Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Private Credit for Yield
Transcript
- Lucas: Luna, I want to talk about something that is quietly reshaping how ultra-wealthy families generate income in their portfolios — and it's not stocks, not bonds, not even private equity. It's private credit. Luna: Like, direct lending? Where a family office essentially acts as the bank for a company? Lucas: Exactly. We're talking about senior secured loans, often at floating rates, made directly to mid-market companies. And the numbers are staggering. The global private credit market is now estimated at about $1.7 trillion. That's up from roughly $600 billion a decade ago. Luna: And a big chunk of that is coming from family offices and high-net-worth individuals, right? Not just institutional money. Lucas: Right. So here's a concrete example I came across recently. A single-family office with about $2 billion in assets under management allocated 15% of their portfolio — $300 million — to private credit. They're not just buying into a fund; they're co-investing alongside a direct lending fund manager. And they recently participated in a $50 million senior secured loan to a manufacturer of industrial valves. The coupon: 12%, floating over SOFR. Luna: Twelve percent. That's nearly double what a broadly syndicated leveraged loan would pay. But you're also taking on illiquidity, credit risk — the whole package. Lucas: Exactly. The trade-off is real. But for families that don't need to liquidate on a quarterly basis, the illiquidity premium is actually a feature, not a bug. You're locking in that yield for three to five years, typically. And because these loans are senior secured — meaning you're first in line for repayment if something goes wrong — the loss rates historically have been very low. According to Cliffwater's Direct Lending Index, the average annual loss rate since 2004 is about 0.5%. Luna: That's surprisingly low. But it's worth noting that the data is largely from a bull market for credit. We haven't seen a real stress test for direct lending since maybe the early 2010s. Lucas: Fair point. And there's another layer here. A lot of these loans are made to companies backed by private equity firms. So you have a sponsor on the other side — someone with skin in the game. That can add a layer of oversight, but it also means the company is already highly leveraged. Luna: Right. So you're lending to a company that's already been bought with debt. It's a double layer of leverage. Lucas: Exactly. Now, if our money conversations have helped you think about a decision differently — like whether direct lending makes sense in your own portfolio — there's a quiet way to support the show. A small group of listeners already chips in monthly at buy me a coffee dot com slash fexingo, and honestly, that's what keeps this whole operation ad-free and independent. Luna: Yeah, it's a simple thing. No ads, no sponsors, just listeners who find value here. Totally optional, but it matters. Lucas: So back to private credit. Let me give you another structure that's becoming popular — the private credit interval fund. These are closed-end funds that offer periodic liquidity, say quarterly, but are not daily traded. They allow individual accredited investors to access a diversified pool of direct loans. Luna: I've seen those. They're a way to get institutional-style yield without having to commit to a full 10-year fund lock-up like in private equity. Lucas: Right. And the yields are attractive. The average interval fund in the direct lending space is yielding around 8 to 9 percent net of fees. That's significantly higher than investment-grade bonds or even high-yield bond ETFs. Luna: But the fees — those are worth talking about. We're looking at management fees of 1 to 1.5 percent, plus a performance fee sometimes. That eats into the gross yield. Lucas: It does. But net of fees, you're still getting a premium. And for a family office, the tax treatment can be favorable. Interest income is ordinary income, but if you structure it through a corporation or a trust, you can manage the tax drag. Luna: Let's talk about risk a bit more. What keeps you up at night about private credit? Lucas: I'd say the biggest risk is correlation. A lot of these loans are floating rate, which is great when rates are rising — but if the economy slows and defaults rise, you could see losses cluster. And because the market is opaque, you don't always see the stress until it's late. Luna: There's also the risk that banks start competing again. If bank lending standards ease, direct lenders might lose some deals. Lucas: That's a real possibility. But the structural shift — banks pulling back from mid-market lending due to regulation — that's been a decade in the making and doesn't seem to be reversing anytime soon. So private credit is probably here to stay. Luna: I've been reading about something called 'private credit secondaries' — where you can sell your direct lending positions on a secondary market. That's starting to emerge as a liquidity valve. Lucas: Yes, and that's fascinating. Firms like Blackstone and Partners Group are now offering secondary liquidity for private credit. It's still small — maybe $20 billion in annual volume — but it's growing. For family offices, that's an important option if they ever need to exit early. Luna: So what should a listener with, say, $10 million in investable assets think about allocating to private credit? Lucas: I think the rule of thumb is 10 to 20 percent of your fixed-income allocation. But you have to be careful about liquidity. If you're going to need that money in the next 18 months, don't put it in private credit. This is for the patient portion of your portfolio. Luna: And it's not just for the ultra-wealthy, right? There are now interval funds with lower minimums — like $25,000 or even $10,000. So accredited investors with smaller amounts can access it. Lucas: Exactly. The democratization of private markets is a huge trend. But with that comes the responsibility to understand what you own. You're not buying a liquid ETF; you're buying a loan to a company you've probably never heard of. Luna: And you're relying on the fund manager's underwriting. So due diligence on the manager is critical. Lucas: Absolutely. Look at track record through cycles, the size of their team, how many loans they've originated, and what their recovery rates are. A good manager will have loss rates well below the industry average. Luna: One more thing — how does private credit fit into a broader portfolio? You mentioned replacing some fixed income, but is it also a substitute for high-yield bonds? Lucas: I'd say yes. Private credit historically offers a higher yield with lower volatility than public high-yield bonds, because the loans are not marked to market daily. That can be a smoothing benefit in a portfolio. But again, it's illiquid. So you're trading away liquidity for that smoothness. Luna: And there's a behavioral element too. If you see your public bonds drop in value during a sell-off, you might panic. With private credit, you don't see the daily price, so you're less likely to make a bad emotional decision. Lucas: That's actually a major psychological advantage. The opacity can be a feature, not a bug — as long as the underlying credit quality is sound. But you have to trust the manager. Luna: So, if someone wanted to get started with private credit today, what's the first step? Lucas: I'd say talk to your financial advisor or family office about whether you're accredited and what allocation makes sense. Then look at interval funds from established managers like Ares, GSO, or Golub Capital. Or, if you have enough capital, consider a direct co-investment through a platform like iCapital or CAIS. Luna: And don't forget the tax implications. Interest income is fully taxable at ordinary rates. So if you're in a high tax bracket, the after-tax yield might be closer to 6% rather than 8%. Lucas: Right. So factor that in. But even at 6% after tax, that's still beating most bonds and many dividend stocks. And with floating rates, you have some protection if inflation persists. Luna: One more risk — what about interest rate risk? If rates fall, floating rate loans will reset lower. Lucas: That's true. But most direct lending funds also have some fixed-rate exposure or use floors. So the yield might not drop as much as you'd think. And if rates fall, it's usually because the economy is slowing, which could increase defaults. So it's a complex trade-off. Luna: It sounds like private credit is a powerful tool, but only for those who can handle the complexity and illiquidity. Lucas: Exactly. It's not for everyone. But for the ultra-wealthy, it's becoming a core part of the portfolio. I think in the next five years, we'll see even more innovation — like private credit ETFs that offer daily liquidity. That could be a game-changer. Luna: But would that kill the illiquidity premium? If everyone can trade daily, the yields might compress. Lucas: Probably. But there's a balance to be struck. For now, the illiquidity premium is alive and well, and families are earning it. That's the story of private credit in 2026. Luna: It's a fascinating shift in how capital markets work. Banks used to be the only game in town for loans. Now, the wealthy are the banks. Lucas: That's right. And we'll be watching how it evolves. Thanks for listening, everyone. We'll catch you next time on The High Net Worth Podcast.