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As the alts industry has amassed assets at an increasing pace, private equity often gets much of the attention, but private credit is a growth story in its own right.
Nelson Chu, founder and CEO at Percent, joins Andy Hagans to discuss the Percent private credit platform, and how individual HNW investors and RIAs can take advantage of opportunities in private credit.
- Background on Nelson’s career, and how he got started in finance.
- An overview of the private credit asset class.
- Whether private credit should be considered as a substitute for fixed income in the context of a portfolio, or if it should be classified as an “alt.”
- How the Percent platform works, and its varied product offerings that are available to accredited investors.
- Why private credit can be an appealing asset class for impact investors, and how it is helping to improve the lives of entrepreneurs and consumers in emerging markets.
Featured On This Episode
- Investing in Venture Debt Gives You Exposure to Fast-Growing Businesses (Percent)
- Percent’s 2023 Private Credit Outlook (Percent)
Today’s Guest: Nelson Chu, Percent
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to the Alternative Investment podcast. I’m your host, Andy Hagans. And you know what they say, income never goes out of style. At least that’s my quote. I’ll stand by it. So very excited that joining me today is Nelson Chu, who’s founder and CEO at Percent. Nelson, welcome to the show.
Nelson: Thanks so much for having me. And, I 100% agree with that quote and we’re gonna talk all about it today.
Andy: All right. I want to find the high-net-worth investor or RIA, who says, “No, Andy, I hate income, and income is out of style.”
Nelson: I have yet to meet one, so, you know, I think we’re in good company there.
Andy: Okay, great. So before we dig into Percent, this is a really cool platform, but why don’t we start with your background? How did you get started in the private credit sector?
Nelson: Yeah, absolutely. It’s an interesting journey for me I think over the years. In many ways, I feel like I was always destined to be an entrepreneur, for better or worse. I was probably the most rebellious child you could possibly ever imagine. My parents absolutely had enough of me after a certain point, and I didn’t follow a traditional path, right? They wanted me to go to an Ivy League school, be a doctor, lawyer, or banker, and I just basically bucked all those trends.
Didn’t go to an Ivy League school. Spent a very minimal amount of time in finance, where I learned absolutely nothing about finance whatsoever, definitely not about credit, that’s for sure.
Andy: What did you learn? What did you learn? If you didn’t learn about finance, I assume you learned something.
Nelson: I learned about red tape, bureaucracy, and politics, probably is what I learned in traditional finance. So no, no regrets either way. I think it actually teaches you a lot, and I actually always encourage everyone to go through corporate at least once or twice. I think it teaches you about perfectionism. It teaches you about professionalism. Email writing is an art, no matter what. And so, I learned all of that in finance. Just the actual finance side, not so much. But, you know, that’s okay. Water under the bridge.
But after that, I kind of set out to do my own thing. I helped launch or I founded a consulting company that basically helped other founders build their companies from the ground up. Definitely not finance-related. But because of the finance background, I actually always got a lot of fintech clients, for better or worse. And so, even though I tried to avoid finance, I kept going back to finance and it worked out totally fine. So we had…
Andy: Finance, I just can’t quit you. Right?
Andy: I’m the same way. I’m the same way. Just when I think I’m out, they pull me back in.
Nelson: I quit my last job in finance in 2013 and I was, like, I will never do finance ever again. And those are very, very famous last words because here we are building probably one of the most difficult platforms in fintech and in finance with private credit and with infrastructure in that space as well. Right?
But yeah, so did the consulting company for about five years. Had a lot of great clients coming out of that, some of which you probably definitely know. And at that point I was thinking, it’s 2017, 2018, we have a good team that knows how to build products, we have good access to VCs for the right idea at the right time. We should do things the old-fashioned venture backed away. And that’s really how Percent came to be.
So it was really seeing a gap in the market where we thought there was a tremendous opportunity to make private credit and alternative investments more approachable for the average investor, whether it’s through shorter durations, lower minimums, good yields. All that worked out really well for us.
We got a lot of users at the outset. And now, that we’re in a higher rate environment where the actual risk of sitting on the sidelines is even higher, we’re coming out to market and peaking at a really good time, and it’s making for a very good opportunity for investors to see a good risk-adjusted returns through things like private credit, which they likely probably didn’t have exposure to before because they didn’t need to, because equity markets were ripping. And now, you kind of have to find a way to get a return in a year like this and last year as well.
Andy: So current environment, basically higher inflation. Inflation, the silent killer. That reminds me of “The Simpsons” episode. I think it’s Troy McClure. He’s like, “You may remember me from movies like Firecrackers, the Silent Killer.” But inflation is the silent killer, right? And I mean, having a lot of dry powder, having a lot of cash, when inflation is 2%, you can kind of squint and round that down to zero, right? But when it’s 6%, 7%, 8%, 9%, arguably, it may be higher depending on where you live…
Nelson: Kind of whether you believe CPI is a real number or not, but yeah.
Andy: Well do you? Do you believe CPI is a real number?
Nelson: Not really, no. I think it’s probably understating some of it at this point. But yeah, no, right? Like, I think CDs and Treasuries these days, yielding 4%, 5%, 6% feels good compared to what it used to be, that’s for sure. But you’re not beating inflation. So you gotta find something else at that point to be able to offset all of that.
Andy: Yeah. And, you know, with a 4%, 5% CD, whatever, also keep in mind, if that’s taxable income, taxable yield, and now you’re really behind with inflation. And family offices, very high net worth, ultra-high net worth investors, you know, a lot of this stuff we cover, private equity, real estate, you know, all these tax-advantaged investments. The triple net aspect is so important. So you need to make sure you’re playing enough offense with a high enough yield and then also make sure you’re looking at that whole tax picture, right?
And if inflation is basically eating up all of your gross return and then some, then that’s where I feel like paying taxes, it’s like salt in the wound. Like, because you just lost money in real terms, but we’re gonna tax you in nominal terms. Am I wrong about that? Where am I going wrong?
Nelson: No, you’re not wrong. But in order to finance the deficit, we got to make some money from somewhere. So the IRS is more than happy to take our money, for better or worse.
Andy: Okay. So before we dive into Percent, and…I mean, the platform is really cool. So we’re gonna talk about that a lot. But I wanna step back and talk about the asset class in general. So in our audience, we have a lot of high net worth, very high net worth, ultra-high net worth, RIAs, basically, folks managing larger portfolios. They’re open to alternatives in general, right?
I think we’re a little bit preaching to the choir on the Alternative Investment Podcast. But, you know, when I talk to a lot of high-net-worth investors…there’s a ton of them. I don’t know the statistics maybe you do. But a ton of them are not invested in private credit at all. So what’s the case for this asset class? Does this belong in every portfolio?
Nelson: Yeah, that’s a great point and I don’t blame them. Right? I think private credit as a, well-understood asset class that’s really kind of hit its stride, didn’t really happen until after the global financial crisis. So after ’08, when the banks really stopped lending to consumers, to small businesses, you had this rise of nonbank lending that emerged. Right? These are guys who probably raise VC capital, don’t really have a balance sheet since they’re not a bank and they’re the ones, kind of, powering the growth of the broader economy as a whole without a balance sheet to do it.
And so, as a result of that, you had a lot of these credit funds, asset managers providing the capital to finance these lenders who can then finance these loans for these small businesses and consumers.
So it is a very recent phenomenon, call it 12, 14 years, give or take. And so, it makes sense that the average person either hasn’t heard of it or hasn’t really invested in it, but the reality is they’ve probably interacted with it in some way, shape, or form, which we’ll go into it a little bit.
But at this stage and at this rate, the 60/40 model is most definitely dead. I would hope it’s dead for the average listener at this point, just based on the sheer number of things that are investable. I think real estate tends to continuously be what’s viewed as the best alternative, per se, to stocks and bonds, which is pretty normal, right? So a lot of people have access and exposure to real estate. Some of them may have exposure to private credit through some of their funds that they invest into, but they might now know exactly what goes into it. So in terms of just…yeah.
Andy: Yeah, Nelson, just an interesting point there. Some of the larger, not the largest, like, institutional, but, you know, in the world of 506(c)s and some of these private real estate funds, some of the more of what I view as the more sophisticated ones, they’ll have credit funds, they’ll have their equity funds.
And so, it’s interesting what you mentioned. Real estate. It obviously is the 800-pound gorilla in the alts world. But the more sophisticated managers, I think they’re kind of playing on both the equity side, but also the credit side. And I think they look at it almost, like, we wanna be flexible. And a certain year might be more of a year where we wanna put equity to work. And then there might be other environments where actually we’re more bullish on credit right now.
Nelson: You could put both to work too, right? Because in a lot of these situations, the credit side needs the equity side. And so, you can almost control the outcome of your returns and your investment with some of these asset managers because they’re putting in the equity tranche and they’re putting in the debt tranche and essentially guarantee the survival of a lot of these companies as a result of that. So that in of itself is a really good position to be in that just really wasn’t possible before.
And when you think about the environment that we’re in today, where real estate obviously has taken a big hit as a result of the rates going up and the average maybe, like, millennial who’s trying to buy a house right now, has never seen rates this high in their entire life. It’s a shock, right? And you’re seeing this impact a lot of the real estate funds that are out there.
And so, fortunately, for better or worse, a lot of these funds like Blackstone, KKR, Aries, and all these guys, have both a real estate fund and a private credit fund. And the private credit fund, at this point, is outpacing the real estate funds and really any of the other ones at this point, right? Private credit as…
Andy: Outpacing in terms of inflows or in terms of returns?
Nelson: Both, yeah. I mean, I think the most recent stats were that private credit was number three in terms of demand and interest for it as an asset class in the latter half of 2022. I think that’s PitchBook data. That’s coming from the fact that, you know, there is a need to get consistent returns that’s really asset-backed at the end of the day.
And yes, real estate is asset-backed, or it is a hard asset ultimately underlying it all. But the reality is it’s completely up to the whims of the market, right? And so, in a high rate environment, you’re gonna get a lot of, I would say, probably redemptions on the real estate side, which Blackstone definitely has been facing and you’re seeing it in the news.
But the private credit side has held strong and it’s been resilient. And so, in terms of being a recession-resilient asset class, a truly recession-resilient asset class, private credit is really interesting. And so, just to give a little bit of a primer onto what private credit actually entails since like I mentioned, a lot of people have probably interacted with it in more ways than one, but there’s two different arms of private credit.
There’s the asset-backed side, which is essentially securitizing cash flows coming out of things that generate interest income or cash flows. So, for example, loans. So these nonbank lenders, whether it’s consumer lending or small business lending, you can create a package of, let’s say, a thousand loans that have interest being paid off of that on a regular basis.
And you can essentially create a structure that ensures that the investor principle is protected because you can advance 60% of the total loan value, as an example. And you can also put other risks and mitigants in there to protect in the events of a default or anything like that, where you then repossess the assets or the loans or whatever it may be. So that’s one option.
The other side is more on the corporate debt side. And so, corporate debt is kind of exactly what it sounds like. You’re essentially lending to or financing a single company. There’s a single counterparty risk in that instance. And you either have to believe in the long-term growth story of the company if it’s venture-backed, or you believe in the cash flows and EBITDA that it’s spitting out, right? In which case, that is going to work perfectly fine.
So these two sides of private credit are things that have continued to grow over the year. I would say ABS, the asset backside, has probably grown quite a bit recently as a result of these nonbank lenders. And so, when you talk about nonbank lenders, you’re thinking things like SoFi, Affirm, all these guys from back in the day, like, lending 1.0 that have grown very quickly.
But now, there’s new companies coming out like Capchase and Wayflyer, and all these guys that, as a small business, you may have wanted to take money from them before. Or as a consumer, if you’re doing buy now, pay later, you might have wanted to interact with them before.
So it is a very, very common practice at this point for private credit. It’s just that you didn’t realize you were interacting with the asset class, to begin with. And I would say it’s probably better to be an investor in private credit than it is to be a taker of private credit because, obviously, you want to get a return instead of giving money to somebody else.
Andy: So you mentioned the two different broad types of private credit. I’m guessing one of them is further out on the risk-return profile, right? Am I right to assume that the asset-backed, would that be more like the A-grade corporate bond, and then you kind of move into more like junk bond or triple B, whatever we want to call it, territory?
Nelson: Yeah, actually there’s a wide spectrum on all sides, right? So there’s always the, call it the triple C’s of the world in the lower middle market range that is in ABS and corporate debt. Like, you could have a very early-stage lender, right? They’ve done 5 million, 10 million worth of loans. Are you going to give that a, you know, 5%, 6% APY deal? Definitely not. Right? They have no experience or track record to justify that. Versus a company that is about to go public that has done several billion dollars’ worth, they need a $500 million securitization. They can get it rated by a rating agency. That’s gonna get single-digit cost of capital. Right?
Nelson: On the corporate debt side, if you’re doing venture debt, so backing a company or providing a corporate loan to a company that has probably not a line of sight into profitability, realistically, but has a lot of cash on hand from the venture capitalists who back them, that’s gonna be a little bit risky, right? But it has high-risk adjusted upside because you probably get warrants in the company or something like that. So that’s that equity debt split that you and I were talking about earlier, right?
But then, if you’re doing, like, middle market lending or bank commercial lending, these are loans that are upwards of $7500 million to companies that are generating $300 million in free cash flow every year. Like, that’s fine, right? That’s generally probably gonna be fine. And so, it really just runs a spectrum of high yield all the way to investment grade on both sides of the asset class spectrum of private credit.
Andy: And is there… I don’t know. There probably is not. But is there, like, a general… I’m gonna ask anyway. Is there a rule of thumb? Is there a way, as an investor, that I could think of it, like, if I’m comparing private credit, a private credit product to a liquid credit product, to a bond fund, a corporate bond fund or a junk bond fund, what would be, like, a normal premium? Like, is it in the private credit equivalent with the same maybe underlying risk? But with the additional aspect that it’s illiquid, is it an extra 150 basis points of yield? Like, what does a typical investor RIA expect?
Nelson: Yeah, for sure. I would say broad spectrum there. But the closer you get to investment grade from a rating standpoint, the closer it tightens, right? So you’ll still get, you know, call it 50 to 150 bips on the IG side, probably, realistically. In this market, maybe a little bit wider, all things considered. But for the, like, earlier stage side and less investment-grade side, more high yield side, it widens dramatically from there.
So it really just depends on sort of the way it’s been structured, the sophistication of the underlying borrower, and the experience and the maturity of the borrower. And that will dictate a lot of terms. But you can still expect definitely an illiquidity premium that comes from being in the private credit side versus the public credit side.
Andy: And investors in general, I mean, I’m guessing there’s a spectrum of institutional investors all the way to kind of an everyday accredited investor who has $100,000 to place or whatever, those two groups, do they invest differently? By that I mean, are the institutionals more interested in corporate grade where maybe the individuals are more interested in high yield? Or is it just case by case?
Nelson: Yeah, it’s a great question. We’ve kind of seen the entire spectrum, right? So Percent as a platform, the smallest deal we ever did was 50 grand. So I can’t name any asset manager who wants to put something into a 50-grand deal, realistically. So that was all accredited. And then we had a deal, the largest one we ever did was $144 million. There’s not many accredited investors that can fulfill that type of responsibility, even if there is a bunch of them, right?
So naturally, it kind of shakes itself out, from a bell curve standpoint, as to what each one is suitable for. And the reality is it’s also based on their risk profile, right? So accredited investors, for better or worse, tend to want higher-yielding products. That is just sort of the nature of what they expect. And they have other returns coming from their equity side, coming from their other alts and things like that. But to make it worth their while, they wanna be able to get the things that are in the mid-teens and higher, from an APY standpoint. It’s just the way it is, right?
We did see though, coming out of this recession and the rates being so high, even though the rates were so high, there was actually a shift toward flight to quality. And so, the ones that were under 10% yields means that it’s probably a hard asset, probably a very low default rate. We actually oversubscribe most of those deals. So credit investors, over the course of the last call at nine to 12 months, have gotten wiser from terms of a risk management standpoint and what they’re looking for. And they’re now starting to see if there is a low rate or a low return type product and the structure is sound, I want it.
I think we peaked at 1.6x oversubscription on these sub-10% deals. We just don’t have that many sub-10% deals out there to market these days because the risk in general has gone up, right, just naturally. And the risk-adjusted expectation has gone up as well.
On the institutional investor side, they tend to take down super large chunks. They need $20 million, $30 million, $40 million a pop each time, right? But they also have various different portfolio allocation buckets they need to fill. So, like, they have a certain threshold for high yield and certain sectors they wanna be in high yield and they have to fulfill a certain allocation on that front. And there’s other ones on the IG side.
So the institutional investors have a more defined range based on the investment mandate that they have to invest into. But you are seeing, just in general, they have a lower APY expectation threshold because their hurdle rates are also a little bit lower from where they’re getting their capital from. The LPs are dictating they want, you know, on the IG side, 3%, 4%, give or take. In which case, if they clear five or six, then they’re in good shape, right? And so, that in of itself makes for just a very different profile of what they’re looking for.
What was interesting was we actually offered a private credit rated double B opportunity to our retail credit investor base. And I think we got, it was, like, a $40 million deal. We allocated a million or secured a million for retail. I think we got 50,000 in demand from the investors. And I’m pretty sure they were just, like, pitying us that no one else was putting money into the deal because it just was such a low rate that it just wasn’t interesting for them.
And I get it, right? Like, when you’re comparing that 5%, 6% return with a Colombian consumer lender that’s yielding 12%, 14% that has a shorter duration of 60, 90 days versus six years, I’ll take the 12%, 14%, 60, 90 days all day, every day as retail.
So just in general, they kind of shake themselves out in terms of what they expect and where they put money into, and it works out totally fine.
Andy: So here’s my question. It’s both your personal opinion as well as just all of the portfolio managers that you talk to, how they think of this asset class in the context of the larger portfolio. Because a lot of these RIAs, a lot of high-net-worth investors, they’ve already made the shift from 60/40, or whatever, to 50/30/20. But I think what a lot of us have a hard time with private credit is, is this part of the 30? Is it part of the credit? Or is it… Because it’s also classified as an alt, and it’s kind of both, it’s either. It’s both.
Like, I don’t know. And I’m almost… I don’t know that I even have an opinion so much as I’m interested in the opinion of the market because I’m not gonna fight. You know, if the market kind of sorts this into the alts bucket, then I’m going to say, okay, then it must be an alt. And if they sort it into the income bucket, then I’m gonna say this is like a bond substitute, you know, on the credit side.
What do you think and what do you think that the market thinks?
Nelson: So I absolutely have to, for the sake of my compliance guy, he’s gonna tell me this is not investment advice, and I’m gonna have to definitely say that. But the reality is it is actually very dependent on the individual, and we’ve seen that already, right? So when you think about institutional investors, that is very cut and dry. There is actually a mandate from the LPs that they have to adhere to, based upon how much goes into private credit versus equities versus whatever may be if they’re a multi-strap or it’s just a private credit fund, in which case it’s 100% in private credit.
And then the difference is, what are my sector concentrations? Right? So we’ve had instances where we’ve had transactions that have gone out the door and it was, for example, litigation finance. And the deal, they didn’t end up coming in with as much as they needed to, where they said they could because they breached a threshold for how much they could put into litigation finance. So there is a lot more rules on that side at the institutional level that dictate allocation strategies much more so than kind of feeling about what they wanna do at any given point in time.
But that brings up the important point, which is like sector concentrations within private credit, right? And we’ve seen that with even retail investors as well. Our platform, as a whole, is designed to give optionality. We have U.S. deals. We have international deals. Within international, we have Canadian deals, Mexican deals, Colombian deals, Asia deals, Africa deals.
Like, there is a lot of options on that front and there are also different types of sub-sectors within there, right? So you have small business lending, consumer loans, factor receivables, litigation finance, equipment leasing.
So how much an individual wants to allocate to private credit really depends on their own risk tolerance and also their own personal preference because we have no shortage of investors who just look for a predictable income and not for any equities, like, upside, downside. So they are almost, like, 90% on credit, 10% on equities just because that’s what they want, right? So it’s totally up to them.
Andy: But if this is… Yeah. No. I get that. And I mean, I guess it would make sense to me that, depending on the sector, I might say it’s more exotic, it’s more of an alt the more exotic the sector is. Versus if this is just a private equivalent of a normal bond, then I’m gonna say, “Well, I’m gonna say that this belongs in that 30, you know, in the fixed income side of the portfolio.
But I still am not sure. Like, do I call this an alt or is it more a substitute for fixed income?
Nelson: I think because of the nascent nature of the asset class, it’s still considered an alt for now. But I think the longer it stays out there and people recognize what it is, it starts to look and feel more like fixed income. That’s the nature of it, right?
Now, does it take up your entire fixed-income portfolio? I think probably not for the average person, but it does become a bigger and bigger portion of it, if only for the fact that they saw during the boom years when the rates were so low, public market fixed income was yielding nothing, right? So you almost had to get returns elsewhere and that’s why they all looked to private credit.
I think the future of alts is really in a lot of the more niche asset classes. So collectibles, for example, that’s definitely an alternative investment that will never become I think, or I would hope it doesn’t become a big part of a person’s portfolio unless that is only what they want. Art is a great asset class to be in, but it is still definitely in the alternatives bucket, right?
Crypto is definitely still in the alternatives bucket for now, except for the people who made all their money in crypto, in which case it’s probably making up an unhealthy disproportionate part of their net worth. But hey, they made all their money in there, so all the power to them. So those are really what are truly considered alts in my perspective.
I think private credit starts shifting into more of a true pure play credit allocation strategy over time the longer it’s been around.
Andy: Yeah, I think that makes sense. And I mean, to me, maybe it’s a spectrum is maybe the best way to look at it because the more niche and the more exotic and the less liquid it is, you know, personally, that’s where I’m like, “Okay, this is starting…it looks like an alt, smells like an alt, talks like an alt,” whatever. Wait, no, quacks like a duck, whatever. However that phrase goes.
Nelson: It ends up being at all by the end of it. But yes.
Andy: Exactly, that’s the point. So now I wanna dig into the Percent platform a little bit and how it works. So kind of, we’ve talked about it briefly. But I have to say, I’m gonna link to it in the show notes, I was clicking around on your guys’ website and your website is just awesome. Like, the design, the UX, just all of it. I don’t know if you manage that internally or work with an outside firm, but the design, I’m just like, wow. Every alternative asset manager should look at your website because this is how it’s done. You know, the messaging is just very intuitive.
But how does it work? So I’m an investor. I land on your website. What are my options? Where do I go? What can I do?
Nelson: Yeah, absolutely. And I’m gonna have to give a shout-out to our design team and our product team and our marketing team for the design, the UI, the UX, the copy, all that stuff. They are phenomenal. We do actually do it in-house.
Andy: Well, it looks like a venture… Like, I mean this as a compliment. It looks like a venture capital-backed company, just, like, from the website and just how…just the UX. I love a good UX. You know, just as a web user, I love a website that just has beautiful, clean, clear design.
Nelson: Thank you. Yeah. Well, right now, actually, beginning of February that we’re recording this, we’re actually rolling out a huge overhaul in the investor-facing experience. So over time, as listeners listen to this in later months, they’ll see an even better experience than we have right now. So we’re very excited to roll that out.
But in terms of an investor, what happens when they join? So, a pretty simple sign-up process. You gotta provide the usual, email, phone number, etc. Go through that process, get your identity verified. Because this is a 506(c) platform, you do need to get accreditation verified. And so, we use third-party services for that. But on average, it takes less than a day to get it fully, fully verified. And then once you link up your bank account, you’re good to go, right?
And so, we try and, to my point earlier around optionality, give as much optionality as possible for investors. We have investors who oftentimes go through the try-before-you-buy model, right? So we always try and keep a couple deals out there that have $500 minimums, which is very, very low and also short-duration investments. So sub-nine months with the ability to refinance them in, like, two to three months’ time.
So really it’s a lockup of about two to three months just for the investors to get a sense for how it works. And oftentimes those investors will put in to start $500, a $1,000 into a deal they like, an asset class they like, a sub-sector, they like, whatever it may be. The interest pays back within a month. The deal refinances in two to three months. They get out. They see the money actually comes back to their bank account. They put more money to work. They add a couple more thousand dollars.
And then, at that point, you know, it’s a little bit tedious to manage this sometimes if they have dozens of investments outstanding, so we also have what’s called a blended note. And a blended note is, effectively, think of it as, like, a diversified basket of different investments based on theme.
So we have a total market one, which is what it says. So it’ll invest in every single deal that goes out on the platform. We have U.S. only, we have short duration only, we have high yield only. We have all these different themes that just end up algorithmically allocating across dozens of different opportunities. And it’s a bit of a set-it-and-forget-it mentality.
So we’ve seen that natural evolution for investors who try before they buy, put a couple of hundred, a couple of thousand to work, put it across a bunch of different deals, and then move into the blended notes and call it a day. And we do these blended notes all the time.
Andy: Oh, yeah. I have a question, yeah, right away on the funds. So it sounds to me, like, within the Percent platform, they’re almost like index funds where you don’t have someone internally saying, “We wanna allocate more or less to this deal.” It’s just if it’s on the platform, we allocate to it, in the fund, if it’s in that particular sector. But then obviously, there’s some active management involved with underwriting and due diligence. So, like, what deals are even ending up on the platform? Like, how does that process work?
Nelson: Yeah, absolutely. So over the last three and a half, four years, we were actually the only underwriter on the platform. And that was designed for us to kind of really get a crash course for how private credit really works and setting all these standards that people can come to expect, right?
So private credit, historically, has been a very opaque asset class. When you invest in a private credit fund, you kind of sort of know what they’re investing into. You get a statement at the end of every month. You have like a mark to market NAV at some point over the course of the year. And that’s all well and good.
But what actually happens underneath the covers is very opaque and really unknown to the average investor who is investing in these funds. And so, for us, as part of the, I think, like, over 400 deals that we’ve done at this point, we’ve learned how to create almost like the market standard for a private credit, right? Similar to how you see it in public markets, we have the ability to actually compare structurally one deal with another deal down to as detailed and granular level as how many obligors are in this specific thing. How many… What’s the portfolio expected default rate of all the loans? What are you advancing? How much… Is there a cash control account? Are you hedging the currency if it’s non-U.S.?
Like, all these things are things that are table stakes in public markets, you would never see in private markets.
So investors have gotten, on the platform, very savvy at comparing deals. And we get emails all the time saying, “Hey, this advance rate is lower, but the yield is higher. So why is that the case?” And we have to actually answer them with thorough details about how we’ve structured it and pointing to them on the comparison table, like, why that’s the case. We love that, right? That means that they’re actually putting all the hard work we put into it to good use in terms of getting that transparency around deal structure.
Andy: Well, I mean, maybe you’ve never made an underwriting mistake, but it’s almost like leveraging wisdom of the crowds, getting real-time feedback. And if nothing else, just even communicating how the underwriting…you know, how the deals are structured and why they’re structured that way.
Nelson: Exactly. And that’s actually a big feature we’re launching this year is the ability for all these questions that our team gets internally to be made public for every investor as well, so they can see how everyone else is thinking about it. And it becomes almost like a forum for discussion around these deals, which is fantastic. So that is launching. Top secret. Keep it on the down low for now, but it is coming out in short order. So that’s one piece of it on the market standards side, right?
On the data standard side, we’ve actually been able to create essentially the ontology for all things private credit within each asset class. What that means is the underlying asset performance, for example, like a small business lender, may have 1,000 loans with this one lender and 500 loans with another lender. There’s gonna be a lot of different things that tell you whether the loans are performing or not. Whether it’s the over-collateralization of the deal, the days past due of the loans that are kind of in default, the collections analysis, the vintages that are in there. So all that stuff normally is just made super opaque. Like, you would never know that across these borrowers who need debt capital.
And we actually have a standardized reporting, so you can compare the asset performance of one borrower with the asset performance of another borrower, and it’s side by side. The same graphs on all of them, just different performance on each of them.
So that level of transparency is, again, unheard of in private credit and it allows investors to make their own decisions at the deal structure level and at the asset performance level as to whether this deal is a fit for them. And our job is just to disclose as much information as humanly possible so they can make the most educated decisions.
On top of that, the average alternative investment platform is almost always, like, first come, first serve, which is not great, right? Because you’re always just under the gun to basically make a decision very quickly and not be able to review the materials properly. In our instance, we’ve done almost like a public market style execution process for bonds into private markets.
So investors have the full, you know, call it two or three weeks, to decide and due diligence and all that stuff. And they put in an order, similar to, like, a limit order in equity markets. And in that order, they would say, “What’s my minimum that I’m interested in? What’s my maximum that I’m interested in? And what’s the minimum APY that I’m interested in? Where if it goes below that API, I don’t wanna be in the deal,” right?
So on the back end, the underwriters and the borrowers are gonna see the order book build in real-time and they’ll see how much demand is there at each rate. And so, they can decide what rate is what they want to clear at. And once they understand that, then we pro-rata the investors who fit that criteria and they get kind of the range that they’re looking for or they get out of the deal because it wasn’t in the range that they wanted anyway. And so, everybody gets what they want by the end of it all.
And this level of transparency around the deal structure, the actual data performance, as well as around how the deal is priced, is designed to give investors as much time, confidence, and comfort in making the investment that’s the right fit for them.
Andy: It honestly sounds like that would be good for you too, because you can kind of get real-time feedback, the best kind of feedback, which is people putting skin into the game, right? You can get that real-time feedback on the offering. Is it priced right? Is it structured right? I’m guessing… I won’t ask you about any embarrassing failures or anything. But mean, I’m guessing every once in a while, you might have an offering that has no traction and it allows you to dig in and say, “Well, why doesn’t anyone want to invest in this offering?”
Nelson: Absolutely, and we track all of that. Right? So in the underwriter portal that we have and the borrower portal that we have, they actually can see the full market and how it’s pricing. And so, they can go into each asset class and look at how the rates are trending based on what investors are looking for. They can compare themselves, from a structural standpoint, against other deals that have gone out the door and see how their pricing and what makes sense.
So we’re arming these underwriters and borrowers with the most information possible to understand what they can expect when they bring a deal out to market.
And we also track these over subscriptions. Right? And it’s interesting what we were talking about earlier, for better or worse, accredited investors actually invest in alts and in private credit at the whims of how public equities are doing. And so, when public equities go down, we’ve seen, historically, under-subscription in our deals. And when public equities go well, then we’ve seen over-subscription in our deals. That has just consistently been the case.
So I think people feel richer when public equities go up and they naturally feel like they can deploy into more stuff. That has been what we learned over the past, you know, three and a half, four years of doing this. This side of the market is very, very subject to the whims of public equities.
Andy: Yeah, no, that makes sense. So on the platform, I mean it sounds like the theme, a lot of transparency and just a lot of choice because you’re giving investors ability to select individual deals as well as you have these various funds that are thematic. Is anyone… I mean, obviously, I would guess most folks on the platform, individual investors are looking for yield, looking for high income. Income never goes out of style. But with these different sectors, are there any impact investors who are like, “I just wanna…you know, maybe I’m interested in a particular sector or overseas, and I’m interested in just providing credit from more of an impact angle”?
Nelson: Absolutely. We’ve seen a couple anecdotes coming out of that. I’ll get to the ESG side because that word has been completely thrown around at this point. And we’ll decide what exactly is ESG.
Andy: Well, you’ll know… I’m sorry, I gotta stop you there. I purposefully don’t even use that word. I say…various reasons. I won’t get into all of it. I wrote an op ed on AltsDb about this about six months ago. But it’s just a phrase that’s now so politically loaded that I’m, like, let’s sidestep all the Democrat versus Republican stuff.
We’re talking more individual investors interested in making an impact, right?
Nelson: Doing good for the world. Yes, exactly. So interesting enough, based on the various different sectors that we have and ways to kind of create and cultivate your own portfolio based on interest, during COVID, a lot of sectors did not do well, right? So small business obviously directly impacted by COVID. And what we saw was investors demanding a higher rate for taking on small business risk, essentially. So the small business lending sector actually had a 700-basis point increase over nine months.
In terms of just expectation for what APY should be. It went from 11% to 18% in nine months. That is crazy. And then the moment PPP hit and, like, businesses opened back up again, you start to see the rate come down. So we are as good of a proxy for real-time health of the market as any, all things considered.
What we did see, though, was a lot of demand into things like ecommerce finance, into things like mobile apps and mobile gaming, right? Because that’s what everyone was doing when they were at home. They were buying stuff online and playing games on their phone. And so, those deals oversubscribed like crazy. And we had more demand that we could fulfill basically in terms of actual supply of deals.
So investors are demonstrating what they’re looking for with how they invest, which is just very fascinating.
So to your point around impact, we’re not gonna use that three-letter acronym, for the ones that are doing good, we have seen groups and individuals who basically say, “I only do international deals,” right, especially in emerging markets. And that’s very important for them. They don’t touch the ones that are in the U.S. They don’t touch the ones that are consumer-oriented, for whatever reason it may be.
But then in the emerging markets, they focus almost exclusively on consumer and the under-banked population and how they can actually support the lenders for providing capital and access for this population that desperately needs some sort of banking capabilities, right?
So the name of the game here for us is always to give investors that freedom and optionality to decide what’s suited for them. And as long as we always have that option, you’re gonna see these little scenarios emerge from investors who have certain theses.
And this brings up the point of the blended note, right, that kind of basket product. That emerged because we had a poor guy who was investing $500 in every single deal that went out and I was just like, “Let me help you out here, buddy. Like, this is crazy that you’re doing this,” Because we had, I think, 250 deals at that time. He was by far the most active investor on the platform. And so thankfully, I think he’s in the blended note now and he’s gonna call it a day. It’s much easier for him.
But yeah, you know, learn from your users and what they want.
Nelson: I love the emerging market story. We actually have a guest scheduled on the show upcoming but talking about that credit gap or financing gap. There’s, in emerging markets, so many entrepreneurs, right? But there’s a gap in just basic banking services. So really cool that your platform gives opportunity for individual investors to make an impact, finance that, but also achieve a return, right? You can still do well. You can do well by doing good.
And I know we’re running short on time, Nelson, but I wanna talk about the outlook because there’s a lot going on in the macro picture right now. We have higher inflation, although now we’re seeing disinflation. You know, hopefully, there’s more and more disinflation as the year goes on.
But these higher rates, higher inflation, to me, it’s a little bit of a mixed bag when it comes to private credit or really any credit, whether it’s good thing, bad thing. You know, where do you see, I guess, private credit this year going as hopefully inflation starts to fall a little bit? Is it gonna be another really strong year for private credit?
Nelson: I think so. And that’s really where the projections are putting it for all of these prognosticators that are out there, right? They’re all expecting private credit to have a very good year. And that bodes well for us, at the very least, as a fairly market-agnostic platform to be able to offer things like ABS, like venture debt, like corporate debt. We’ll give investors as much choice as possible to decide what they wanna do.
So breaking down each asset class by asset class, it’s not without risk, right? Without a doubt. And so, when you think about how this all has played out, on the venture debt side, the venture equity like venture capital, has obviously been tougher to come by this year and last year. And so, you’re seeing a lot of companies look for venture debt, right? So naturally, the ones who can raise venture debt to bridge them to the next round of equity financing will be the ones that survive.
And so, the ones who are able to back that if there’s interest from an investor in taking part in that debt story, that will always be out there this year. And there’s a lot of optionality and a lot of deals to look at on that side and we’ll continue to kind of provide that, right?
Andy: And then, is that a flight to quality? I mean, do these tend to be the more brand names type companies, whatever? You know, it kind of feels like maybe it will be a thinning of the herd with some of the weaker companies probably.
Nelson: It will be. And the reality is, anybody who can raise in this environment, either equity, debt, or both, is probably going to make it, realistically. The ones who raise, unfortunately, in, like, Q4 of ’21 or Q1 or 2022, they’re gonna come out to market in Q3, Q4 of this year. And it’s gonna be a very tough market to raise realistically. And so, the ones who can do it right now at this time in Q1 2023, it bodes well for their prospects to ride this recession out over the next, call it, 18 to 24 months.
So, you know, there will be no shortage of options of companies seeking venture debt. And it’s up to investors to decide which ones they like, which ones have the good underwriter, which ones have the good lead investors, that’ll be up to them. And it’s all fully disclosed, right?
On the asset-backed side, there’s always the split between small business and consumer. I think consumer, as much as we like consumer and that story is still valuable, I think in the underbanked emerging market populations, that is still a very credible story. In the developed economies, it’s a little bit of a tricky situation, right? I think credit card debt has never been as high as it is right now. So people are clearly feeling the effects of inflation and they’re putting it on the credit cards.
I think the desire to be able to put money to work on the consumer credit side is gonna come down to 100% of the underlying asset performance. And we help show you that, right? So if you wanna take on consumer credit risk when credit card debt is increasing, when auto loans and leases are having challenges and getting paid, like, that is a risk you’ll be willing to take. I promise you the rate will be much higher as a result. So it’ll be offset, right? It’s, what is that worth to you, in that instance. And investors can decide what they wanna do on the consumer credit side.
Andy: Well, so far, I think what I’m hearing with these two asset classes is maybe more risk this year, but higher yield to compensate for that. I mean, and frankly, I guess that seems like a good thing for private credit in the sense that folks on this platform, they’re probably willing to take a little bit of risk, right? That’s the whole point. Higher yield, I go out a little further on that risk-return profile.
Nelson: Exactly. And the reality is, this is not the case with equity markets because they do seize up, right? With credit markets, whether it’s public or private, it doesn’t matter. They never stay illiquid for long. Like, there is always a price that someone’s willing to take that feels like it’s the right risk for them, right? So if the APY…
Andy: And does your platform… Sorry, I meant to ask this earlier. If I invest in a note on your platform, is there a secondary market right on the platform?
Nelson: There isn’t a secondary market. But part of the thesis when we launched Percent was to give investors inherent liquidity. So inherent liquidity comes from shorter refinancing cycles. So public debt oftentimes has, like, 25, 30-year maturities. You buy the bond itself, but there is a secondary market. The private credit side traditionally does not have a secondary market. But if the deal is nine months and it refinances in three months, then as long as you have line of sight into how much cash you need in three months, then you can decide what you wanna do when it comes out to market.
Andy: I see.
Nelson: So inherent liquidity was really the answer here for us versus…
Andy: So it’s not actually that illiquid, I guess is the…
Nelson: Not really, no.
Nelson: Yeah. Investors go in and out all the time. Like, they like a deal. They like a sector. Now they fall out of favor with that sector. They back out. [crosstalk 00:43:15] something else.
Andy: It’s almost like an interval fund or something where it’s intermittent liquidity, I guess, the way you describe…
Nelson: Yeah. The blended notes, though, that basket product we were mentioning, that has a longer shelf life. That usually is, like, 24 to 36 months because we have to deploy it into various different deals. We don’t have cash drag. But that is gonna have a interest-only period for a little bit and then principal and interest comes back over time. So you do get amortization payments back, which is good, right, for them.
But that naturally is meant to be a lot longer. But you’re getting the diversified exposure, which inherently means also lower risk because, you know, the likelihood of all of them defaulting at one time I think the world will have bigger problems if that was the case. So yeah.
Andy: Right on. And I’m sorry. I took you off track with the outlook. I mean kind of the headline prediction probably this year with venture-backed companies and maybe some of these other spaces, perceived higher risk, the market will likely perceive higher risk. There will still be a need for credit. So there’ll be lots of opportunities and maybe investors can expect higher yields. Is that…
Nelson: They are definitely expecting higher yields. Yeah. So small business side too, right? That’s the other side of the non-consumer credit side. We’re seeing kind of healthy performance on that side even still. And so, small business in general, that continues to always perform. It takes almost like a complete shock to the system, like COVID, where it fully gets shut down for something to be actually problematic on that side.
In a world like today where people are still buying things, needing things, small business tends to be able to write it out okay in the grand scheme of things. And you can always structure elements of the deal away to mitigate some of the risk of potential increase in defaults and things like that. So that is always kind of hedge-able for all intents and purposes.
So I think between consumer and small credit…small business, I would say small business probably performs better this year than consumer. But consumer is going to be priced, realistically, probably higher at that point. And so, what is that risk worth to you? That’s totally up to you to decide. And in many economies like the emerging markets where they actually need these solutions in place, performance is probably gonna be still pretty good in the grand scheme of things, right?
So it really is a case by case, do your own research, have your own thesis. Just like those investors during COVID would double down on ecomm and double down on mobile games. If you have a thesis, test it, see how it goes. You can monitor the performance of the investments and you can see how you want to rebalance and refinance it in that interval basis like you had just mentioned, as you see fit.
Andy: Yeah, I love it. And, you know, I think you kind of hit the nail on the head in the sense that some of these markets, some of these sectors in the United States, it’s an alternative investment, it’s alternative financing. It’s a nice to have with the income, of course it’s an attractive offering. But then in emerging markets, this kind of product is a structural need. It’s not a nice to have. It’s in a very important part of the infrastructure for SMBs, for entrepreneurs in these emerging markets.
Nelson: Yeah, completely.
Andy: So I think that’s a really exciting part of the story.
Nelson: Absolutely. We’ve seen it too, right? Because a lot of these founders actually were educated in the United States. Maybe they were born in their respective countries, but they were educated in the United States. They see the various different innovations in banking and technology over here and they bring it to their home country where there’s probably, like, two or three banks that provide all of the banking solutions that ignore a huge portion of the market.
And they essentially take that modern Western, call it, technology and innovation that they’ve seen and bring it and tailor it to their home country in a way that resonates with that consumer and small business audience down there, right? And in many ways, these countries are actually better than us technologically. They never had the need to write checks. They bypass all of that. Versus here, you’re still writing checks to your landlord. I mean, it’s like ridiculous.
So to bypass all of that and make it mobile-first and make it…and essentially meet the consumers and small businesses where they are, from a technology standpoint, is incredibly impactful. So we’re seeing the impact. We love the fact that we can support companies in countries like this. And it will continue to be a core part of our story going forward.
Andy: The private credit revolution in the U.S. and elsewhere. I love it. Nelson, thank you so much for sharing your insights today on the private credit industry, as well as the Percent platform. I mean, it’s just a really cool platform. And that being said, where can our audience of high-net-worth investors and independent advisors go to learn more about your platform?
Nelson: Absolutely. We keep it really simple around here. Percent.com is where you can find it and our investor relations and syndication team will be more than happy to chat with you. We have a chatbot on the bottom that always goes to one of us and so don’t hesitate to reach out on that side or even just shoot us a note at [email protected].
Andy: Yeah, great domain name. I’ll make sure to link to it in the show notes anyway. And I’m also gonna link to the outlook, that we referenced, report from the Percent team. A very good outlook there. And as always, you can access those show notes at altsdb.com/podcast. Nelson, thanks again for coming on the show today.
Nelson: Thanks so much for having me. It was great talking to you.