This Investment Giant Is Moving to Safer Waters

Blackstone (BX) is looking to expand its credit operations beyond its usual domain... 

Traditionally, the private-equity titan has been involved in high-yield, U.S.-based lending.

And it has targeted highly leveraged companies, with a client base of more than 2,000 non-investment-grade borrowers.

However, according to a recent interview with Gilles Dellaert, the global head of Blackstone's credit and insurance unit, the company now wants to capitalize on credit opportunities in Europe and Asia.

Specifically, it will do more deals involving local currency investments in the regions.

At the same time, Blackstone is trying to get more exposure to investment-grade debt like some of its major competitors, including Apollo Global Management (APO) and Carlyle (CG).

Blackstone markets this shift as a growth opportunity in the private-credit space, though it may actually be more of a distraction...

Dellaert's recent comments don't tell the whole story... 

For instance, he announced Blackstone's plan to add a $5 billion lending platform in Asia to its $120 billion global direct-lending portfolio.

Yet, he didn't discuss why the company is so focused on expanding into new markets...

Just two days ago, we talked about the emerging issues in the U.S.'s high-yielding private-credit market. Namely, we shared how these companies are resorting to risky business strategies like "payment in kind" debt.

Earlier this month, we also covered the deteriorating returns of private-credit funds.

Recall that private-debt funds returned 15.5%, on average, since 2022 compared with the mere 2% return we saw in the first quarter of 2024.

Clearly, private credit has left its shiniest days behind – at least, when it comes to the U.S.

As Dellaert mentioned, Blackstone is now targeting lending markets in Europe and Asia... and it's largely because the U.S. market is running out of juice.

It's the largest private-credit market by far. And now that the Federal Reserve is prepared to cut interest rates, some domestic borrowers may soon be able to tap traditional public markets again.

Internationally, private credit is still a bit niche... So Blackstone is rushing to tap those markets as fast as possible.

The U.S. private-credit market, on the other hand, is bloated...

As of June 2023, it accounted for more than 65% of the global private-credit market, nearly double the share of the European and Asian markets combined.

And we may be closer to the top of the market than the bottom. We can see this in the private-debt slowdown in the first quarter...

According to investment-data company Preqin, global private-credit fundraising decreased 14% year over year in the first quarter of 2024.

This past April, the International Monetary Fund ("IMF") even warned investors about the growing risks in private credit in its Global Financial Stability Report.

The IMF said increasing borrowing costs and payment-in-kind debt make private credit even riskier.

It also highlighted that private credit suffers from a lack of transparency. Unlike banks, whose loans are regulated, nobody really knows what's happening inside these private-credit portfolios.

If some of these funds start suffering from defaults, valuations for the private-credit market could suddenly fall.

Moreover, the agency highlighted the need for regulation in the area. This would help decrease risk... though it would also mean lower returns.

We'll say it again: Private credit has started to run out of fuel...

The market is entering a downtrend, and Blackstone knows it well.

That's why it's focusing on moving away from the U.S. private-credit space and riskier investments.

Involving itself in growing markets like Europe and Asia, while also dealing with investment-grade companies, would provide Blackstone with a modest but reliable cash flow.

However, that's also the opposite of what made private credit so popular... above-average returns due to higher risk.

Blackstone's shift of focus is really an attempt to ignore the issue at hand by growing its business elsewhere.

If this market's downtrend continues, we wouldn't be surprised to see other private-credit companies following suit.

Regards,

Joel Litman
August 28, 2024