Summer is heating up, and so are the markets. This month, Peter and Jeff break down two of Wall Street’s hottest topics: the boom in private credit and the return of the IPO. What’s fueling the frenzy, where’s the risk and what should investors watch? Get the answers to these questions plus their tips of the month.
Hosted by Creative Planning’s Director of Financial Planning, Jeff Stolper, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Transcript:
Jeff Stolper: I’m Jeff Stolper, Director of Financial Planning at Creative Planning. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Things aren’t just heating up weather-wise as we head into summer. There are two hot topics right now in the financial markets in private credit and upcoming initial public offerings, or IPOs. On the private credit front, some of the headlines read, “Rising Private Credit Defaults Are Testing Banks and Insurers” from Forbes, or another one of my favorites, “Private Credit Blowup Leaves $1.7 Billion Missing and Six Ferraris Found” from The Wall Street Journal. So, Peter, this is one of the fastest-growing areas in the private markets. Let’s just start with what is private credit?
Peter Mallouk: Yeah, I always think that’s a good starting point. So basically, I’d even start with the stock market. Everyone’s familiar with stocks. Nike, Google, McDonald’s. You can buy these publicly traded companies, click a button in your Schwab or Fidelity account or whatever, and own these companies. But there’s also private companies, like Anthropic and OpenAI and SpaceX and so on. Well, you can’t invest in those as publicly traded stocks because they’re not publicly traded yet. They’re private. So if you wanted to own those, you either have to be a direct investor or invested in a private equity fund that then in turn invests in private companies. So you know, a lot of people put money in a private equity fund. That fund looks for private businesses to invest in that they think are going to do well, and then they will sell them to a strategic investor or another private equity fund, or take the company public.
Well, these private companies need to borrow money. Well, they can’t go to the bank and borrow $100 million or $300 million. After ’08-’09, that kind of dried up. So the majority of lending no longer happens from banks for these businesses that have revenues of $25 million and up. They can’t issue a bond and borrow money because unlike Nike, Google, Microsoft, they’re not publicly traded. A publicly traded company could just go on the public markets and say, “Hey, we want to borrow money. Here’s what we’re willing to pay,” and the public market can decide if it wants to pay it. But these private businesses can’t do that. So without access to the banks and without access to the public markets, they have to borrow from private credit funds or private debt funds.
So just like there are private equity funds, there are private credit or private debt funds, same thing, private credit, private debt, and these funds are set up to evaluate businesses and work out terms of the loans. In general, the lending rates will be significantly higher than the public markets because, simply, the private company doesn’t have access to the public market, so they’ll pay a premium for the private credit fund. So, private credit funds have gotten a lot of attention lately in Wall Street Journal, Barron’s, a lot of national media because a lot of people are talking about pending problems in the private credit space. Some private credit funds that particularly lend to technology companies with recurring revenue have really struggled of late as the marketplace has said, “Hey, we’re concerned that AI is going to replace a lot of these companies that are charging a monthly or annual fee to their clients.”
So think of companies like Salesforce. Every single year, they charge every single user at a company that uses their product a little bit more to use their product. And a lot of people are saying, “Hey, AI is going to wind up replacing a lot of these recurring revenue-type companies.” So funds that lended primarily to them got hit very hard, and a lot of people are saying, “Well, is there a crisis brewing in private credit?” And to me that’s like saying, “is there a crisis brewing with bonds?” So if you look at publicly traded bonds, we can lend money to the federal government. That’s a treasury. Safest investment in the world. They’ll always tax people more or print money to pay you back. Municipal bond, you lend money to a county, city, state. Corporate bond, McDonald’s is borrowing money. Or a high-yield bond, which is a company that’s not doing very well is borrowing money. A lot of people call those junk bonds.
Well, private credit works similarly. Private credit can be loaning money to a very, very big, stable company, and the yield you’re going to get on that if you’re part of that investment’s probably going to be relatively low. Or they can be lending money to movie productions for six months, in which case the yield will be very, very high because it’s very risky. All credit is are loans. And so the profile of whether you’re going to get paid back or not is a function of the risk that you’re taking. And so, will there be pockets of problems with private credit? I think most certainly there will be.
We’re going to have times where, just like we have stock market crashes, bear markets, corrections, we have bond market crashes and bond market corrections. They tend to not be as significant, and like not even close to as significant in terms of percentages. Private credit is kind of in between these two things, between the stock market and the bond market, and I think what we’re going to see is there will be pockets where some companies in private credit took more risk lending money to companies that weren’t in trouble. The ones that are the more conservative and more diversified into the spectrum are probably going to be just fine.
And so it’s hard to just say private credit like it’s one thing, like it’s big cap U.S. stocks. That’s not what it is. Private credit is just loans. It can be loans to U.S. companies, international companies, emerging markets companies, big companies, small companies, low-risk companies, high-risk companies. So where you are in private credit is going to matter. It hasn’t mattered in the past. All private credit has generally worked out. For the most part, you lend money, you’ve been doing better than you would in the public markets. But yeah, sure, there will be a reckoning someday where there will be winners and losers, as there are with every major market in the world.
Jeff: So you think about this as it relates to the public equity market in terms of managers, and I guess that would be CEO or the management team for the public company. In terms of how they operate and how they make it through these ebbs and flows, how do you think about that in terms of the private credit space? When you’re looking at assessing, “Okay, this is a fund that maybe has more longevity or more stability, this is a fund that maybe is going to experience more volatility,” how do you think about that manager risk or the company that you should get your fund through?
Peter: I think you look at a couple different things when you’re thinking about risk and exposure and return. One is who are you going to trust to handle the lending? From my perspective, I’m not really looking for the new manager. I want the company that’s been doing this over and over and over again for years and understands the space inside out. Now you’ve immediately eliminated 90% of private credit managers. Second, I want to see scale. I want to see a fund that really has a lot of scale and negotiating power and breadth and depth. And third, I want to see diversification. This doesn’t mean diversification is right, but you dramatically reduce the odds of having an extremely negative outcome.
So I don’t want a fund that’s only investing in one sector. I mean, we saw with Blue Owl, very popular private credit fund, got hit very hard because they lent specifically to companies that were technology oriented that had recurring revenue tied to subscriptions, which is the part of the market that got hit the hardest by AI. You saw the more diversified funds held up just fine. And so to me, I’m looking for quality, scale, diversification and a long history.
Jeff: So how should somebody think about this private credit space in terms of their overall portfolio?
Peter: I think if you’re a higher-net-worth investor, so $1 million and up, it can make sense to include private credit in the portfolio. Just like we would want to have stocks in private equity, we’d want to have bonds in private credit. Private credit, there are some negatives. Sometimes there is separate reporting for taxes and so on. The pricing isn’t updated every day, so you have less transparency. And the liquidity isn’t daily, meaning you can’t just say, “Hey, I changed my mind,” sell it and get out of everything whenever you want. But in exchange for those negatives, there’s a very high probability of a higher return than the public bond markets.
Jeff: Great. Yeah, great summary, I think, and good place to wrap in terms of private credit on there are some risks, but a lot of rewards in the space as well.
Moving on to initial public offerings, which I think is going to be an exciting topic for the remainder of the year, I found just one headline that I want to share from the Financial Times. It says, “To Infinity and Beyond With the SpaceX IPO.” And I think you could more broaden that to the IPO market in general, as there’s definitely a lot of buzz — way more than recent history. Although, IPOs haven’t historically performed the way you would expect long-term. Maybe talk us through that?
Peter: So, first of all, the fact that there are IPOs at all is a sign that the market is, you know, pretty strong. IPOs can really let up for six months, 18 months, but when markets are strong, you’ll see private companies go public. We’re seeing that now with, famously, SpaceX, which will be probably the biggest IPO in history. I think what surprises most people who are really dying to get into these is that six months after an IPO, about 60% to 70% of the companies that went public are trading at lower than their IPO price. Facebook was an incredible example of this. I’d never seen so many people wanted to get into an IPO, and six months later it was trading for less. Now, since then it’s up many, many, many times over.
But the reason for that is, think about why the company’s going public. It’s a lot of the insiders, they want to sell their stock, right, and they don’t have another way to sell it. So when the company goes public, a lot of the stock gets dumped on the market and there’s this kind of supply-demand issue, while people that are inside have been waiting years and years and years to go buy their home and whatever else, second home and whatever it is they’re going to do with all of this money. So you see a lot of supply go into the market. Of course, bankers try to control that and match it up, but the reality is the majority of the time the price is trading lower later. SpaceX is going to be interesting because it’s going to immediately find its way into major indexes, which is something we don’t normally see. And, you know, a lot of people have index funds, which would then force the buying into that company. So this is going to be a very, very well-observed IPO.
Jeff: I think so. Yeah, volume-wise it’s not like what we saw maybe in 1999. I think there was around 450, 460 IPOs that year. 2021, I looked this up because I was curious, it was over 1,000 IPOs.
Peter: Yeah, that’s a hot market.
Jeff: Yeah, that’s a very hot market. Not the same volume. I think this year Goldman Sachs is expecting maybe 100, 120, something like that. But you’re right, you mentioned in there that SpaceX is probably going to be the largest ever in terms of market cap and probably proceeds. So hearing that about SpaceX, Anthropic, OpenAI, I mean, the three of them combined I think will probably surpass any amount of proceeds historically. Do you think this time’s different in terms of the IPO market?
Peter: I do, I think these three will be the first trillion-dollar IPOs, and we’re going to see, I don’t know what we have, maybe six trillion-dollar companies now or so. To see three more just drop into the mix overnight, it’s going to be really incredible.
Jeff: So you got into this a little bit talking about how SpaceX in particular is going to almost immediately move into some of the major indices. The diversified investor, how should they think about approaching an IPO?
Peter: Most people are better off not touching the IPO, because most of the time it’s going to be lower. 70% of the time or so it’s going to be lower six months later, and these companies are going to wind up in the index. You’re going to get them regardless as a diversified investor.
Jeff: It’s somewhat like, you said this when Bitcoin was even more of a topic than it is now, you were getting exposure maybe to Bitcoin by way of some of your ownership in other positions within the S&P 500 too. All right, Peter, let’s move on to our tip of the month. What do you have for us?
Peter: Okay, so cyber criminals are more active than ever, and they’re using all kinds of AI solutions to be able to … well, I, solution — AI weaponry to really attack many, many people over and over all at once. And it really, the gateway still remains clicking on a link. The difference is that these criminals have gotten a lot more sophisticated about making it look like something you’re used to receiving. So I would just say this is a big reminder, and very big reminder, as I’m seeing more and more of our clients fall victim to this fraud, where someone emails them something, and they click on it and it creates access to everything. Before you click on a link, ignore what the link looks like and go look at the web address, at the URL, and just make sure that looks familiar to you and that there’s a reason you would be getting this link.
That link invites someone into your entire ecosystem where they can be tracking your keystrokes, figuring out your passwords and it opens the door to a lot of things. I’m seeing more and more and more of this. And they’re getting better. It used to be very obvious, a lot of misspellings and spacings. It’s gone next level now. You really have to pay attention.
Jeff: Certainly can pay to be diligent, no doubt about that. My tip is to get together with your spouse and go through where everything is. My hunch is that if you’re listening to our podcast, you are likely the spouse that knows all of the stuff financially for your family. And I think it can definitely pay off if something were to happen, to have the other spouse know how to log in to all your financial accounts, knowing where your life insurance policies are, how to access the bank accounts. Maybe you put all of that into some kind of physical binder. It really, really will not only I think give you peace of mind, but if something were to happen, it would make the surviving spouse’s life easier.
I’m Jeff Stolper, Director of Financial Planning at Creative Planning, and with me has been Peter Mallouk, President of the firm, and we are Down the Middle.
Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.
