Private Credit Funds Provide Accredited Investors With Alternative Assets to Bolster Portfolios

In a Nutshell: People who want to protect their portfolios against conditions that cause an asset class to plummet in value have options. Prime Meridian Capital Management offers funds that give investors access to private credit markets. The company’s size and strategy allow it to find opportunities that fly under the radar of larger investment firms.

You’ve probably heard the phrase “don’t put all your eggs in one basket.” We ignore its message every time we go to the grocery store and place a carton of eggs in our shopping cart. But if the wheels fall off our shopping cart and all the eggs we were planning to buy break, we can go pick up a new carton (and cart). 

The phrase carries more weight when applied to business ventures and money matters. You shouldn’t put all your funds into one investment. 

If you do, and the investment suddenly becomes worthless, you’ll be out of money. And you won’t be able to grab an investment of equal value off the shelf like you can grab a new carton of eggs. People who build a diverse collection of investments are better positioned to weather storms that beat up one particular investment or asset class. 

Prime Meridian Capital Management is an alternative credit manager that provides accredited investors with access to private credit markets. You must meet certain net worth and income guidelines to become an accredited investor, which allows you to invest in assets that haven’t been registered with the Securities and Exchange Commission. We spoke with Sean Bill, Prime Meridian’s Chief Investment Officer and Portfolio Manager, to learn more about the company and the private credit space.

“Prime Meridian started in 2012 when our founder, Don Davis, saw a niche market, peer-to-peer lending, that he believed wasn’t well understood at that time, and, as a result, was mispriced in favor of the investor,” Bill told us. “Over the last decade, the firm has expanded beyond peer-to-peer lending to focus on other credit markets as banks have pulled back from private credit lending to repair their balance sheets from losses related to the rapid hike in interest rates and the resulting losses in commercial real estate.”

Sometimes it helps to be small. Little animals can go about their business in broad daylight without fearing their size will attract the attention of predators.

Prime Meridian is smaller than other private credit lenders investors can work with. Bill told us the company’s size allows it to be creative and nimble. 

“We try to think like an entrepreneur with institutional resources,” Bill told us. “We aim to be a very flexible partner that crafts solutions that work for the borrower. Our hope is that we’ll be the first call a borrower makes when they need additional funding, so that’s kind of how we differentiate ourselves from the competition.”

The great thing about investing is that anyone, including the underbanked and people with bad credit, can benefit over time from even a small initial investment. If you’re an amateur investor, you’re probably familiar with popular investment vehicles such as stocks, bonds, and mutual funds. 

Private credit funds provide investors with a diversified asset that’s tied to loans owned by private entities. Prime Meridian offers investors four funds to choose from. Bill told us the company’s Special Opportunities Fund focuses on complex and relatively illiquid investments, including insurance assets and litigation finance.

“When the courts shut down during the pandemic, law firms still had to pay their paralegals and associates to try to keep their cases moving forward,” Bill told us. “So a lot of those folks were looking to borrow funds to be able to pay everyone they needed to. We felt like this was a temporary dislocation in the market and began lending to law firms, which were very good opportunities in terms of risk and reward.”

Prime Meridian has benefited from changes in bank lending strategies that have caused some institutions to become more conservative in offering financing to businesses. Bill told us the company has used commercial-grade electrical equipment as collateral to provide a loan to a data center that couldn’t secure the financing they sought from a regional bank. Prime Meridian not only wrote the business a loan, but it also took a small equity stake in the company through warrants.

Prime Meridian serves various investors around the world. Bill told us most of the company’s clients are individuals or families with extremely high net worths. Prime Meridian also counts a foundation among its clientele and is exploring working with pension funds.

“Probably about 50 to 60% of our investors are what I would call overseas, non-U.S., investors who are very wealthy and want to stay that way,” Bill said. “If you think about the spectrum of investments, there’s liquid investment grade debt in the public markets, which is where most people start, and then they get into high-yield and possibly senior floating rate debt. Prime Meridian offers access to private credit funds that help build and preserve wealth.”

When you’re preparing to go on a long hike, you may take a few moments to make a list of the items you plan to take with you. If I were making that list, hiking boots would probably be at or near the top of it. After all, if you’re going to be spending a lot of time on your feet traversing rocky terrain, you want to be comfortable.

Hiking boots serve a purpose, but they’re not as versatile as a multipurpose tennis shoe. Similarly, Prime Meridian helps investors access a specific type of investment, but some of the company’s clients also invest in more mainstream funds from other sources to build their core portfolios. Bill told us many of the company’s investments are too small for most of its biggest competitors to even consider.

“We differentiate our investments from those offered by larger firms, and we try to be a complimentary option to them,” Bill said. “If a family office has a core allocation from a large alternative-asset manager like Blackstone, our goal would be to function like a satellite allocation that helps them improve their overall alpha within that bucket. There are a lot of inefficiencies out there that we feel like we can capture to take advantage of opportunities.”

Alpha in the investment world refers to a measurement of a security’s returns compared to the returns of a market benchmark, such as an index fund. 

Investors preparing to contribute money to one of Prime Meridian’s funds need to understand that private credit funds function differently than other, more mainstream investment vehicles. But when you’re building a diversified portfolio, you have to expect some differences in assets.

“If you think of the public markets, they’re so liquid that anyone with a portfolio consisting of public securities could unwind it all in a matter of days,” Bill told us. “In a private credit fund, an investor will typically commit to a five to seven year term with a couple of one year extensions at the discretion of the manager. As a hedge fund, we’re kind of sitting somewhere in the middle and capturing some interesting niches at attractive prices.”

When the Federal Reserve announces an adjustment to interest rates, it impacts the entire U.S. economy, including the price of securities. But Bill told us that Prime Meridian’s funds are relatively insulated from short-term fluctuations in interest rates as a result of its fund’s short duration.  

Of the company’s four funds, its Income Fund is the investment option that’s most geared to consumers. Introduced in 2012, the Income Fund is the oldest fund Prime Meridian offers. Bill told us the fund has had an annualized rate of return of 6.89% since it began.

The Income Fund focuses on consumer lending, including credit cards, unsecured loans, and mortgages.

“It’s done quite well over time, and we’ve found that it consistently outperforms other assets in its space,” Bill told us. “There’s been a kind of small industry built around trying to help consumers that have gotten over-leveraged on their credit cards and might be paying interest as high as 29%. In those cases, it makes sense to bring in a personal loan that consolidates that debt at a much lower interest rate.”

In addition to democratizing access to private credit markets, Prime Meridian values innovation and financing for entrepreneurs and fintech companies. Bill told us the company works with platforms that have accumulated massive data sets. Prime Meridian leans on artificial intelligence and machine learning to help it organize and analyze data quickly.

The company also uses machine learning in its underwriting practices. Bill told us about some interesting ways in which artificial intelligence can help lenders determine whether a borrower will default on their loan.

For example, he said that consumers who complete a loan application in all capital letters have a higher rate of defaulting than those who don’t. The same is true of a borrower that uses a mouse rather than the tab button when completing a loan application. Prime Meridian uses the platforms to screen for variables that indicate a higher likelihood of collecting payments longer from borrowers, which in turn can improve the overall return of the company’s investment portfolio.

“Machine learning and AI are exciting areas that can really help us sharpen our pencils when making decisions about loans,” Bill told us. “I think there’s still a lot of excess margin out there that will be available to capture for the next several years.”