CFA Institute

Private credit has rapidly evolved from a niche asset class into a dominant force in the global lending ecosystem, now representing an estimated $2.5 trillion industry[1] rivaling traditional bank lending and public debt markets. For institutional investors navigating a shifting macroeconomic and regulatory landscape, the asset class presents both compelling opportunities and growing concerns. While private credit promises bespoke deal structures, superior yields, and diversification away from traditional fixed income, its accelerated growth — fueled by bank retrenchment and heightened investor appetite — raises critical questions about liquidity, transparency, and systemic risk. This transformation has been driven by structural shifts in the financial system. Chief among them: tighter post-2008 banking regulations, the persistent search for yield in low-interest-rate environments, and the growing demand from private equity for more flexible, non-traditional sources of financing. Drivers of Private Credit Growth Several key factors have contributed to the rise of private credit: Banking Regulation & Retrenchment: Post-2008 financial reforms, such as Basel III and Dodd-Frank, imposed stricter capital requirements on banks, limiting their ability to lend to middle-market firms[2]. Private credit funds stepped in to fill this gap. Investor Demand for Yield: In a low-interest-rate environment, institutional investors, including pension funds and insurers, sought higher returns through private credit investments.[3] Private Equity Expansion: The growth of private equity has fueled demand for direct lending, as firms prefer tailored financing solutions over traditional syndicated loans.[4] Flexibility & Speed: Private credit offers customized loan structures, faster execution, and less regulatory oversight, making it attractive to borrowers.[5] Implications for Financial Stability and Systemic Risk Despite its benefits, private credit introduces new vulnerabilities to the financial system: Liquidity Risks: Unlike banks, private credit funds lack access to central bank liquidity. Even though many funds restrict investor withdrawals to quarterly or annual redemption windows, during economic downturns when borrower defaults rise and secondary market liquidity dries up, investor redemption demands could trigger fire sales and market instability. Leverage & Concentration: Many private credit funds operate with high leverage, amplifying returns but also increasing fragility. Business Development Companies (BDCs), for example, were allowed to increase their leverage cap to 2:1 in 2018[6], raising concerns about systemic risk. Opaque Valuations: Private credit assets are not publicly traded, making valuations less transparent and potentially stale, which could mask underlying risks.[7] Interlinkages with Banks: While private credit operates outside traditional banking, its growing ties to bank funding could create contagion risks in a downturn.[8] Regulatory Outlook Regulators, including the Federal Reserve, the International Monetary Fund (IMF), and the Bank for International Settlements (BIS), are increasingly scrutinizing private credit’s role in financial markets. The IMF warns that private credit’s expansion could amplify economic shocks, particularly if underwriting standards deteriorate. The BIS highlights the need for greater transparency and risk monitoring, especially as retail investors gain exposure to the asset class. More to Think About For allocators and asset owners, private credit represents a strategic lever in pursuit of yield and portfolio diversification. But as capital continues to pour into the space, often outpacing risk infrastructure, the investment thesis must be continually reexamined through a risk-adjusted lens. With increasing scrutiny from global regulators and the growing complexity of credit markets, due diligence and scenario planning will be essential to avoid hidden vulnerabilities and ensure resilience in the next phase of the credit cycle. At the same time, policymakers are increasingly alert to the broader financial implications of private credit’s ascent. Global regulators including the Federal Reserve, IMF, and BIS have warned that unchecked growth in opaque, illiquid segments of credit markets could amplify shocks and create feedback loops across institutions. Notably, the growing accessibility of private credit products to retail investors, often via interval funds and public BDCs, raises further concerns about liquidity mismatches and valuation transparency. These dynamics are likely to draw heightened regulatory attention as retail participation expands. Striking the right balance between market innovation and systemic oversight will be crucial not just for regulators but for institutional investors who must navigate these crosscurrents with discipline and foresight. [1] Bank for International Settlements (BIS) Private Credit Market Overview, 2025. [2] Federal Reserve Report on Private Credit Characteristics and Risks, 2024. [3] IMF Global Financial Stability Report, April 2024. [4] IMF Blog on Private Credit Growth, 2024. [5] What is private credit, Brookings, 2024. [6] H.R.4267 – Small Business Credit Availability Act, 2018 [7] Federal Reserve Report on Private Credit Characteristics and Risks, 2024. [8] Bank Lending to Private Equity and Private Credit Funds: Insights from Regulatory Data, Fed Boston 2025 source

Even as the inclusion of sustainability targets in investment portfolios grows in popularity, the challenge of balancing this approach continues to perplex investors. But a Financial Analysts Journal study, “Bonds with Benefits: Impact Investing in Corporate Debt,” may offer encouragement. It finds that sustainability-oriented investors can meet their goals with corporate debt strategies and that profit-oriented factor investors can achieve a portfolio with a certain sustainability level at a low cost. I spoke with Desislava Vladimirova, who coauthored the study with Jieyan Fang-Klingler, for insights on the authors’ findings and to produce an In Practice summary of the study, which can be found on our CFA Institute Research and Policy Center. Below is a lightly edited and condensed transcript of our conversation, as well as a brief author video. The study analyzes some of the implications of sustainable investment in actively managed credit portfolios using carbon emissions, Sustainable Development Goals (SDGs), and green bonds and reveals a concave relationship between outperformance and sustainability. A nonlinear relationship between sustainability and factor investing is the salient finding, according to Vladimirova. CFA Institute Research and Policy Center: What does your research study have to tell bond investors? Desislava Vladimirova: What we are trying to say is that there are two types of investors—those who focus on returns and those whose investment beliefs include considering the environment and thus they also target sustainable companies. Because a focus on sustainable companies would limit the investable universe, investors intuitively expect returns to be reduced. We are trying to show with our research that this is not necessarily the case, and that depending on investors’ preferences regarding the level of sustainability they are seeking, there might be optimal combinations that would allow them to stay profitable and still have sustainability. Who should be interested in your research findings and why? Our findings are interesting to institutional investors with a focus on corporate debt. The study aims to draw the attention of credit investors who need to fulfill regulatory requirements in terms of sustainability as well as investors with a strong sustainability focus. Our research provides useful insights for all investors willing to integrate sustainable investing because we find that there is an optimal solution for investors with different green preferences. What motivated you to conduct this research and author this paper? Two reasons: one was the academic aspect—this was a niche that had not been filled in the literature. The second is we work for an asset management company, and we’re interested in whether this is feasible and achievable with profitable strategies—to see how plausible it is to achieve these two goals together. What is novel about your study? There has been no research on how to integrate sustainability into active credit strategies. We analyze measures that haven’t been discussed previously, such as Sustainable Development Goals (SDGs). We confirm our findings for three different sustainable measures — carbon footprint, SDGs, and green bonds — and we are consistent with our results. We show that these three measures can be integrated into active factor strategies. The factors are quantifiable, and the sustainable measures are quantifiable. What do you deem your study’s most important findings or key takeaways? Our study analyses the relationship between sustainability and factor investment. The most important finding is that this relationship is not a zero-sum game. We find that constructing optimized dual-target portfolios reveals a concave relationship between factor investment and sustainability, meaning that investors’ target trade-offs are not zero-sum in nature. This implies that factor investors willing to comply with minimum sustainability standards can do so with minor impact on performance. And investors with a strong sustainability focus can benefit from exposure to profit-oriented strategies, while still being predominantly invested in sustainable assets. What are the key practical applications of your research? We believe that our study can be applied to the portfolio construction process of factor strategies. We provide a dual objective optimization methodology that can consider various investors’ sustainability preferences and combine them with credit signals under plausible risk and turnover constraints. Our results exhibit robustness for different sustainability measures and factor definitions. And, as such, investors only need to decide on their optimal factor sustainability mix. We show that for a practitioner who wants to be profitable and wants to reduce carbon emissions, this is very easily achievable. But we also show that investors who want to participate in environmental projects and invest in green bonds can be profitable. We basically show that there is an optimal solution for everybody. If you liked this post, don’t forget to subscribe to Enterprising Investor and the CFA Institute Research and Policy Center. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / Olemedia Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

It’s often claimed that small-cap stocks are more interest-rate sensitive than their large-cap counterparts because of their reliance on outside financing. This seems plausible. But what do the data say? In this blog post, I explore the relationship between small- and large-cap stocks and interest-rate changes using the Stocks, Bonds, Bills and Inflation® (SBBI®) monthly dataset — which is available to CFA Institute members — and the Robert Shiller long-bond rate dataset. I use graphs and correlations (and a little regression). My main findings are: Small-stock monthly returns are no more sensitive to rate changes than large-stock returns. Small stocks fare no worse on average than large stocks during periods of Federal Reserve (Fed) interest-rate tightenings, where tightening periods are as defined by Alan Blinder in a recent paper. The relationship between stocks and rates isn’t stable. There are periods when equities are highly rate sensitive, and periods when they aren’t. The Federal Reserve Bank of Chicago’s (Chicago Fed’s) National Financial Conditions Index (NFCI) — a proxy for ease of overall access to capital — has about the same relationship with small-stock returns as with large.   R Code for calculations performed and charts rendered can be found in the online supplement to this post. Stocks and Rates: The Big Picture I start with the full period for the SBBI® dataset: January 1926 to April 2024. The left panel in Chart 1 shows the correlation between small-stock monthly returns and the long-government bond interest rate (hereafter, the “long rate” or just “rate”) from the inception of the SBBI® dataset in 1926 to April 2024, which is the last available month of SBBI® returns. The right panel in Chart 1 shows the correlation between large-stock monthly returns and the long rate during the same period. The correlation between large stocks and rate changes is modestly negative (-0.1) and significant at the 95% level. The correlation between small stocks and rate changes is not significant. These results are robust to lagging the rate change variable by one period and to restricting rate changes to positive values. That is, accounting for possible delayed effects and limiting rate changes to the potentially adverse doesn’t change the results. Chart 1. Monthly small- (left) and large-stock (right) returns versus long-rate changes, 1926 to April 2024. These correlations are suggestive, but obviously not conclusive. The long timeframe — nearly a century — could mask important shorter-term relationships. Table 1 therefore shows the same statistic but grouped, somewhat arbitrarily, by decade. Table 1. Large- and small-cap stock monthly return correlations with all long rate changes. When viewed this way, the data suggest that there could be meaningfully long periods when correlations differ from zero. I omit confidence intervals here, but they don’t include zero when correlations are relatively large in an absolute sense. Correlations are usually of the expected sign (negative). There doesn’t seem to be much difference in the way that small and large stocks respond to long-rate changes, with the possible exception of the last few years (the 2020s). These findings are robust to lagging the rate-change variable by one period. Restricting rate changes to positive observations changes both the sign of correlations and (significantly) their magnitude in some periods, as shown in Table 2. Nothing about Table 2’s results, however, suggests a difference in the reaction of small and large stocks to a rise in rates. Table 2. Large- and small-cap stock monthly return correlations with positive long-rate changes. But, as noted, decades are arbitrary periods. Chart 2 therefore shows the rolling 60-month correlation between the small-, large-, and long-rate change series for the length of the SBBI® dataset. Chart 2. Rolling 60-month correlations between small (left) and large (right) stocks and long-rate changes. Two features are noteworthy. One, the charts are nearly indistinguishable visually, vertical-axis values aside. Small and large stocks appear to exhibit similar behavior in response to rate changes. It’s hard to avoid the inference that small-cap stocks don’t respond differently to long-rate changes than large-cap stocks. And two, the stock-rate relationship varies, and can have the “wrong” sign for long periods. Removing Market Effects Could the observed similar response of large and small stocks to long-rate changes be due to the influence of “the market” (large-stock returns) on small stocks? It seems plausible that broad market effects could mask an adverse reaction of small stocks to rising borrowing costs. Removing them might give us a better sense of the effect of long-rate changes on small-stock returns. I do this by first regressing small-stock monthly returns on large-stock monthly returns (a proxy for “the market”). I then calculate partial correlation using the residuals from this regression, which reflect the non-market part of small-stock returns and long-rate changes.[1] Overall (1926 – April 2024), the partial correlation is again not different from zero. However, as shown in Chart 3, the rolling, 60-month partial correlation has been mostly (though not always) positive — the opposite of the expected sign — and sometimes large, particularly lately. Controlling for “market beta” therefore does seem to impact the relationship between small stocks and long rates. These results probably aren’t practically meaningful or useful, however. Chart 3. Rolling 60-month partial correlations between small stocks and rate changes. Monetary Policy and Returns Small-cap stocks could be more sensitive to shorter-term rates to which their borrowing costs are more closely linked. Table 3 therefore shows the average annualized performance (in decimals, so, e.g., 0.03 = 3%) of small and large stocks during the 12 Fed tightening episodes identified by Alan Blinder (listed in column 1) in his paper on “soft landings.” Table 3. Large- and small-stock performance during Blinder’s monetary tightenings. Before the early 1980s, a researcher might have concluded that small stocks performed better than large stocks when the Fed was hiking. The fourth column (“diff”), which shows the difference between small and large stock returns, was positive in all tightenings up to that time. Since then, small stocks have underperformed during tightenings more often than they’ve outperformed. But

What could a US sovereign wealth fund mean for markets and investors? It could alter the balance between state and private capital by de-risking strategic projects, legitimizing new asset classes, and attracting global co-investment into critical industries. Since President Donald Trump announced the establishment a US sovereign wealth fund (SWF) in February, it has fueled both expectations and controversies. Investors should pay attention because state-backed capital is no longer theoretical. It is being deployed in semiconductors, digital assets, and even major technology platforms. This week’s news that the US government is considering taking a 10% stake in Intel underscores how quickly the idea is moving from concept to concrete deals, raising urgent questions about how far state capital will reach into the private sector, and what that means for investors. Many experts are calling for a formal, legislatively grounded US sovereign wealth fund like Norway’s Norges Bank Investment Management (NBIM). But instead, the Administration has taken an ad-hoc path, using executive power to direct capital into strategic sectors. Can a country that runs persistent deficits really build one of the world’s biggest sovereign wealth funds? President Trump’s unconventional approach suggests yes. If successful, it could redefine the SWF model. How the US Is Redefining the Sovereign Wealth Fund To see why this approach is so unconventional, it helps to compare it with traditional sovereign wealth funds. A sovereign wealth fund is a state-owned investment fund that manages a country’s financial assets, typically derived from surplus reserves, natural resource revenues, or trade surpluses. These funds are generally managed by a country’s ministry of finance, a central bank, or a specialized government agency. But under President Trump’s executive order, America is carving an alternative SWF path, one that is distinctly bottom-up and industrial strategy-driven. Far from displacing private capital, it is increasingly proving to be a powerful “crowd in” catalyst for public-private investment partnerships. De-risking Projects and Crowding In Capital Nowhere is this more evident than in the Department of Defense’s (DoD) $400 million equity investment in MP Materials , the only rare earth producer in the United States. Under the Defense Production Act, the Pentagon is becoming MP Materials’ largest shareholder, with a potential 15% stake and long-term offtake agreements to buy 100% of the magnets made at the company’s new facility. This investment enables the United States to secure critical mineral flows, countering China’s dominance in this space. The DoD’s commitment has attracted $1 billion in private financing from JPMorgan Chase and Goldman Sachs to build MP’s new “10X” magnet manufacturing facility in Texas. Wall Street followed because the US investment de-risked the project with guaranteed procurement and revenue certainty. The same playbook is now being tested in the digital asset space. In March, the Administration announced the creation of a US strategic bitcoin (BTC) reserve, which was seeded with over $5 billion BTC seized in law enforcement actions and will be supplemented by budget-neutral acquisition strategies. Another case at the intersection of politics, technology, and capital markets is TikTok. Executive orders have granted TikTok a reprieve from a sell-or-ban order, and the administration has signaled interest in taking a stake through golden shares, granting veto power over key corporate decisions. Global Parallels and Key Differences Although these US moves may look novel, similar strategies have been used in other advanced economies, including Germany’s use of its sovereign fund KfW. For instance, the 50Hertz transaction in 2018 saw KfW orchestrated an investment to prevent State Grid Corporation of China from acquiring a stake in a critical utility infrastructure. Furthermore, it is the general practice of global sovereign wealth funds to seek both strategic industrial promotion and financial returns in their investments. The sovereign capital could avoid crowding out and unlock private capital when serving as a co-investment platform. What sets the United States approach apart is that the proposed sovereign wealth fund is a decentralized, transaction-driven model. With multiple agencies leading strategic investments, this federated approach departs from traditional SWF orthodoxy. Another distinguishing feature of the US approach is its reliance on foreign capital tied to tariff agreements. Foreign Capital and Tariff Revenue The bigger components of the US sovereign wealth fund are now coming from foreign capital as part of the tariff agreements with global nations. This week, the Administration announced a US-Japan Strategic Trade and Investment Agreement, and Japan has pledged to invest $550 billion to rebuild and expand core American industries, including semiconductor manufacturing, research, and pharmaceutical production. It could mark the beginning of co-investment partnerships with global sovereign fund peers. The United States has asked South Korea to help create a manufacturing cooperation enhancement fund to finance Korean firms expanding production in the United States. Finally, as part of the US-EU trade deal reached days ago, EU companies have expressed interest in investing at least $600 billion in various sectors in the United States by 2029, according to the European Commission’s explanation. The Road Ahead: Strategic Sectors and Risk Looking ahead, the central question is how this decentralized model will shape strategic sectors and market risk. It is emerging as a platform for co-investment in politically sensitive areas, guided by governance protocols. For investors, the test is whether it reduces risk and creates opportunity, or whether political involvement complicates capital allocation. Stargate, the $500 billion AI data infrastructure initiative led by OpenAI and SoftBank, could find the US sovereign wealth fund a crucial partner. The White House’s “Winning the AI Race” plan calls for fast-tracking permits for large-scale data centers and energy supply. Yet six months after its launch, Stargate is struggling to gain traction and may be scaled back, despite a $30 billion-a-year, 4.5 GW partnership with Oracle. Long-term US SWF support could reduce risk and attract private capital. Some AI chip-related funding is already being directed to the US sovereign wealth fund, and Washington may continue to draw on new revenue streams. In August, President Trump negotiated an agreement allowing Nvidia and AMD to resume certain semiconductor sales to China in exchange for

Looking for a way to “beat the market” in 2024 and beyond?  If so, you’ve probably heard about the market-beating potential of private equity investments. The most recent U.S. Private Equity Index from Cambridge Associates reports an average return of about 15% from June 2003 to June 2023, compared to 10% on the Russell 3000 Index. However, before diving into private equity investing, everyday investors should be aware of a few important considerations.  For almost 100 years, the world of private equity was largely “off limits” to Main Street investors. Legally speaking, only accredited investors were allowed to invest in private equity offerings. But thanks to the Jumpstart Our Business Startups (JOBS) Act — and an influx of new publicly listed private equity offerings — everyday investors are seeing a Cambrian explosion in access to private equity opportunities. How Private Equity Investing Has Changed in Recent Years It is worth noting that private investments such as private equity, hedge funds, and venture capital funds typically require individual investors to be accredited: they must have an income of more than $200,000 for an individual and $300,000 if married and filing jointly for two years prior to investing, or a net worth of $1 million, excluding a primary residence. In the early ’80s, only 1%-2% of households were considered accredited. However, because the financial thresholds to become an accredited investor have not been indexed to inflation, more than 13% of all American households now qualify. Despite this growing number of eligible households, private equity still operates like a private club. To get access to opportunities, you probably need to be a client of a name-brand financial institution. That’s not to mention the administrative challenges like 200-page subscription documents, underwriting, and complicated terms most people don’t understand. With that said, the biggest innovation in private equity has been the JOBS Act of 2012. Thanks to this landmark piece of legislation, two important things happened.  The first was lifting the ban on “general solicitation” and advertising for specific types of private market deals. Before this ban was lifted, the only way to get into a private deal was to “know a guy,” as it was otherwise illegal for them to advertise the opportunity. However, those offerings — called Rule 506(c) of Regulation D — were still restricted to accredited investors only.  Then, in 2016 Title III of the JOBS Act went into effect, introducing a new framework that allowed both accredited and nonaccredited investors to invest in private market deals. More commonly known as Regulation Crowdfunding, this framework created a new pathway for companies seeking investments to raise capital from anyone over the age of 18, regardless of income or net worth. There’s no doubt the JOBS Act transformed investment banking and capital markets as we know it. but the looser regulatory and disclosure requirements carry risks and may open the door for increased fraud. The Biggest Risks of Private Equity Investing One of the most common questions asked by people considering private equity is some version of, “How much can I make?” and “How fast can I make it?” While there is a potential to make significant returns in a short period, there is also plenty of risk that comes with it.  Outright fraud is always a concern when it comes to early-stage investing. But outside of that, the key risks are the same fundamental risks that are present in any investment:  Valuation Risk: Are you investing at a good price? If the goal is to make money as an investor, you don’t want to hurt your chances by overpaying. Execution Risk: Can the management team execute on the business plan they’ve presented? If not, the returns likely won’t be what you expect. Market Risk: Could forces outside of the management team’s control damage the company? It happens all the time, and that’s just part of the risks you’re signing up for as an investor. However, most retail investors cannot accurately evaluate these risks and, therefore, have difficulty understanding the exact risks they are taking at the price and terms being offered.  What Are the Tax Implications? Unless you’re investing into a fund structure — or otherwise receiving income reporting on a K-1 or 1099 — there really are no tax implications outside of normal due course. If you’re investing in private credit or cash-flowing real estate deals, taxes will be a consideration. Otherwise, for most private equity plays, it’s a three- to five-year hold, at least.  The only time you would incur tax liability would be on the asset’s sale (or disposal). This means you would be taxed at the long-term capital gains rate, just like any other investment you’ve held for more than 12 months. 5 Strategies for Investing in Private Equity as an Everyday Investor With all the nuances, it can be difficult to navigate private equity investing. Here are five steps for everyday investors to incorporate private equity investments into their portfolios while balancing risk with potential returns: 1. Develop a comprehensive financial plan. Before making any investment decisions, it’s crucial to have a well-defined financial plan that aligns with your personal financial goals. This plan should encompass budget management, cash flow, expenses, and essential recordkeeping, as these factors contribute significantly to achieving financial objectives. 2. Create an Investment Policy Statement. Establish an investment policy statement — a written document that outlines your portfolio allocation, target returns, and rules for rebalancing. It’s essential to base your investment strategy on reasonable forecasted returns, typically in the 6%-10% per year range. Avoid the temptation to pursue excessively high returns, as this can lead to taking on unnecessary risk. 3. Focus on Downside Protection and Liquidity. For retail investors managing their money, prioritize downside protection and liquidity, especially in the current late-stage market environment. While taking calculated risks is important, ensure that you can hold quality positions through market downturns and avoid being forced to sell assets at a discount due to short-term cash flow needs. 4. Seek Professional Advice. Consider getting help

Private credit in Europe’s lower mid-market offers something increasingly rare: structural inefficiency that favors investors. While the United States dominates private credit by scale, Europe’s reliance on banks, smaller fund sizes, and regional fragmentation leave a persistent financing gap for firms too small for global capital markets but too large to depend solely on local banks. This creates a compelling, and likely durable opportunity for private credit funds with local market expertise. Despite lower base rates, borrowers in Europe are paying higher spreads and fees as the all-in yields in Europe and the US are broadly similar. Further, bank retrenchment and concentrated fundraising among the largest funds have left the fragmented lower mid-market less competitive. For investors, that means an attractive entry point today. Structural inefficiencies continue to preserve pricing power, making partnership with the right managers critical. Access to debt financing is critical for the growth of small- and medium-sized enterprises (SMEs), which form the backbone of the European economy. According to the European Commission, SMEs represent more than 99% of the European Union’s 32.3 million enterprises. The lower mid-market — firms with 250 to 5,000 employees — comprise roughly 8% of EU businesses, or about 2.6 million companies. Historically, SMEs have relied heavily on banks, particularly in continental Europe. Stricter capital requirements imposed on banks post-financial crisis have constrained bank lending, in turn hitting the lower mid-market especially hard, particularly outside major financial hubs such as London or Frankfurt[1]. Private credit has stepped in to partially fill this gap, but capital is increasingly concentrated. In 2024, 94% of all private credit capital raised globally went to the largest 50 funds, up from 81.5% a year earlier[2]. As a result, terms and pricing in the upper mid-market (typically EBITDA > €25–30 million) have largely converged between the United States and Europe, with borrowers enjoying ample access to credit. In contrast, the lower mid-market remains fragmented and less intermediated, creating a structural opportunity for non-bank lenders and offering greater degree of transaction control and pricing power. Recent research by Aksia supports this conclusion[3]. Quantifying the Opportunity To compare the European and US lower mid-market landscapes, we gathered data on direct lending funds in both regions from various data sources[4]. In total, we considered approximately 20 senior secured loan funds in each region.  While not statistically exhaustive, the analysis reveals several consistent patterns. All-in yields in Europe are slightly higher than they are in the United States, despite lower base rates. This has been the case since mid-2022, the start of the Federal Reserve and European Central Bank rate hikes. As of September 1, 3-month SOFR stood at approximately 4.03% versus 3-month Euribor at roughly 2.07%. While difficult to measure empirically, this suggests that borrowers in Europe face higher spreads, higher upfront fees, or both.   More importantly, we observe more conservative deal structuring and risk profiles in Europe, particularly in terms of leverage. In cash flow-based loans, leverage (Debt/EBITDA) tends to be lower in Europe: our sample suggests a difference of approximately 0.5x. From our own market observations, debt-to-ARR multiples in the software sector peaked at around 2x in Europe and have since fallen to below 1x, compared to current US levels of 2x, and as high as 3x at the peak. Why the Gap Persists The attractive risk-reward profile in European lower mid-market private credit reflects a combination of structural inefficiencies and cyclical dynamics. While market conditions may evolve, many of the underlying drivers point to a lasting transatlantic gap. Cyclical factors include interest rate and currency differentials, which affect base rates and hedging costs. Europe’s weaker recent macro backdrop including slower growth, geopolitical uncertainty, and energy shocks, has tempered lending appetite. In contrast, parts of the US market have shown signs of exuberance, with tighter spreads and looser structures. Structural differences like a shallower institutional capital pool, bank dominance, and borrower conservatives are more enduring. The European private credit market remains less developed than the US market.  In 2024, North America–focused private credit funds captured ~72% of global capital raised[5].  Since 2008, ~70% of private credit capital has been raised in North America and ~25% in Europe, according to the RBA summary of IMF/PitchBook work. While capital flows might be shifting, the depth and dynamism of the US market means near-term convergence is unlikely. As of December 2024, European direct lending dry powder stood at approximately $80 billion, down from nearly $95 billion a year earlier, whereas North America hit a record $167 billion in December 2024, up 17% year-on-year[6]. In addition, the more advanced private credit landscape in the United States also gives North American managers the ability to employ scale-enhancing tools such as fund-level leverage and co-investments more readily. This disparity illustrates the depth and efficiency advantages in the US market. At the smaller end of the spectrum, the gap widens. Since 2023, 453 North America-focused direct lending funds below $2 billion have been raised, compared to just 185 funds in Europe[7]. Investor preferences reinforce this divide. European LPs, typically more risk-averse, have limited appetite for niche strategies. Instead, they have favored large, plain-vanilla direct lending funds offered by the biggest US managers. On the demand side, European borrowers remain more conservative, with smaller deal sizes, slower decision-making, and less familiarity with structured credit. Such cultural and behavioral factors reduce transaction velocity but also limit lender competition and support more conservative structures with arguably superior risk dynamics. Bank reliance, especially in DACH (Germany, Austria, and Switzerland), and Southern Europe, further entrenches the gap. While non-bank lenders have grown market share in sponsor-led transactions — accounting for 56% in Germany in 2024 and 20–40% in Spain over the past two years — most SMEs still lack access to tailored credit.  Combined with Europe’s legal, cultural, and regulatory fragmentation, and the need for local presence across multiple jurisdictions, these structural factors make near-term convergence unlikely, particularly in the lower mid-market. Implications for Investors Europe’s private credit market has progressed just as investor sentiment towards the asset class has shifted. Borrowers in the upper mid-market have

“We don’t think we were wrong. We think we were early.” A cringe-worthy answer that rings alarm bells for investment consultants. Higher inflation, increased market volatility, and more variable nominal interest rates are significant opportunities for active managers who can demonstrate their value with differentiated, customer-centric products. But with active management under ongoing scrutiny, investment managers are being caught off guard by tougher questions from an increasingly sophisticated allocator market. Are you prepared for your next beauty parade? The Changing Conversation Between Allocators and Managers I recently sat down with manager selection experts Evan Frazier and Joe Wiggins. During our conversation, they shared the tough questions that investment consultants and asset allocators are now asking prospective managers. Frazier, CFA, CAIA, is a senior research analyst at Marquette Associates in Chicago and Wiggins is director of research at St. James’s Place in London and author of a popular blog about investor behavior. The following are four of the most productive and challenging questions, as well as the motivation behind them. If you were to run your strategy systematically as an algorithm, how would you do it? Wiggins looks at three main aspects when evaluating a portfolio manager: The manager’s beliefs about markets and their competitive advantage, The manager’s decision-making process and its consistency with their beliefs, and The outcomes generated by those beliefs and processes. This question focuses on the manager’s process. The manager’s answer reveals the extent to which they have thought through the best use of their human energy, and the extent to which they have embraced technology to do the things that can be done systematically. What are some mistakes you’ve made throughout the strategy’s history or your tenure? How have you reacted? “Every PM loves to talk about — and can talk about — the winners that they’ve had,” Frazier notes. “But I think it’s helpful to get a sense of when things may not have worked out.” Allocators want to hear, and ideally see evidence, that the manager has reflected on their mistakes without just blaming bad luck. They are interested in understanding what lessons were learned and how those insights are being applied to achieve better outcomes in the future. Demonstrating humility, accountability, and objectivity goes a long way with sophisticated investors in this day and age. Assuming recent performance is not necessarily a good indicator of your actual skill level, how do you measure the success of your decision-making? This is one of Wiggins’ preferred questions from an outcomes perspective. He’s not looking for a specific answer. He wants to know if the fund manager has thought about this question because it provides insight into the philosophy and approach behind their strategy. “If they were taking a view that headline performance was all you needed to know to assess whether someone had skill or not, I would be incredibly skeptical,” he says. This gets to the heart of our Behavioral Alpha Benchmark: It looks beyond the historical returns and the effects of luck to measure a portfolio manager’s demonstrated skill across a range of investment decision types. How has your investment process evolved over time? Frazier and Wiggins agree on this one. Investors want to see that the manager is consistently making decisions that are aligned with the fund’s philosophy, but they also expect the investment process to evolve as technology advances. “Clearly no investor has got an unimpeachable or perfect process,” Wiggins remarks, but he cautions that a change to process should not be based solely on a single, painful example. “You really want to build up an evidence base and recognize patterns in your process and decision-making about where you can potentially make enhancements.” More and more, active managers are realizing that there’s no longer a competitive advantage to being smarter than everyone else or even to having access to better information. As I’ve discussed previously, what’s left is “behavioral alpha” — the excess returns that can be generated by “knowing thyself” and being more focused on self-improvement than the next person. And that starts with asking yourself hard questions. It’s clear that the landscape of active fund management is shifting. Transparency is increasing, data is more accessible and cheaper alternatives abound. Managers who are caught off guard by the tougher questions being asked by the sophisticated end of the allocator market are at an avoidable disadvantage. The good news is that a new generation of both allocators and fund managers is more committed than ever to continuous improvement, fostering true partnerships and doing their best for end investors. source

What’s the outlook for the office real estate sector and regional banks? In “Sonny Kalsi: Navigating Bank Failures and Commercial Real Estate Holdings,” a Guiding Assets podcast from CFA Institute, Paul Andrews, head of Research, Advocacy, and Standards at CFA Institute, speaks with Sonny Kalsi, co-CEO of BentallGreenOak (BGO), a leading global real estate investment management adviser and provider of real estate services with approximately $83 billion in assets under management (AUM), about the sector’s prospects. Financial market practitioners and observers have grown increasingly anxious this year about the health of the economy and particularly about the banking sector’s exposure to the real estate sector. The collapse this year of Silicon Valley Bank (SVB) and Signature Bank, as well as the hasty acquisition of First Republic Bank, has convinced some market players that regional banks, which are already under financial stress, may now face a potential crisis in the shaky commercial real estate sector. Of greatest concern is the banking sector’s exposure to the office sector. Andrews opened his discussion with Kalsi with the systemic risk issue: “With many banks holding large portfolios of real estate, what do you see as the end game, particularly from both a systemic risk angle as well as the banking angle?” he asked. Many big banks have retreated from real estate lending, and their lending to commercial real estate especially has gone down on a percentage basis, Kalsi said. But the non-bank sector has stepped in to help bridge the lending gap. “Non-bank lenders are often getting repo financing from those same big banks. Regional banks are now providing a huge amount of real estate lending and are probably at least one-third of the real estate lending that’s been happening and have been a big part of the incremental real estate lending for the last five years,” he explained. “So, the long answer to your question is, I think, the regional banks have a fair amount of exposure there.” The two big issues to consider are liquidity and the condition of office real estate, according to Kalsi. “There’s no financing available. The big banks aren’t providing it, and the regional banks are now no longer providing it.”  Because commercial real estate is a large category, Kalsi believes there are sections of it that will be less problematic. He cited the industrial and multifamily sectors as examples. Multifamily is also buoyed by government-sponsored agencies that provide financing, he said. The office sector is a headache, he warned. “It’s not really the canary in the coal mine,” he said. “It’s the 800-pound gorilla sitting squarely in the middle of the room!” Regional Banks’ Challenge “So, what are the regional banks going to do? Are we just sitting on another time bomb?” Andrews asked. “Yes, I think It could be a time bomb,” Kalsi said, “but I think it’s going to be a time bomb with a long fuse.” Unlike a security, which is a short-term instrument that can be rolled over in the capital markets, many bank loans are structured such that the banks must themselves pull the trigger to create a default. “So, there are plenty of assets right now that are in technical default,” he said. “There might be lack of compliance with different covenants, maturity, defaults, etc., where a lot of the banks are just rolling them over because they know that their borrowers are in an illiquid market and not in a great position to refinance them.” Regulators will therefore hold great sway over whether and when the default time bomb goes off, Kalsi asserted. “You could argue that on the one hand the [regulators] caused this by the interest rate environment, right?” he said. “A lot of people got caught flat-footed. I didn’t think rates were going to go up at the pace that they did, but we knew rates were going up. So, I am a little bit surprised that some of these lenders got caught as flat-footed as they did. It’ll be interesting to see how the regulators approach this.” If regulators compel lenders to mark to market their positions, the result could be something ugly, Kalsi warned. “But if the regulators take it easy on them and give them time, then I think this is going to be a slow process.” Most Beleaguered Sectors  “I’ve said jokingly that office has replaced retail as the worst six letter word in real estate,” Kalsi said. For perspective, he noted that 10 years ago it was the retail sector that faced an “apocalypse.” “No one was shopping in stores anymore,” he said, and although retail asset values are down 30% to 50% over the last 10 years and many tenants have gone bankrupt, those retail tenants that survived face less competition and thus there is a better business environment for them now. “So, retail has found its footing somewhat and is doing okay,” he said. “I think that’s what’s going to happen with the office sector. But remember, I said 10 years. The office sector is going to take a while to find its footing. Therefore, we must decide to be patient to work through that, and regulators will have to decide if they’re going be patient or if they’re not,” Kalsi said. So, if regulators are patient, we won’t face another huge systemic risk event? “I hope that we don’t face another systemic risk event,” Kalsi replied. “I’m not going to name names, but there are certain lenders out there for which 30% to 40% of their book is commercial real estate,” he said. He declared that those banks have issues, pointing to the failures at SVB, First Republic, and Signature Bank this year as examples of the kind of failures that could be in the offing. “I’m not a banking expert. But if I were a betting man — which I am — I don’t think we’re done with three banks. I think we’re going to see more.” “The members of CFA Institute are asset owners, asset allocators, intermediaries, etc. How would you

Artificial intelligence (AI) was the most raised issue in the past 12 months among asset manager respondents to the annual Index Industry Association (IIA) member survey. Sustainable investing, thematic investing, and customized investment, respectively, ranked as top of mind after AI among survey respondents. Overall, the results illustrate that the asset management industry in Europe and America is in transition, facing mounting levels of complexity and a need for new partnerships, new and more specialized information sources, new skills, and stronger ecosystems and alliances. Background Four years ago, IIA began publishing a survey in partnership with our member firms and fielded with the support of Opinium Research. Each year, we engage with 300 chief investment officers, portfolio managers, and chief financial officers across a wide range of investment providers in the United States and Europe to gauge how asset managers view progress against current challenges and opportunities, and the key factors shaping the longer-term evolution of the industry. When we started this endeavor in 2020, the goal was to make sure index providers understood the future needs of asset managers in terms of environmental, social, and governance (ESG)- and sustainable-related indexes. Based on our learnings over the last three years and feedback from our IIA members, we decided to broaden the 2024 survey beyond ESG- and sustainable-related questions. ESG and sustainable investing of course remain central and material to global investors, but we wanted to make sure that our aperture was wide enough to capture the full pallet of drivers and trends impacting our clients. I am so glad we took this approach as our findings revealed a much deeper set of challenges, opportunities, hopes, and concerns. What is clear from this year’s results is that industry is facing growing complexities. What Factors Will Have Greatest Impact on Investment Performance? We asked which factors over the next 12 months would have the greatest impact on investment performance. Over the next year, asset managers are more keenly focused on macroeconomic issues like interest rates, inflation, and a potential economic slowdown than they are elections and geopolitical events. Notably, 81% of US respondents prioritized interest rates and inflation as the most important issues. We asked managers what trends they have been thinking about the most during the last 12 months. I was surprised by the substantial number of respondents who ranked AI as their most raised issue, overtaking sustainable investing. Other technological issues like tokenization and blockchain were only raised by approximately 10% of managers. Managers focused on thematic investment and customized products after sustainable investing. Only about 25% identified crypto products as a topic they are discussing with their colleagues — about the same percentage as those thinking about how to bring private markets into their firms’ offerings. Generative AI: A Game Changer One big dividend from our decision to expand the range of topics in this year’s survey is the insights we gained around AI, and what it means in the eyes of asset managers. ESG Exuberance Tempers We revisited ESG and sustainable investing in this year’s survey to see if the torrid pace of growth cited in prior years was continuing. What we found is that while ESG is still a very important part of global asset managers’ strategy, the high expectations for future growth we saw in prior years of the survey have tempered. When viewed over the four-year arc of the survey, survey respondent expectations for ESG portfolio implementation have come back to earth after the spike we saw in 2022 and 2023, landing back down near 2021 levels. For us, this indicates not that ESG is going away, but rather that it is settling into a more realistic long-term growth curve. Once again, environmental factors (the “E” in ESG) continue to be most on the radar of investors when it comes to sustainability. Private Markets: A Puzzle to Solve Private markets continue to be an area of opportunity for global asset managers but also an area of challenge, according to our survey. While asset managers like the concept of private markets for investment opportunity and diversification, they cited several challenges when it comes to implementation. Difficulty integrating private equity into their investment lineup, liquidity concerns, and data gaps were cited as top-of-mind issues. This is not surprising given the historically slow pace of the development of global indexes which capture private equity market data and performance. Index Providers in Demand While our survey pointed out several categories that represent significant challenges for our clients, it was encouraging to see that asset managers’ top four areas to partner with index providers are for sustainable investing, direct indexing, thematic investing, and customized investment solutions. The survey shows that more than half of respondents believe that index providers and the services we offer will become more important to their success in the next 12 months. Importantly, about 20% expect to use more index providers in the next 12 months. This is a very high-level snapshot of our survey findings. I invite you to take a deeper dive into this year’s results. I welcome your feedback and suggestions for future research. source

Environmental, social, and governance (ESG) ratings should reflect the risks that such factors pose to a company’s financial performance and how well equipped that company is to manage those risks. Such ratings may assess carbon emissions (E), health and safety in the workplace (S), and executive compensation structures (G), among other criteria. ESG ratings are predicated on the notion that companies with better ESG scores will exhibit better financial performance over time because they face lower ESG risks, are more adept at managing them, or some combination thereof. As a corollary, assuming markets are efficient, higher ESG ratings should also lead to higher valuations. So, do better ESG scores correlate with improved financial performance, or better valuations? There is no simple answer. The literature is diverse and lacks clear consensus. Part of the problem is how to conduct the assessments. Should researchers compare companies in different industries? What role should balance sheet size or market capitalization play? How long is a suitable observation period? What is the proper measure of financial performance — return on assets, net income, operational expenditures (opex) ratios, free cash flow, revenue growth, or some combination? For market valuations, are market prices sufficient, or should they be adjusted for volatility and liquidity? Should the effect of rising (or falling) ESG scores be taken with a lag, and if so, how much of one? In order to provide a clear, if limited, signal, we formulated a narrow hypothesis: that the bond market views companies with better ESG ratings as better credit risks, and as such, these firms’ corporate bonds should have lower risk-adjusted yields. If the effect is significant, a sample set that adequately reflects the overall market should demonstrate the effect at any given point in time. We created a universe of large US companies with ESG ratings and with publicly quoted bonds maturing in 2024 and 2025. We selected 10 issuers from each of the 11 sectors defined in the S&P 500 methodology and derived their risk-adjusted yields (credit spreads) by subtracting the comparable maturity US Treasury yield from the current corporate bond yield. We took all our observations from a single two-day period, 6–7 April 2023, and sourced our ESG scores from Sustainalytics. According to our hypothesis, corporate bond credit spreads should have a negative correlation with ESG ratings. After all, better ESG ratings should result in higher bond prices and thus lower risk-adjusted yields. But that is not what we found. There was, in fact, no significant correlation. As the graphic below demonstrates, our results show wide dispersion and an R-squared of only 0.0146. In fact, since Sustainalytics uses an inverse rating scale in which lower scores indicate better ratings, the line of best fit actually slopes away from our hypothesis. That is, better ESG ratings actually correlate with higher credit spreads. Company ESG Scores vs. Risk-Adjusted Bond Yield The correlation coefficients varied substantially by sector. Utilities and four other sectors show some support for the hypothesis, or positive correlation, given the inverse ESG ratings scale. Communications Services and four other sectors support the contrary view, that better ESG ratings are associated with higher yields. Of course, with only 10 issuers per sector, these results may not be indicative. Correlations by Sector Sector R-Value Communications Services –0.66 Financial –0.29 Health Care –0.26 Technology –0.12 Consumer Staples –0.03 Energy 0.00 Industrials 0.01 Materials 0.02 Real Estate 0.02 Consumer Discretionary 0.19 Utilities 0.45 Average –0.06 Why might bond investors ignore ESG scores when making investment decisions? Several factors could be at work. First, credit rating practices are well-developed, and credit rating agencies are far more consistent in their determinations than ESG rating agencies. So, bond investors may feel that ESG scores add little to their credit risk assessments. Also, even if bond investors believe ESG scores convey real information, they may not view the risks such metrics measure as the most salient. The bond buyer is concerned first and foremost with the company’s contractual obligation to make debt service payments in full and on time. So, while employee diversity and the structure of the board of directors may loom large in ESG ratings, bond buyers may not view them as especially critical. If you liked this post, don’t forget to subscribe to Enterprising Investor. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images /Liyao Xie Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source