Assets under management in private debt funds have already risen sharply, but the entry of more retail investors in the years ahead will fuel further growth, says Morningstar DBRS Inc.
In a new report, the research firm said private debt AUM has grown globally at a 22% compound average growth rate since 2010, rising from around $100 billion (all figures in U.S. dollars) to more than $2 trillion. That’s a similar size to the syndicated loan and high-yield bond markets.
Despite the rapid rise in AUM, the growth outlook remains robust.
“Looking ahead, we expect private debt AUM to double by the end of the decade,” DBRS said, with future growth powered by greater allocations from retail investors.
The share of the sector’s AUM held by retail investors is already up to 13% from less than 1% a decade ago, the report noted, citing data from the Bank for International Settlements (BIS). That share is expected to rise further.
“Several large alternative asset managers are targeting 25% of all fundraising to come from the private wealth channel,” it said, with mainstream retail investors seen as another key source of growth.
Fund managers are increasingly eager for retail investment as the traditional institutional investor base reaches its asset allocation limits.
The U.S. administration is also championing easier access to alternative assets — including private debt, equity and crypto — for retail investors. A recent executive order called for allowing investors to hold these assets in registered retirement accounts.
“We believe private credit remains attractive to investors because it adds portfolio diversification, has low correlation to public markets and has delivered comparatively high risk-adjusted returns,” the report said.
Compared with syndicated loan investments, private credit has historically produced a yield premium of about 100 to 200 basis points, it noted.
“This premium reflects compensation to investors for loan illiquidity and various benefits for which borrowers are willing to pay, such as loan customization as well as ease and certainty of execution,” it said.
However, this advantage may erode as the sector goes mainstream.
“New funds require new deals to populate them, and the market’s inability to provide sufficient volumes to match the emerging demand could lead to asset quality deterioration and lower risk-adjusted returns,” it said.
Rising transparency in asset valuation could also reduce the private debt premium as funds expand their use of mark-to-market pricing amid increased retail participation.
“Ultimately, we believe the private credit premium over broadly syndicated loans will decline over the longer term, but the emergence of individual investors in private credit is just beginning,” it said.