The market initially provided finance to private equity businesses and rapidly grew in the wake of the global financial crisis as banks facing increasing regulation pulled back from lending. Since 2015, it has roughly tripled in size, growing to encompass traditional direct lending to smaller companies, buyout financing as well as real estate and infrastructure debt.
"There's been an evolution into private markets; before the global financial crisis the risk was inside the banks, now it's outside," Weinstein said in an interview. "There's been this big transfer of risk to investors. The question is when will the regulators start looking."
Supporters say the asset class shields investors from the volatility of mark-to-market losses in public markets. But for Stracke, the flood of money pouring into the sector is worrying because it's channeling into debt funds that aren't transparent.
"It's staggering when you look at what happened since the global financial crisis and how much more leverage there is in the system," said Stracke. The question is who owns the debt and is it in safe hands?"
Calls for the market to be more heavily regulated are growing and the dangers of investors not being able to exit their positions in private debt has been highlighted by watchdogs such as the European Union. The majority of investment managers at pension funds, insurance companies, family offices and wealth managers surveyed by Aeon Investments said they planned to increase allocations to private credit in the next year, Bloomberg reported.
Private credit has become a new high-yield bond and leveraged loan market, Stracke said, adding that debt-to-earnings at middle market companies has risen to 5.4 times from 4.3 times at the beginning of the crisis in 2008.
"Defaults so far are low for now but if we keep rates where they are there will be real stress across the higher risk parts of the market," Weinstein said.
Pacific Investment Management Co. has been positioning itself to profit from any meltdown in private lending, real estate or other alternative assets, as it looks to juice returns from nontraditional lending. The firm expanded its so-called capital solutions business to lend more to businesses struggling to raise funds amid high borrowing costs, Bloomberg reported in September.
The strategy build-out is an extension to private credit and offers equity as well as debt in complex deals across the senior and junior parts of the borrower's capital structures. The firm has hired 50% more portfolio managers focused on private strategies since 2020.