Private loans are losing ground in the battle for family office wealth

(Bloomberg) — It's the hottest business on Wall Street. Asset managers everywhere have increased their investments in private credit, helping the asset class grow into a $1.7 trillion industry. But there's one group where interest already appears to be waning: the family office.

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Managers of the world's super-rich are looking to private debt funds more slowly this year than last, according to the latest data from Preqin, an analytics firm that tracks the alternative investment industry.

That doesn't bode well for direct lenders, who are banking on the trillions of dollars that family offices manage to fuel the industry's next phase of growth. In a tough fundraising environment this year, private credit funds have stepped up their efforts to attract the world's wealthiest people. Yet family offices' overall allocations to private debt remain at around 2%, according to a recent report from UBS Group AG.

“We don't need to invest through the usual private credit fund managers,” said Grace Cheung, chief investment officer and founder of TGIM Assets Capital, a private investment group with capital allocations from family offices. “We have the resources, expertise and network to do many private credit transactions ourselves,” she said, adding that they sometimes co-invest with established private credit firms.

According to the company, the Preqin report is based on fund searches that reflect investors' active investment intentions for the next 12 months.

Searches for North American private credit funds accounted for 11% of the total this year, down from 18% last year and less than the 39% for private equity and venture capital and 45% for real estate. Hedge funds and infrastructure made up the rest.

In Europe, the number of searches for private credit funds fell from 10% last year to 8%.

Among the biggest concerns for wealthy investors when weighing how much to invest in private credit is the possibility of lower returns if the U.S. Federal Reserve and European Central Bank begin cutting interest rates, says Preqin's Rachel Dabora, lead analyst on the report.

Higher borrowing costs helped direct lending funds' returns reach double digits last year, according to data from Cliffwater LLC. But given the floating-rate nature of the loans they make, investors worry that rapid rate cuts could cut into future profits.

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On the other hand, North American family offices' interest in real estate has surged as pressure on this asset class leads to deep discounts, while in Europe private equity accounted for three-quarters of all searches this year, continuing the dominance of this asset class.

For Alex Chaloff, Chief Investment Officer at Bernstein Private Wealth Management, private equity may simply be a more natural fit for family offices given their risk appetite and often long-term investment horizons.

This year's UBS Global Family Office Report found that 39 percent of respondents plan to increase their investments in direct private equity, compared to just 29 percent who wanted to increase their allocations to private debt.

“If a private credit fund returns 20 percent, I think they may have taken on too much risk,” Chaloff wrote in an emailed comment. “If a private equity fund returns 20 percent, I look at how that fund compares to other funds. There is no reason for alarm.”

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In regions with high interest rates such as Russia and Latin America, the hunt for higher potential payouts is even more acute.

“Due to high domestic interest rates, Latin American investors have so far been reluctant to invest in credit, often opting for more sophisticated strategies such as private equity,” says Philippe Stiernon, CEO of ROAM Capital, a Latin American alternative asset placement agent that works with high net worth individuals, family offices and institutional investors.

Still, many family offices appear keen to increase their exposure to private credit. Citigroup Inc.'s global family office survey last year found that optimistic respondents on private credit were more than 30 percentage points higher than pessimistic respondents in Europe, the Middle East and Africa and North America.

A number of private credit institutions aimed at wealthy individuals have also successfully raised capital in recent months.

However, for TGIM's Cheung, avoiding private debt funds offers more flexibility in both managing risk and optimizing prospective returns.

“We prefer to be robust and focus on those direct and scaled private debt investments where we have good control over the risk and return profiles and the flexibility to continue investing in the respective capital stacks,” Cheung said.

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