislocation in the syndicated loan market. That pushed some borrowers toward private credit, which was able to fill a gap and help prevent a credit crunch. If rising trade tensions and other economic shifts restrain the syndicated loan market, that may turn out to be good for private credit.
Flexible, creative lending solutions involving junior debt can also be important as markets get more challenging, Reynolds says. Private credit lenders may be able to provide capital to good companies that perhaps need more runway because an initial public offering or other exit has been delayed. “We\’re starting to see an increasing number of situations around the world where our capital can be very helpful to these borrowers,” Reynolds says.
The pace of private credit investment
The pace of private credit investment picked up last year. Goldman Sachs Asset Management has $130 billion in private credit assets under management, spread among more than 600 positions, making it one of the world’s largest private credit managers. The global private credit platform invested more than two times what it did in 2023, according to Reynolds. This activity was helped by an increase in certain types of M&A activity, including larger companies borrowing to make smaller bolt-on acquisitions. The strong pace of investment continued through the first quarter, Reynolds says.