Private credit has been “in the eye of the storm” recently, with investors making “big assumptions” about a potential “doom loop” that may never materialise, according to Schroder Strategic Bond fund manager Martin Coucke.
It is for this reason he is positive on the asset class, despite some US private credit companies bringing redemptions to a halt.
The rise of AI has fuelled a rise in private credit, which is highly exposed to tech and software companies, said Coucke.
“Ultimately, you decide if private credit is a risk depending on your view about the software sector,” he said. “If you think that this sector is going to default overnight, then yes, it's going to be a problem and you're going to see some losses.”
However, he doesn’t think the issue is systemic and that a default wave will ensue. While “some [companies] obviously will go under”, others will be able to “thrive with the help of AI”.
He views the asset class as part of the high-yield spectrum, noting there is no real distinction between public and private markets in this regard.
To gain exposure, he lends money to business development companies (BDCs), funds which provide private credit to unlisted companies. Here, “very short-dated credit” is offering “attractive spreads”.
These companies borrow from creditors and then lend that money at higher rates. For example, he noted that many are taking out debt at around a 200 basis-point spread and then lending at 600 basis points.
“Overall, when you lend to a private‑credit fund you have a pretty large buffer before you actually experience some losses and we are quite comfortable with that,” he said.
“My feeling is a lot of people don’t really know what they are actually talking about when they talk about private credit funds. Most of these funds tend to be relatively well‑diversified – they will hold hundreds of positions, different names, different sectors, and so on.”
At present, he added that these companies are “not overly levered”, meaning there is a lower risk than the market is appreciating. BDCs would need to see default rates of 20-40% before being impacted, which he described as “a bit extreme”.
“So when you're saying private credit is going under and you’re going to see a large amount of defaults, you’re making a big assumption that is not necessarily true,” he said.
“Growth looks pretty decent. We’re not seeing meaningful increases in defaults in public markets, which usually will correlate with what's happening in private credit markets. Something needs to give to actually see this private‑credit doom loop that most people are talking about.”
Part of the appeal of private credit is a lack of opportunities in the investment-grade space. The Schroder Strategic Bond fund is highly invested in the top end of the quality curve (AAA and AA) and in the high-yield space, but has limited exposure to the middle portion of the investment grade universe.
“BB and BBBs are relatively expensive. We would rather be in safe‑haven assets like agency MBS [mortgage-backed securities], treasuries or cash, rather than being invested there,” he said.
Coucke is also taking selective opportunities in the high-yield sector on areas such as debt with a B rating, where there are “some interesting stories with attractive yields”.
One area that could have potential in the investment grade area is European real estate, which has underperformed recently as interest rate expectations have risen.
Following the US/Iran war, energy prices rocketed as the Strait of Hormuz was effectively closed, pushing energy prices higher and creating inflationary pressures around the world.
This changed investors’ projections of interest rates, which were expected to keep falling this year as inflation weakened and growth stalled but are now anticipated to remain at their current levels (or even rise if the Strait remains closed for any extended period of time).
European real estate performed “relatively well through the 2022 crisis” when central banks meaningfully increased interest rates.
“Should that happen again, we think the sector should be able to weather the storm quite easily,” he said.
Part of this is because European real estate companies can pass inflation through the rent, which is often contractually linked to higher prices, making them “well‑equipped for this kind of environment”.
“Obviously, you have to be selective – not all real estate companies are great. The office sector is under pressure. So you have to actually do the work and make some decisions based on that. But that’s one thing we like,” he said.