It is no secret that the COVID-19 pandemic has plunged the world into economic turmoil. Companies of all size and configurations are struggling with profitability, forcing many to seek alternative strategies for driving business growth. One such strategy is that of private credit funds, a potential solution that offers investors certain advantages in a low-return market. Private credit encompasses a broad range of mechanisms; in this guide, we will explore what private credit funds are and how the pandemic has affected the performance and feasibility of this funding option.
What is Private Credit Funding?
In simple terms, private credit funds are funds comprised of the physical or financial assets held within high-yielding private companies’ fund partnerships. Credit of these funds are typically repaid in one of two ways: corporate, where repayment comes from the operating company’s cash flows, or asset, where repayment comes from the cash flows associated with a physical or financial asset.
Capital Preservation vs. Return Maximization
In private credit funds, strategies can be divided into two major categories:
Capital preservation – this strategy is designed to protect against losses while providing a predictable level of return on investment. This is the more risk-averse of strategies; portfolios tend to be negatively oriented, with few losses or unexpected gains in performance. They typically employ mezzanine or senior debt funds.
Return maximization – the opposite of preservation, this strategy is aimed at producing the maximum possible return on investment, and often include potentially risky assets like distressed corporate credit funds or capital appreciation funds. Positively skewed, these portfolios offer greater returns, but at much higher potential losses.
There are other categories within private credit funds, particularly in opportunistic or specialty financing, but these are typically evaluated for risk and return by investors and may depend on the availability of suitable market opportunities.
The Effects of COVID-19 on Private Credit Funds
Private credit fund investments gained popularity during the economic boom, and were sold as a lower risk option than equity-based funding strategies. Now that COVID-19 has negatively affected world economies, these selling points may now be in question.
Companies are now facing challenges with asset liquidity. This has caused a significant drop in credit fund portfolio returns over the long term. Despite drops in returns, certain near-term investment opportunities for private credit exist, and investors are taking advantage of these emerging market opportunities. Prior to the pandemic, private credit funds were seen as an advantageous defensive strategy, with many such funds set up for minimizing losses while producing predictable returns. Market dislocations continue to influence returns, but there is hope: credit managers have raised substantial funds with capital for spending on stressed and distressed companies struggling in the economic downturn. In fact, several larger private credit funds have closed with assets in excess of $1.5 billion. The future of private credit funding investment is unclear post-pandemic, but financial analysts suggest this funding strategy will regain its key advantages as the markets recover.
