Financial advisors and clients seeking diversification outside of traditional market swings and ongoing questions
Investments in
The alternative asset class carries risks, particularly when investing in the "subordinated" tranches of debt paid off after "secured creditors" in the event of a default or liquidation. Besides high fees, other investing perils include slower lending due to interest rates, the complexity of the products and potential regulatory scrutiny or shifts, according to Cerulli.
Pension allocations to private debt instruments reached an eight-year high last year at 3.8% of their portfolios. Still, investments like collateralized loan obligations and business development companies and
Advisors should remind some clients who want to invest only in basic index-based funds because of the healthy gains of stock values this year that, "You want these things that zig when the rest of the market zags in your portfolio," said Gene Goldman, the chief investment officer of
"There are a lot of investment opportunities out there," Goldman said in an interview. "Active management needs to do well and should do well in this environment."
The
"It has been a beneficiary of tightening regulation of banking loans, growing demand for financing buyouts and a decade of (until recently) ultra-low interest rates that spurred investors to search for a higher-yielding, fixed-income replacement," Cerulli's report said. "Like private equity, private debt is illiquid, locked-in capital but is less risky, given seniority of repayment, attractive contractual and floating rate yields and active downside protection by fund managers."
The most common types of private debt strategies are, according to
- Direct lending, or loans to companies without an intermediary
- Distressed debt, or purchases of notes in the secondary market
- Infrastructure, longer-termed instruments often spanning 30 or more years
- Mezzanine debt, which is often used in leveraged buyouts
- Real estate debt, for asset acquisitions in the sector
- Special situations, capital seeking to gain control of a struggling company
- Venture debt, which is short- to medium-term financing of companies that have received venture capital.
After the first quarter, three funds each with direct lending, distressed debt and special situations strategies, plus one real estate debt-linked vehicle, comprised the 10 largest products by assets, Pitchbook data cited by Cerulli showed. Ares Management, Carlyle Group, Blackstone and Bain Capital each had products in the group amounting to $53.7 billion in assets. Private debt investments and private equity funds have "a symbiotic relationship," since they often come from the same firms and investor pools and are both closed-end products, Cerulli noted.
"Private debt has been described as the 'Swiss Army knife of an investment portfolio,' given its diversity of sub-strategies that are capable of meeting investors' unique risk and return needs as well as matching business cycle conditions," the report said. "Investors can choose to invest in senior debt of direct lending loans for low and predictable returns, or they can move in the direction of distress and mezzanine strategies that offer higher but less predictable returns."
