Holistic Approaches to Risk in Private Markets: Navigating the Future of Private Credit

During discussions at Interact New York 2024, including sessions on “Holistically Thinking About Risk in Private Markets” and “Navigating the Future of Private Credit,” panelists from various investment firms — spanning private credit, private equity and venture capital —acknowledged the rebound in the public debt market. However, they emphasized that the private credit market remains better positioned to address unique investment challenges, offering tailored solutions that remain unmatched in the public market.

The Strength of Private Credit Markets

Private credit, according to panelists, can be superior when it comes to scaling investments. While the public debt market has rebounded, private credit offers flexibility and agility that banks and traditional financial institutions struggle to provide. Although banks have curtailed their lending exposure to mitigate risks, they still play an essential role in supporting the private credit market. Private credit firms provide an array of solutions in addition to direct lending, the most commonly known type of private credit. In fact, private credit firms routinely collaborate with banks rather than compete with them, helping to diversify risk and provide innovative solutions to support the evolving financing ecosystem.

The reach of private credit continues to grow and expand into new asset classes and areas beyond traditional direct lending, as panelists noted, keeping the sector active and robust. Private credit’s flexibility allows it to serve niche investment opportunities of all sizes, where lenders underwrite the risk directly—unlike the public markets, which caters to larger transactions that are underwritten and syndicated by separate, distinct parties.
 

The Evolving Investment Landscape: Public vs. Private

During the second day of the conference, a session titled “Blurring the Lines Between Public & Private Markets” delved deeper into the strategic decisions investors must make when choosing between public and private investment options. Panelists discussed the nuances of each market and highlighted the evolving trends shaping investor choices.

One significant issue raised was the compression of spreads in private markets. As the margins on private credit deals have tightened, some investors have shifted their focus back to public markets, where transactions are generally more borrower-friendly with fewer financial and maintenance covenants making them easier to manage, and they are by nature more liquid. Public debt markets, with their greater transparency, regulatory oversight and the backing of entities like the Pension Benefit Guaranty Corporation, offer unique advantages. The stabilization of interest rates has further contributed to the growth of the public markets, consistently attracting pension funds and other large institutional investors.

However, the private credit market is not without its challenges. Panelists highlighted the increasing selectivity among private credit deal sponsors. In some cases, investors may opt for less favorable deals simply to ensure the backing of a more reputable sponsor. Moreover, private credit transactions have become more difficult to exit due to the longer duration of sponsor portfolios. Nevertheless, many investment firms have successfully acquired companies through private credit channels, noting the option of refinance later through the public market — a flexibility that continues to drive the appeal of private credit.

The Symbiotic Relationship: Convergence of Public and Private Markets

A recurring theme throughout the conference was the potential for coexistence and convergence between public and private markets. Panelists explored the idea of a “symbiotic relationship” between the two, noting that the optionality to obtain financing in either the public or private markets is available for larger, upper middle market, investment-grade borrowers. This fluidity is driven by the lower cost of capital in the public markets, as well as the relatively low associated transaction fees.  

The growing integration of public and private markets has also led to greater deal-making opportunities. Such flexibility provides investors with optionality and more opportunities to optimize their portfolios. As one panelist pointed out, having access to a broader range of financing options only enhances deal-making opportunities. However, despite the uptick in private credit deals in 2024, some panelists noted that the volume of transactions has still fallen short of expectations—due in some part to the broader themes of relatively expensive financing, reduced M&A activity, and high valuations.

Regulatory Changes and Challenges Ahead

Looking ahead, private credit faces regulatory headwinds that could reshape the landscape. Beginning December 31, 2024, changes to U.S. federal regulatory reporting requirements, set forth by the Federal Reserve Board, U.S. Treasury, and FDIC, are expected to impact private credit asset management. These changes will likely complicate the market environment and could introduce new risks and operational challenges for private credit firms.

Opportunities in 2025: Capitalizing on Credit

Despite these challenges, interest in credit as an asset class remains high. As one panelist noted, the imbalance between demand and supply for credit presents significant opportunities for investors. Another panelist said the future of private markets depends on answering the question of whether these markets can be more risk-efficient, whether managers and investors can increase efficiency, and if their structures can provide better outcomes. Firms that are able to remain flexible and transact across direct-lending, sponsor-backed strategies, and other middle market investments will likely capitalize on this demand. As we move into 2025, firms are expected to spend more time scrutinizing potential transactions, ensuring they align with long-term portfolio goals and generating target returns for investors.