It’s not complicated.  Allocators are formulating return and risk assumptions for private debt that compare favorably to other asset classes, in turn recommending new or higher private debt allocations using traditional asset allocation models.

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Allocators universally direct monies to asset classes based upon long-term expected returns, risk, and correlations, collectively known as capital market assumptions, or CMAs.  CMAs have ruled institutional asset allocation for the past 40 years.  The recent emergence of private debt in asset allocation discussions was made possible by indexes like the Cliffwater Direct Lending Index that provide an historical record of private debt return and risk, which in turn assist allocators in developing CMAs for that asset class.  Allocators evidently like what they see, both historically and prospectively.  

Private debt plots well above the average return/risk spectrum shown by the dotted line and its 8.9% consensus 10-year return is second only to private equity, which has roughly double the risk.  Unquestionably, individual allocator assumptions reflected in consensus forecasts are driving new or higher private debt allocations from optimization models.

Also noteworthy:

• Private debt’s 8.9% expected return is highly accretive to the average institutional portfolio with a consensus 6.9% expected return.3

• Individual allocators’ private debt expected returns range from a 7.0% low to an 11.5% high with 8 of 12 allocators posting expected returns in the 8-9% range.  

• Real estate allocations will likely decline judging from their low 5.8% consensus expected returns, a full 3.2% below private debt with roughly the same risk level.

• Allocators continue to see non-US stocks as a value opportunity relative to US stocks, rather than a value trap, with consensus non-US stock expected returns at least one percentage point above US stocks.

• Hedge funds will continue to struggle to gain allocations as investment grade fixed income expected returns have returned to pre-2008 levels.  

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