Why Some Are Paying More Attention to Private Credit Investments

Private credit was once an asset reserved for a select group of investors with access to significant amounts of capital, like endowment funds, insurance companies, and ultra-wealthy individual investors. But over the years, the asset class has grown in both size and popularity, creating more opportunities for self-directed IRA investors to participate.

What is it about private credit that has attracted so much attention, and what should investors consider before adding it to their portfolio?

What Is Private Credit?

Private credit, sometimes also referred to as private lending, is a type of financing provided by non-bank institutions, such as self-directed IRA investors. Some borrowers accept private credit because, while the interest rates and fees may be higher than traditional bank loans, the exact loan terms are often more customizable, and funding may be faster.

Why Is It Gaining Attention?

Private credit has attracted growing attention in recent years as both borrowers and investors have embraced the asset class. As companies have sought more flexible financing options outside of traditional banks, the private credit market has continued to grow. At the same time, some investors have been drawn to the asset class for its income potential, floating-rate loan structures in a higher interest rate environment, and the opportunity to diversify beyond traditional public markets.

Potential Benefits of Private Credit Investments

Private credit provides investors with an avenue to add exposure to non-publicly traded companies and private loans to their portfolio, which help increase diversification and reduce the impact of market volatility. Many private credit opportunities utilize floating rate loans, which typically have interest rates that adjust based on a benchmark rate plus a fixed spread. This can help protect lenders during periods of rising interest rates.

If you originate your own loan, then you also gain more flexibility to adjust the interest rate, the payment schedule, maturity date, and other loan terms depending on the borrower, investment structure, and your own risk tolerance. It’s also often a low-maintenance investment once the loan has been originated, with payments generally made according to the terms of the promissory note.

What to Consider Before Investing

While private credit may offer attractive opportunities for some investors, understanding the characteristics and risks of these investments can help you evaluate whether a particular opportunity aligns with your investment goals, risk tolerance, and liquidity need.

Before investing in private credit, it’s important to consider:

• Default risk. Borrowers may fail to repay their loans, making due diligence of managers, funds, or borrowers essential.
• Limited liquidity. Private credit investments are typically illiquid, making it more difficult to access IRA funds before the investment matures.
• Potential tax implications. Some private credit investments may trigger Unrelated Business Income Tax (UBIT).

Investing in Private Credit with a Self-Directed IRA

Private credit investments in a self-directed IRA can present an opportunity for diversification and potential income generation. There are two main ways that self-directed IRA investors can include private credit in their portfolios:

1. Pooled Funds. Many investors choose to invest in private credit through funds managed by a sponsor or underwriter. This is typically the most hands-off approach, as the fund manager handles all administrative work related to the underlying loan. There are typically management fees associated with this approach.

2. Self-originated Loans. While a slightly more involved approach, investors who originate loans directly typically have greater control over the loan terms and repayment structure. Investors can customize lending arrangements, but they may also assume more administrative responsibilities.

While private credit most often refers to corporate lending, self-directed IRA investors can hold other types of private debt, including real estate and mortgage notes, corporate loans, and personal loan promissory notes.

Next Steps

Private credit has attracted growing interest from investors in recent years. Customizable loan terms, income potential, and portfolio diversification may make private credit worth exploring for some investors.

There’s more than one way for self-directed IRA investors to add this asset to their portfolio, and each approach offers different benefits and considerations. Pooled funds may offer greater convenience but less control, while peer-to-peer lending provides more flexibility but may require additional due diligence and administration. It is always a good idea to discuss your specific situation and investment goals with a tax professional.

Download Equity Trust’s free 15-Minute Guide to Building Your Wealth with Self-Directed Notes Investing to learn more about private credit and lending.

Ready to get started with a rollover or transfer to a self-directed IRA? Talk to an IRA Counselor today.