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You may have noticed that (other than the future of midsize American banks) rising interest rates have become the most exciting thing in finance. People who used to make you look at their memestock portfolios now only want to compare interest rates on savings accounts and guaranteed investment certificates. It’s all thanks to the financial moment we currently find ourselves in: central banks raised interest rates to try to slow inflation, pushing the stock market lower but savings rates higher. That’s made the market for cash much more attractive. And while 5% yields on GICs (the current offerings as of mid-March) are pretty darned exciting compared to the less-than-1% rates of a year ago, there is another class of investment that potentially offers a far bigger premium for taking on more risk.
If you’ve heard of private credit, you probably know that access to it has long been restricted to institutional investors — think the Canada Pension Plan or Caisse de dépôt et placement du Québec — and people who were already quite wealthy. Wealthsimple wondered why that needed to be the case. Together with the expert fund managers at Sagard, we have opened up access to the asset class — and to our fund’s current target of a 9% annualized yield. There’s no reason the best investments should be available only to the type of Canadians who could afford to have Drake play their birthday parties.
You probably have some questions. When someone talks about a potential 9% yield, you really should. Questions such as: how does it work, anyway? Is it even possible to earn 9%? Is it risky? Illegal? (Spoiler: it’s not illegal.) For answers to those questions and more, we talked with Wealthsimple’s Chief Investment Officer Ben Reeves, who led the team that created our Private Credit fund.
What is private credit?
Private credit lets investors lend money directly to companies. The money is pooled and loaned out to private businesses and individuals, who pay interest for the privilege of borrowing. It’s “private” because, unlike stocks or bonds, these loans aren’t issued or traded on public financial markets.
Who borrows this money? Typically, it’s businesses that need capital to grow. Until the early 2000s, most of them would go to large banks for loans. But after consolidation and regulatory changes, the big banks pulled back — and private credit stepped in, taking on slightly riskier loans in exchange for higher returns.
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Why does private credit pay more than a savings account or GIC?
Private credit is riskier than either of those things. When you deposit your money into a GIC or savings account, the bank loans it out to other people and businesses. Those people pay interest on the loan and the bank shares that interest with you. The bank earns its cut by taking on all the risk. If one of those loans isn’t paid back, the bank takes that loss and the people invested in GICs and savings accounts still receive interest payouts.
With private credit, investors take on the role — and the risk — of a lender. And with that increased risk comes the potential for higher yields.
What are the risks of private credit?
Private credit makes loans to companies — and sometimes those companies run into financial trouble. When that happens, it can affect both your return and how long it takes to get your money. That’s why we suggest only investing money that you don’t need access to for a while, ideally three years or longer.
Other risks include:
Changing interest rates. Because the fund targets floating-rate loans, as interest rates fluctuate, so do payments from borrowers. If rates go up, those payments go up. While higher payments are a good thing for investors, they also mean increased risk, since borrowers are being asked to pay more than they originally planned. If rates go down, the opposite happens: payments from borrowers go down and the fund can see lower yields.
Unrealized gains and losses. The same way that stocks have the stock market, loans have the credit market. And just like a stock, a loan might see its value go up and down — typically based on the perceived riskiness of the borrower or the market as a whole. For each loan, only realized credit losses (not these price movements) matter for an investor’s returns. Which often means having the patience to wait through volatility can be rewarded.
How does Wealthsimple manage those risks?
When you invest with Wealthsimple Private Credit as part of a managed portfolio, you enter into a fiduciary relationship with us. That means we act in your best interests, no matter what.
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While we can’t remove the risk from private credit, we’ve worked with our partners at Sagard to do everything we can to minimize it. They limit the riskiness of the borrowers they choose and target companies they believe can withstand the current economic environment. That starts with finding their own loans instead of using a private equity company the way many other funds do.
Sagard conducts its own deep due diligence in each company instead of relying on the sponsor’s due diligence. They make sure loans are secured against assets that can be used to pay the fund back in the event of default — and that companies are not already saddled with a lot of debt. If a borrower does have debts, Sagard builds it into the contract that, if the company gets into trouble, the fund is first in line to get paid back.
How does Wealthsimple make private credit available to retail investors?
We’re a tech company and we’re good at making processes simpler, more scalable, and low-cost. We’re also good at finding the right partners. Sagard’s private credit team is led by the former head of credit investments at CPP Investments, which oversees investments for the Canada Pension Plan. Wealthsimple clients get access to the same caliber of opportunities as Sagard’s institutional investors.
Who is private credit good for?
Private credit is only appropriate for people whose portfolios can handle extra risk and who have the time to withstand volatility. There are some basic investor requirements, which we’ll get into later, but assuming you meet those, private credit can be a great diversifier. It’s especially beneficial in a registered account, such as a TFSA or an RRSP. It can be good for retirees looking for portfolio income or people who want to add high-returning diversification to a standard portfolio of stocks and bonds, since it may outperform both when interest rates are up.
How often are yields paid out?
We plan on paying out yields monthly. Borrowers make interest payments to the fund and the fund gives a portion of that interest to investors. Those payments are put in your account for you to do what you want with — or just leave the money in your account and we’ll automatically reinvest it into the fund.
What if I need to withdraw my money?
Because private credit funds are loaned out to borrowers, withdrawing your money is not quite as simple as pulling money from a savings account. Beginning six months after the fund launches, we plan to offer quarterly opportunities for investors to withdraw money, but in some extreme circumstances, you may need to wait. Again, that’s a big part of why we recommend Private Credit only to investors who don’t need immediate access to their money.
What are those basic investor requirements you mentioned before?
While Wealthsimple Private Credit isn’t available to every single investor, we did open it up to a lot more people than ever before. A high-quality institutional-grade fund that’s available to retail investors is basically unheard of, so we’re proud of how many barriers to entry we were able to remove.
Our new private credit is available exclusively to Wealthsimple clients as part of our managed portfolios. We ask that clients have $100,000 in deposits at Wealthsimple. We also require a minimum investment of $10,000, and because of the risks involved, we limit your private credit investment to 20% of your portfolio.
One thing private credit investors need to understand is that this investment has a relatively wide range of outcomes and it should be only one part of their overall portfolio. Also, since this fund provides a lot of its returns in interest payments, which would be taxed like income, investors should consider using tax-protected accounts.
I want in. What do I do?
There are two options. If you click here and submit your email, we'll take it from there and send you the next steps. Or you can use the Wealthsimple app to log in to your account (or set one up if you’re new to us), then tap on the “Private Credit” tile on the main screen. You’ll be prompted to take a short survey. The answers you give will help an advisor assess whether this type of investment is a good fit for you. If the fit seems appropriate, an advisor will reach out and help you get started.
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