Portfolio diversification with a history of high returns

Private credit — also called “private lending” or “direct lending” — refers to loans made directly by investors to companies. It is private credit because the debt is not issued or traded on the public markets.

Wealthsimple private credit invests in two types of loans: the first are loans made directly by our credit management team to medium-sized companies, and the second are loans made by banks to medium-sized companies. These companies aren’t as risky as many private equity-backed companies and aren’t taking on as much debt, relative to their earnings. This means there’s a higher likelihood that the debt will be repaid.

Much of the private credit landscape consists of loans made as part of private equity deals, known as “sponsored” private credit. This investment avoids these kinds of deals because we believe that their risk-reward is lower than loans originated by our credit managers.

This investment differs from most private credit options available to Canadians in two ways.

Firstly, the focus on directly originated loans where our team has deep expertise, as opposed to loans made alongside private equity deals.

And secondly, the quality and experience of the management team. The credit team is led by Adam Vigna, who led Canada Pension Plan’s Principal Credit Investments group. This group invested $20B in bank-led and direct credit investments. He has recruited an investment team with high-quality investment experience managing significant credit portfolios across the private and syndicated markets for Canada Pension Plan, KKR, and Garrison Investment Group.

The investment will target a 9% annual yield, net of fees, which will be distributed monthly to provide investors with income. The yield is based on a floating rate, which resets with interest rates so returns will vary year to year. The income will be reported out on a monthly basis right in your Wealthsimple app.

As an asset class, private credit typically offers 2–5% higher returns than public credit.* For example, from 2012 to 2021, private credit as an asset class has offered a 9.7% internal rate of return. This has provided a similar return profile to real estate and infrastructure, which have returned 10.4% and 12.8%.**

*From March 2007 to September 2022, private credit returned 8.9% annualized while U.S. Corporate Bonds returned 4.1% annualized (see chart above). **Data compiled by J.P. Morgan Asset Management (p11). Sources: Cliffwater Direct Lending Index; NCREIF Property Index (U.S. real estate only); MSCI Global Quarterly Infrastructure Asset Index. All data represent the period from 12/31/2011 to 12/31/2021.

Figures represent the past performance of private credit; they do not represent investments made by Wealthsimple’s private credit product. The past performance of private credit or any other security or investment strategy is not an indicator of future performance, and past performance may not be repeated.

Although Wealthsimple’s private credit product may seek targeted yield and monthly distributions, its performance and distributions may be affected by numerous factors and targets. Wealthsimple’s private credit product is new and has no performance history. Past performance of the Sagard private credit funds or other security or investment strategy is not an indicator of future performance, and past performance may not be repeated.

The information contained herein is based on sources believed to be reliable and is provided for information purposes only. Where such information is based in whole or in part on information provided by third parties, we cannot guarantee that it is accurate, complete or current at all times. It does not provide investment, tax or legal advice, and is not an offer or solicitation to buy."""

The investment holds loans that come with the risk of loss in the event that a creditor cannot repay. This can and does happen to borrowers who use private credit. We expect the value of the loans to fluctuate as the price of credit fluctuates in the broader market. The investment uses leverage, which can amplify returns but comes with borrowing costs and a wider range of outcomes. There is also liquidity risk, where loans may decline in value due to a lack of willing buyers, irrespective of the underlying credit quality.

The investment primarily targets senior secured credit, meaning that it will have a first claim in the event borrowers run into trouble. This makes it less risky than high-yield bonds, which typically would come after senior debt in these scenarios, and equity, which pays out to shareholders after debtholders have been paid.

The management team conducts due diligence on each investment and only invests in industries in which they have deep expertise. In addition, the loans made have investor protections in place with strong credit documentation and covenants that require lenders to meet certain financial health metrics or incur penalties (known as financial maintenance covenants).

The investment will target floating rate loans, meaning that as interest rates change, the rates paid by lenders will increase or decrease in lockstep. This differs from most bonds, which have fixed interest rate payments. Plus, it will target companies that the management team believes will be resilient to economic conditions, including stagflation.

Finally, the investment manages foreign exchange currency risk, which we believe will allow it to target oingoing returns in Canadian dollars. We believe this is an attractive feature for Canadian investors.

You will be charged an asset management fee of 1.25%, on top of Wealthsimple’s standard managed account fees, to invest in the Wealthsimple private credit Fund. If the fund returns more than 5%, a 15% performance fee applies to those returns. Our promoted targeted yield of 9% is net of these fees.

Management fees are designed to cover the costs of diligence and sourcing to find attractive credit opportunities and to structure the terms of those loans to manage risk aggressively. Historically, private credit has provided competitive returns even net of management fees, though past performance may not be repeated and is not an indicator of future performance.

The investment targets floating rate loans so that the interest paid by borrowers automatically adjusts as interest rates rise (and fall).

However higher inflation comes with additional risk to repayment. For that reason the investment will manage the risk of inflation through credit selection. The investment has sectoral tilts that can handle a stagflation scenario, and the credit management team assesses the fixed and variable costs of each borrower to understand the potential impact of stagflation.

There is a minimum investment of $10,000. Additionally, private credit is available exclusively to clients who have liquid assets of $50,000 held with Wealthsimple or across other financial institutions and have otherwise met the suitability requirements as determined by our portfolio management team.

You can allocate a maxmium of 20% of your managed investing portfolio to alternative investments, including both private credit and private equity.

Private credit is a diversifying asset, so can be added and increase expected risk-adjusted returns. Our portfolio managers will review your profile to find an initial commitment that works for you and your goals. Factors that will determine your recommended contribution include the value of your total investments, your risk tolerance, and your investment time horizon.

Beginning two quarters after the fund closes, you’ll be given the opportunity to make a redemption (a withdrawal from the fund) every quarter. You’ll be able to indicate you want to redeem (pull some or all of your money out) at any point by sixty days before the end of the quarter, and the redemption will happen at the next quarterly opportunity, with cash available 30 days after the end of the quarter. In the event that many investors want redemptions at the same time, some may need to wait until the following quarter or quarters. In addition, the fund manager has the discretion to suspend withdrawals.

The higher yield is due to the private nature of the investments and the premium for lower liquidity. These investments, particularly in the non-sponsor market, are not widely marketed so require a network of relationships to source and structure transactions, and expertise is required to conduct due diligence. Given the relative lack of efficiency of these markets, it offers the potential for higher returns.