Navigating the ever-evolving interest rate landscape requires both a understanding of historical trends and an eye on the future. Over the past two years, we’ve witnessed significant shifts in this realm, presenting both unprecedented challenges and golden opportunities for investors. With risk-free rates soaring to two-decade highs, private credit markets beckon with promising risk-adjusted returns.
Dive into our analysis to unravel the intricacies of interest rate sensitivity in SME lending, and discover how, by leveraging the lessons from the past, you can position yourself to capitalize on the prevailing “deposit delta” and achieve superior returns in today’s market landscape.
The shifting interest rate landscape over the last 18-24 months brings forth a set of unique challenges and opportunities. Despite risk-free rates having increased significantly to levels we have not seen in nearly two decades, the risk-adjusted returns in private credit markets remain highly attractive.
Understanding the historical context of interest rate sensitivity in SME lending is key for investors looking to maximize the “deposit delta” – the gap in transmission of higher lending rates reflected in asset side deposit rates on the asset side.
Federal funds target rate
Note: From December 2008 to present, the chart reflects the midpoint of the Federal Reserve's target range. The target rate started in 1982.
Chart: Gabriel Cortes / CNBC
Source: Federal Reserve Bank of New York
Data as of Sept. 20, 2023
In the last rate cycle which culminated in the 2008 financial crisis, investors flocked to private credit opportunities to take advantage of the space ceded by the banking system, further incentivized by their search for yield.
Aggregate capital raised in private debt markets
Source: Preqin, Goldman Sachs Global Investment Research
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Based on the historical outperformance of direct lending vs. other asset classes of equal volatility in the last rate cycle (peak to trough), retail investors can expect improved risk-adjusted returns in the current environment on SME loans, taking full advantage of the current deposit delta that exists.
Aggregate capital raised in private debt markets
Source: Bloomberg, Cliffwater, Morningstar, LCD, Goldman Sachs Global Investment Research
SME lending during a higher rate environment demands vigilance, adaptability, and a deep understanding of market cycles, but can provide market-leading risk-adjusted returns when deployed through a prudent investment strategy.
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Past performance is not necessarily a reliable indicator of future results.
