Big Tech's private credit story amid AI buildouts, where private markets fit in a 60/40 portfolio

Key Concepts

• Private Credit: A $40 trillion market encompassing debt financing provided by non-bank lenders.
• Investment Grade (IG): Debt rated as having a low risk of default by credit rating agencies.
• Sub-Investment Grade: Debt rated as having a higher risk of default.
• Fed Funds Rate: The target interest rate set by the Federal Reserve for overnight lending between banks.
• Treasury Curve: The yield on U.S. Treasury securities of different maturities.
• Basis Points (bps): One-hundredth of a percentage point (0.01%).
• Capital Expenditures (CapEx): Funds used by a company to acquire, upgrade, and maintain physical assets.
• Magnificent Seven (Mag Seven): A group of seven large-cap technology companies that have significantly driven market performance.
• Leverage Loans: Loans made to companies with already high levels of debt.
• High Yield: Bonds with a rating below investment grade, offering higher yields to compensate for increased risk.
• LTV (Loan-to-Value): The ratio of a loan to the value of an asset purchased.
• 60/40 Portfolio: A traditional investment portfolio allocation of 60% stocks and 40% bonds.
• Asset-Backed Finance: A type of financing where loans are secured by specific assets.
• Origination: The process of creating new loans or financial instruments.
• Proprietary Basis: Developed or owned by a particular company.
• Alpha: Investment returns that exceed a benchmark index.

Private Credit Market Dynamics and Apollo's Perspective

The Scale and Perception of Private Credit

The private credit market is a substantial $40 trillion market with significant implications for the broader stock market. Despite a considerable portion of this market being investment grade (IG), it is often perceived as risky. This perception was amplified by recent bankruptcies like those of First Republic and Silicon Valley Bank, prompting concerns about systemic risk, as highlighted by Jamie Dimon's "cockroach" analogy. However, John Cortezy, Apollo's co-head of corporate credit, argues that this market deserves more attention.

Impact of Federal Reserve Policy on Private Markets

While the Federal Reserve's interest rate decisions are a constant consideration, Cortezy emphasizes that for Apollo, the more significant debate revolves around the potential issuance volumes in both public and private investment grade markets. The difference between an estimated 1.6 trillion or 2.2 trillion in US investment grade issuance has substantial implications for capital expenditures and credit lending potential.

Shifting Yield Landscape and Opportunities

The current interest rate environment presents significant opportunities for long-dated, high-quality lenders like Apollo. Cortezy contrasts the situation from two years ago, when Apple issued long-dated IG bonds below the Fed funds rate due to an inverted yield curve (e.g., 4.85% for 10s/30s vs. 5% Fed funds). Today, similar high-quality issuers are issuing at 150 to 200 basis points above Fed funds rates. This steepening of the treasury curve, coupled with substantial issuance across the curve, creates a favorable "floor for spreads out the curve," which is Apollo's "sweet spot."

Private Markets' Impact on Equity Holders

The largest issuers of equity, particularly the Magnificent Seven (Mag Seven), are increasingly becoming significant players in the credit markets. While many of these companies have historically been underrepresented in public credit markets, they are projected to be the biggest components of the investment grade market in the next 2-3 years. This shift is driving economic activity in both private and public spheres.

The Rise of Data Centers and AI-Driven Financing Needs

The expansion of data centers, driven by the demand for AI, is creating massive financing needs across Europe and the US. This trend, along with defense spending and the energy transition, represents a significant opportunity for private credit lending. These are long-dated cash flow needs that align well with Apollo's business model, which is driven by retirement services with very long-dated liabilities. Cortezy anticipates the next few years will be a "buyer market" for this type of long-dated spread financing.

Addressing Concerns About Debt Issuance

While companies like Meta have significantly increased their debt issuance (e.g., tripling outstanding IG debt in one month), Cortezy notes that most of these companies have low net debt relative to EBITDA and are just beginning to enter the debt markets as they become more asset-heavy. The current capex cycle, particularly related to AI, is expected to last for many years.

Misconceptions About Private Credit

A common misconception is the association of private credit solely with sub-investment grade debt. While this segment is large and has grown, Apollo has focused on private IG for the past 10-15 years, particularly since entering the retirement services business. Private IG is characterized by being diversified, generally secured, long-dated, and a driver of the broader economy, making it a distinct asset class from a generalized view of private credit. Of the $40 trillion private credit market, 38 trillion is considered a private IG opportunity.

Resilience of the Market Despite Defaults

Despite recent defaults like those of Silicon Valley Bank and First Republic, the broader economy remains strong, and credit defaults are not outsized. Projections for next year suggest default rates in high yield around 2% to 3% for leveraged loans. The market is efficient in pricing risk, with a small percentage of issuers trading at significantly higher spreads (1,000 basis points or higher), while the majority of the market trades tightly.

The Strength of Investment Grade

Investment grade debt, in the context of private credit, is not only rated as such but also often secured, with low LTVs and strong collateralization. This segment is growing, even with moderate GDP growth, due to the significant need for safe lending. Historically, default rates in this segment have been "practically zero."

Future Outlook and Investment Opportunities

The potential for further rate cuts, combined with a steepening yield curve, is expected to create more opportunities for long-dated financing. Apollo's strategy focuses on issuing long-dated liabilities and investing in long-term assets, making them less susceptible to short-term funding risks associated with near-term deposits. The next decade is seen as presenting some of the biggest issuance opportunities in the world in credit. The shift from a seller's to a buyer's market suggests potentially wider credit spreads, combined with substantial issuance, offering an attractive environment for investing in high-quality credits.

The Impact of AI on Credit Markets

The entry of Artificial Intelligence (AI) into credit markets is a significant development, marking the "story of 2025 in credit." AI touches various asset classes and requires extensive analysis and origination capabilities to navigate effectively. The current issuance related to data centers and computing power is considered just the "tip of the iceberg."

Reimagining Portfolio Construction in a New Era

The Decline of the Traditional 60/40 Portfolio

Stephanie Dresser, Apollo Global Management's Chief Client and Product Development Officer, highlights that the traditional 60/40 portfolio is no longer the "winning formula it once was." This is due to the anticipation of higher interest rates for longer, which proved to be a headwind in 2022, and the concentration risk within the stock market, particularly the S&P 500, which is heavily influenced by a few large companies.

The Critical Role of Private Market Exposure

To counter these headwinds, Dresser emphasizes the critical need for private market exposure as a component of both fixed income and equity portfolios. This diversification can provide excess return per unit of risk and is crucial for clients and their portfolios to benefit. Globally, 90% of companies are private, yet individual portfolios have a very small percentage of this exposure.

Addressing Valuation Concerns and Maintaining Discipline

Apollo's philosophy is that "purchase price matters." Despite the fear of missing out (FOMO) and the high valuations seen in some private companies, Apollo maintains its discipline through rigorous underwriting and a consistent, proprietary sourcing and diligence process. Their own capital is invested alongside clients, ensuring a shared outcome. While they don't generalize market valuations, they actively seek opportunities where they are comfortable with the entry point and purchase price.

Building a Diversified Portfolio

The ideal way to build a portfolio in the current environment involves providing advisors with more tools to meet client needs. This includes considering liquidity needs and offering a range of structures that blend public and private solutions. Private market building blocks are increasingly being integrated not just as individual strategies but as complementary components or key parts of model portfolios. The focus is on viewing the fixed income and equity portions of a portfolio not just as public options but as opportunities to explore alternatives.

Promising Strategies: Asset-Backed Finance

Among the strategies Apollo is highlighting for advisors is asset-backed finance. This is a significant segment of the credit market, estimated at $20 trillion out of $40 trillion, providing financing to the real economy. Investment grade asset-backed finance portfolios can include diverse assets like aircraft leases, fleet finance, and music royalties, offering a stable return profile that complements overall portfolios. Apollo has built this capability over 15 years, employing a large team to originate these assets on a proprietary basis, generating "real alpha."

The Importance of Transparency and Communication

In a year marked by significant market events, Dresser notes that the transparency of information and active communication have been crucial. These challenging times have strengthened relationships with their global community of partners.