Private equity returns overtook those offered by private credit in the third quarter, according to data from State Street, in what some see as a sign of a longer-term rebalancing between the two markets.
After underperforming private credit for the better part of the past two years, private equity funds returned 3.09% in the period ended Sept. 30, slightly above the 3.06% return offered by their debt counterparts, the data show. A pickup in buyout activity, lower interest rates and narrower spreads on private debt due to increased competition are all contributing to an equilibrium between the two asset classes.
“If inflation is kept under control and buyout performance regains momentum, we will likely see a reversal of current private credit outperformance,” Nan Zhang, head of product implementation and alternative investment research at State Street, said in emailed comments.
Private equity returns started ticking up as conditions to exit private equity investments improved thanks to lower rates and expectations that U.S. President Donald Trump will roll back regulation. In the long-term, further rate cuts would mean lower absolute returns for private credit deals with floating interest. Many market participants are also hoping rate cuts will trigger a deluge of buyout opportunities for private equity firms.
Investors have already started allocating more to private equity strategies than private debt, according to iCapital, which has more than $200 billion in alternative assets on its marketplace for money managers. That shift in allocations suggests a bet on a lower rates trajectory and a more favorable market for initial public offerings, the firm’s Chief Executive Officer Lawrence Calcano said at the end of last year.
Rising private equity returns haven’t deterred some of private credit’s largest players, including Ares Management, from raising tens of billions of dollars for strategies across the world. But funds have to stand out, according to Mark Wilton, the head of European investments for Corinthia Global Management.
“It’s no longer a case of a rising tides lift all boats in private credit,” Wilton, said on a panel at a DealCatalyst direct lending conference in London on Jan. 27. “We all have to differentiate ourselves.”
Spreads for private credit deals have also tightened as competition increased, especially across traditional strategies like direct lending to corporates. Having more competitors in the space has also made fundraising more challenging for firms.
“Private credit is overcrowded,” said Paul Karger, managing partner of TwinFocus Capital Partners, which advises family offices. “I never want to be in the consensus trade. Things never work out like the promoters of an asset class are initially underwriting.”
With these pressures, household names DWS Group and Fidelity International have struggled to make their mark. Alcentra, one of the market’s earliest leading names, has also faced difficulties. That competition is putting off some private markets players from pushing deeper into private credit.
Meketa Capital, an investment adviser that oversees more than $140 billion in private assets, runs an interval fund for infrastructure. But, so far, it’s declined to pursue the more common private credit interval fund, a vehicle traditionally directed toward registered investment advisers.
“Private credit in the interval funds space is very crowded,” Michael Bell, the firm’s chief executive officer, said in an interview. “If you’re just another fund in private credit it’s really hard to stand out.”
