Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Use Private Credit For Yield
Transcript
- Lucas: The landscape for yield has shifted dramatically over the last eighteen months. When you look at the ten-year Treasury, it’s hovering around four percent, but for many family offices, that simply isn’t enough to cover their liability streams or maintain real purchasing power. Luna: Right, and if they’re used to getting six or seven percent from corporate bonds, the drop feels like a pay cut. Lucas: Exactly. So we’re seeing a massive migration into private credit. This isn’t just about chasing yield; it’s about accessing a liquidity premium that public markets can’t offer. The total addressable market for private credit has ballooned to over one point three trillion dollars globally, and family offices are increasingly acting as the capital providers rather than just passive investors. Luna: So they’re moving away from public bonds entirely? Or is this more of a satellite allocation? Lucas: It’s a satellite allocation, but one that’s growing rapidly. The key here is direct lending. Instead of buying a bond on an exchange, the family office lends directly to a middle-market company through a specialized fund or a bilateral deal. They become the bank, effectively. Luna: That sounds like a lot of due diligence work for someone who usually just wants passive income. Lucas: Which is why most go through managers, but the smartest family offices are starting to co-invest. They sit alongside the general partner and pick specific deals. This allows them to negotiate better terms, like senior secured status, which means they get paid first if the borrower defaults. Luna: Senior secured... so they have collateral backing the loan? Lucas: Usually assets like inventory, receivables, or even intellectual property. It’s not real estate, which is familiar territory for them, but it’s tangible enough to provide downside protection. The spreads on these deals often range from eight to twelve percent, depending on the risk profile. Luna: Eight to twelve percent is a huge jump from what they’re getting in Treasuries. Is the risk commensurate? Lucas: That’s the million-dollar question. The risk is different, not necessarily higher. These are companies that banks have turned away because they don’t fit the rigid underwriting models of large institutions. They might be smaller, less liquid, or operating in niche sectors, but they’re profitable and cash-flow positive. Luna: So it’s like the subprime boom of two thousand eight, but with better lawyers? Lucas: I wish it were that simple. The regulatory environment is actually tighter now. Banks are still constrained by post-crisis rules, which creates a vacuum that private credit fills. But unlike twenty-eight, these loans are floating rate, meaning they benefit when interest rates stay elevated. Luna: Floating rate helps when rates are high, but what happens if the economy slows down and borrowers can’t service the debt? Lucas: Then you rely on the covenants. In public bonds, you often see covenant-lite structures where the borrower has very few restrictions. In private credit, the lender writes the rules. They can restrict dividends, limit additional debt, and force asset sales if performance dips. Luna: That gives the lender a lot of control. Does that make the asset illiquid? Lucas: It does. That’s the trade-off. You lock up your capital for five to seven years typically. But for a family office, liquidity isn’t always the primary constraint. They have other liquid assets. What they want is predictable, high-yielding cash flow that isn’t correlated with the stock market. Luna: Uncorrelated cash flow. That’s the holy grail for many affluent households trying to decouple their lifestyle from market volatility. Lucas: Precisely. And there’s another layer: operational improvements. Some family offices are providing not just capital but strategic guidance to the borrowing company. They might help the CEO navigate a transition or introduce supply chain partners. It’s active ownership without running the business. Luna: That feels closer to venture capital than traditional fixed income. Are the returns really that stable? Lucas: They’re reported as stable because they’re marked to model, not to market. Unlike stocks, which swing daily, private credit valuations change slowly. This smooths out the volatility curve, which looks great on paper until you need to exit quickly. Luna: So it’s a valuation game. If everyone tries to sell at once, the price discovery breaks down. Lucas: Exactly. There’s no secondary market for most of these loans. You can’t just click a button and sell. This lack of transparency is both a feature and a bug. It protects the yield during stress events, but it also hides underlying problems until they become obvious. Luna: Have we seen any major blowups in this space recently? Or is it all quiet waters? Lucas: We’ve seen defaults tick up, particularly in the hospitality and leisure sectors. But overall, default rates remain historically low, around one to two percent. The industry is still in its growth phase, and capital inflows are strong. Luna: Strong inflows mean more competition for good deals. Doesn’t that squeeze the margins? Lucas: It does. Spreads have compressed slightly over the last year. What used to net nine percent might now net seven and a half percent. But even with compression, it’s still attractive compared to public high-yield bonds, which are trading at much wider spreads due to recession fears. Luna: So family offices are betting that the economy won’t crash hard enough to wipe out these loans. Lucas: They’re betting on resilience. Middle-market companies are often less leveraged than their larger counterparts. They haven’t borrowed as aggressively during the zero-rate era. Their balance sheets are cleaner, making them better borrowers in a tightening environment. Luna: Cleaner balance sheets. That’s a refreshing contrast to the big tech giants we see in the news. Lucas: Very much so. The focus here is on cash flow generation, not growth at all costs. These businesses are mature, profitable, and focused on efficiency. It’s a boring investment thesis, but boredom pays well in wealth management. Luna: Boring pays well. I like that. How do family offices actually find these deals? Do they have their own sourcing teams? Lucas: Some do. Large family offices hire ex-bankers to source deals directly. Smaller ones rely on relationships with fund managers. It’s a network-based game. Trust is the currency here, not just credit ratings. Luna: Trust over ratings. That makes sense when you’re dealing with opaque assets. Lucas: It does. And it raises the bar for advisors. If you’re managing money for a family office, you need to understand the nuances of these contracts, not just the headline yield. Luna: Yeah, because the headline yield can be misleading if the covenants are weak. Lucas: Exactly. A twelve percent return with no protection is worse than an eight percent return with full recourse. Context is everything in private markets. Luna: Do you think this trend will reverse if rates start falling? Lucas: If rates fall, public bonds become more attractive again. Investors might rotate back into Treasuries or corporates. But private credit has built a momentum that’s hard to stop. The infrastructure is in place, the talent is hired, and the capital is deployed. Luna: So it becomes a permanent fixture in the portfolio mix? Lucas: I think so. It fills a gap that public markets can’t. Even if spreads narrow, the structural advantages of direct lending—speed, flexibility, and customization—are too valuable for sophisticated investors to ignore. Luna: Speed and flexibility. Things that public markets struggle to deliver. Lucas: Absolutely. You can close a private credit deal in weeks, not months. That agility matters when opportunities arise. Luna: It seems like a win-win, but only if the borrower actually succeeds. Lucas: That’s the fundamental truth. We’re all aligned with the success of the underlying business. It’s not a zero-sum game. If the company grows, the loan performs. If it struggles, we all feel it. Luna: Aligned incentives. Rare in finance, but essential here. Lucas: It is. And that alignment is why family offices are sticking with it, even as the market matures. Luna: Before we wrap up, I want to mention something important about how we keep this conversation going. Lucas: Right, we don’t run ads. Our listeners support us directly through buy me a coffee dot com slash fexingo, and that funding covers our research and production costs. Luna: It’s just a small community of people who value independent financial analysis, and it keeps the show ad-free and focused on substance. Lucas: If you’ve found value in today’s discussion on private credit, consider joining them. It helps us continue digging into these complex topics without compromise. Luna: Thanks for listening. Where do you think private credit fits in your own family’s strategy?