What are good alternatives to traditional fixed income and cash? Private Credit & Direct Lending

With all the media buzz regarding expected interest rate changes coming soon, you may have questions about optimizing your portfolio and managing cash reserves. To prepare our client accounts for potential market volatility, we build resilient portfolios to be continuously diversified, including investment strategies beyond traditional stocks and bonds. Two fixed income approaches we often incorporate into client portfolios are private credit and direct lending strategies. Let’s explore the key benefits and considerations of these strategies.

Fixed Income Investment Options

There is a wide array of investment options in the fixed income space. The first four instruments listed below are the cornerstone of many investment portfolios, are widely recognized and utilized by both novice and experienced investors. These instruments have stood the test of time, offering relatively straightforward mechanics and a level of stability that appeals to many. Their longevity in the financial markets has contributed to their widespread understanding and acceptance.

As we move down the list of fixed income strategy options, you’ll see some instruments that offer potentially higher yields but come with increased complexity and risk. Understanding the mechanics and risks associated with private credit and direct lending requires a higher level of financial sophistication. As a result, these instruments remain unfamiliar territory for most retail investors.

• Cash/Checking Accounts
• High Yield Savings/Money Markets
• Treasury Bills
• Corporate Bonds
• High Yield (Junk) Bonds
• Private Credit/Debt
• Direct Lending

Investment strategies continue to evolve alongside changes in technology, policy, and market conditions. At CAM, we recognize the importance of adapting to this dynamic landscape to help our clients achieve their financial goals while managing risk. 

What is Private Credit?

Private credit involves non-bank lenders providing debt financing to borrowers, typically small and medium-sized businesses, through privately negotiated transactions. These loans are often tailored to the specific needs of the borrower and can offer more flexible terms than traditional bank loans. Borrowers are typically companies that may not have easy access to traditional bank loans or public debt markets.

Private credit is a broad term that encompasses various forms of non-bank lending to companies. It includes:

• Direct lending
• Mezzanine debt
• Distressed debt
• Special situations lending

What is Direct Lending?

Direct lending investing is a specific form of private credit where institutional investors provide loans directly to businesses, typically middle-market companies, without the involvement of traditional banks or financial intermediaries. 

Direct lending is a specific subset of private credit. It includes:

• Loans made directly to companies (usually mid-sized businesses) by non-bank lenders
• Often senior secured loans, meaning they have priority in repayment
• Typically negotiated directly between the lender and borrower, without intermediaries

Direct lending represents the largest category within private credit, accounting for about 44% of assets under management in the private credit space.¹ It also has a more conservative risk profile compared to some other private credit strategies like distressed debt.

Advantages of Alternative Fixed Income

Private credit (including direct lending) can be a valuable addition to an investment portfolio for several reasons:

Portfolio Diversification

The unique nature of private credit deals can result in low correlation with public markets, potentially providing portfolio diversification benefits.

Stability Across Market Cycles

Private credit strategies can adapt to various economic conditions, allowing for consistent performance throughout different phases of the business cycle.

Floating Rate Structure

Many private credit loans have floating interest rates, which can be advantageous when interest rates are on the move.

Enhanced Yield Potential

Private credit investments may offer higher yields compared to traditional fixed income assets, as borrowers are often willing to pay a premium for access to capital. Direct lending has outperformed U.S. high yield bonds and leveraged loans in 12 of the last 17 years.¹

Market Opportunity

In the last decade, structural shifts in the lending landscape have created opportunities. Post-financial crisis regulations have led banks to reduce traditional corporate lending, creating a gap filled by private credit providers. The private credit market has grown to $1.3 trillion¹, comparable in size to the high yield bond and leveraged loan markets.

By incorporating private credit and direct lending in a portfolio alongside traditional fixed income and cash investments, investors can create resilient portfolios, ready to withstand various market environments.

CAM’s Investment Approach

Incorporating private credit and direct lending in our clients portfolios is just one area of fixed income that we deem as a way to diversify risk for our clients and help them achieve their goals.  These investment strategies have delivered very strong returns given the interest rate environment the last few years. We’re not here to forecast what’s going to happen or guarantee returns but they’ve served their purpose in terms of achieving return objectives, diversifying risk in areas that we may not be able to achieve with traditional fixed income or equity markets, and they present opportunities to manage risk in the event that rates do come down over the next year or two.

For clients who are interested and it makes sense for their investment goals, we invest with some of the biggest private credit and direct lending providers in the industry. We choose asset managers who are not only established or have good controls in place and manage risk around credit and lending, but who have also been doing this for a long time.

Do you have questions about your fixed income investments or what to do with excess cash? We’re happy to provide a second opinion.

CAM Disclosure

¹ BlackRock

M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. 

This blog has been provided solely for informational purposes and does not represent investment advice. Nor does it provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy.

Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.