Adding Private Credit To A Client’s Portfolio

Bigger companies, says Shah, tend to pay a Libor premium of 500 to 600 bps while smaller concerns pay more.

As attractive as these payouts are, investors in private credit look for more than just yield. Since private loans aren’t marked to market, they tend to exhibit less volatility than publicly traded debt. That, coupled with short durations--investment horizons of just 2 or 3 years are common--make senior loan funds good diversifiers for a qualified purchaser’s fixed income allocation. 

“Given the challenging yield environment, an allocation to private credit can be additive to a client’s portfolio,” says Zoe Brunson, senior vice president of investment strategies at AssetMark. “The mix of private credit and traditional fixed income is really dependent on the investor’s risk profile, not only their risk appetite but their capacity and propensity for risk.”

So, what kind of risk are we talking about? Private loans aren’t rated so apples-to-apples comparisons aren’t possible. Still, says iCapital’s Shah, “On the risk scale they would likely fall between the lower end of investment-grade bonds and the upper end of the high-yield bond market.”

Leverage often figures into the risk profile of direct lending schemes. Gross returns for unlevered senior loan funds tend to range between 6% and 10%. With leverage at the fund level, though, gross returns may climb as high as 15%. Leverage, of course, is a two-edged sword. It not only magnifies returns, it also exacerbates risk, so advisors and investors need to be mindful of the overall level and tenure of leverage lines.

Add this to the credit risk of the underlying portfolio and any idiosyncratic risks arising from the sponsor’s business model and you can readily see why private credit should be considered an augment and not a replacement for a conventional fixed income allocation.

“Using it as supplemental exposure to traditional fixed income to gain extra yield would provide diversification benefits to a portfolio,” says AssetMark’s Brunson. “We don’t think it should take the place of traditional fixed income since it can increase risk in the portfolio if it isn’t appropriately balanced.”

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Disclosure: Brad Zigler pens's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) option ...

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