{"id":1049,"date":"2023-11-08T14:38:00","date_gmt":"2023-11-08T18:38:00","guid":{"rendered":"https:\/\/www.bellvest.ca\/family-wealth-peterborough\/resources\/portfolio-diversification-private-credit\/"},"modified":"2025-06-25T10:44:41","modified_gmt":"2025-06-25T14:44:41","slug":"portfolio-diversification-private-credit","status":"publish","type":"resources","link":"https:\/\/www.bellvest.ca\/family-wealth-peterborough\/resources\/portfolio-diversification-private-credit\/","title":{"rendered":"Portfolio Diversification: The Case for Private Credit"},"content":{"rendered":"

\u201cBanks were once places to hold money and were very careful in lending to finance families as they built a future.\u201d \u2014 \u00a0Elizabeth Warren<\/em><\/p><\/blockquote>\n

Before her political career, Warren was an influential professor in commercial and bankruptcy law and is well versed in banking practices and economics, even calling for tougher bank regulation before the Great Recession of 2008\u20132009. In her famous toaster analogy<\/em>, she noted that the government wouldn\u2019t allow a consumer to buy appliances they deemed unsafe. An alternative way of saying \u201cfinancial products should be treated similarly.\u201d<\/p>\n

While banks are<\/em> tightening lending practices, making it more expensive for households and businesses to get a loan, this is presumably to protect themselves in the event of a recession.<\/p>\n

But credit is a valuable part of the economy, and certain investors are seeing a need to fill the void left behind. Enter private lending\u2014also known as direct lending made through negotiations with a non-bank lender, an alternative investment class that can significantly benefit your portfolio.<\/p>\n

Why are banks tightening lending standards?<\/h3>\n

According to a Federal Reserve Senior Loan Officer Opinion Survey, 51.8% of banks said they had tightened loan standards for large- and medium-sized businesses over the second quarter<\/a> of 2023. The following October issue<\/a> reports that 35.6% continued to tighten while 62.7% have remained relatively unchanged<\/em>. Throughout 2024, three additional surveys<\/a> have been released, and the vast majority have stayed put, with a few going so far as to be even more discerning when offering loans.<\/p>\n

Although recent promising inflation data, interest rate reductions, and more positive news have come forward, banks seem to be more hesitant than the broader market sentiment.<\/p>\n

Respondents largely cited economic uncertainty, deterioration in bank liquidity, weakened collateral values, reduced risk tolerance, deposit outflows, flagging credit quality, and legislative changes. All in all, concerned banking institutions are positioning themselves defensively as pressures increase and demand tapers off. Unpaid loans aren’t exactly known to generate profit.<\/p>\n

Why is credit important for the economy?<\/span><\/h3>\n

For the everyday consumer, loans act as a leg-up to improve their quality of life (within reason), be it through a student loan, picking out a new car for a growing family, or purchasing a home. Whether it be expanding operations and hiring skilled workers, securing more cost-efficient equipment, or acquiring other companies, businesses use credit in a similar capacity.<\/span><\/p>\n

Whatever the case may be, loans typically serve the liquidity demands of today under the assumption that they\u2019ll lead to a net-positive outcome to offset the interest payments they come with.<\/span><\/p>\n

It\u2019s important to remember that credit is ultimately a tool and should be used appropriately\u2014a hammer is best suited for a nail, not a screw. After the global financial crisis, central banks aggressively cut interest rates to zero or near zero; if inflation is above the interest rate on the loan (known as negative interest rates), it incentivizes borrowers to spend or invest instead of saving, as money left in a savings account erodes purchasing power. <\/span>In a nutshell, regulatory bodies may implement negative rates during deflationary periods where cash hoarding hurts overall aggregated demand.<\/span><\/p>\n

When years of negative interest rates are capped by a global pandemic, countrywide lockdowns, increased government support for consumers, weakened supply chains, and pent-up demand without a release valve, you have the recipe for 2023’s economic environment.<\/span><\/p>\n

Once restrictions were lifted and households were flush with elevated savings, central banks were faced with the difficult task of curbing demand. This wasn\u2019t exactly easy, and after years of the softest monetary policy for quite some time, the pendulum swung back with one of the most aggressive interest rate hike cycles in history. Public markets, like households and businesses, have struggled with these rapid changes.<\/span><\/p>\n

How can private lending fill the credit void?<\/span><\/h3>\n

A key word above is public<\/em> markets. As private<\/em> investment opportunities are typically reserved for institutional investors, alternative securities tend to be more insulated from investor sentiment and exhibit greater price stability during periods of heightened volatility. With the public removed from the equation, alternatives usually have a lower correlation to traditional investments and are used as an effective way to diversify portfolios.<\/span><\/p>\n

There are several variations of alternative investments, and while we have exposure to several, the focus today is on private lending strategies. Jonathan Gray, president of Blackstone, has gone so far as to declare that this is a \u201cgolden moment\u201d for the fast-growing industry earlier this year.<\/span><\/p>\n

But how is it positioned to excel? With the rare combination of a high-interest rate environment baring down on borrowers alongside traditional lenders pulling back, private lenders can take advantage of these opportunistic market conditions:<\/span><\/p>\n