In this article, we discuss the opportunities and challenges associated with building well-balanced portfolios of private credit investments and fixed income investments available in public markets.

Exploring the opportunities and challenges of private credit investing

Private credit allocations can be significant contributors to investment portfolio total returns. They have the potential to enhance diversification, to provide differentiated return streams, and to have low correlation to traditional bond investments. In a diversified portfolio, private credit can lead to potentially lower volatility compared to portfolios comprised only of publicly traded bonds.

The growth of private credit issuance since 2000 helps to illustrate its increasing acceptance and presence among fixed income investors (See Figure 1). In 2022, total private credit assets under management surpassed high yield credit issuance for the first time and private credit continues to represent a growing portion of overall fixed income portfolio allocations.

Managing private credit investments also can present higher risks and demand more time and attention. Private credit is inherently more complex and less transparent than public market investment grade bonds. For example, private credit instruments may be priced less frequently. Issuers may have lower credit ratings or be more highly leveraged. Investors may need to assess a wider range of financing structures, and liquidity premiums can be difficult to measure.

In addition, because meaningful differences in managers’ skill and experience can lead to dispersion of returns, success in capturing alpha relies upon the ability of investors, asset allocators, consultants, investment committees, and chief investment officers to identify and source top-performing private credit managers.

Seeking balance among private credit and public investment grade bond investments

Because private credit allocations can command more time and attention, Breckinridge recognizes that it makes perfect sense to budget a greater time, energy and resources to private credit allocations relative to public market exposures.

At the same time, decision makers who reduce the time and attention dedicated to investment grade fixed income allocations may risk outcomes contrary to their overall portfolio objectives. For example, choosing to limit public bond investments (i.e. capital preservation, liability hedging) can also impede exposures to the return seeking potential of higher risk market segments. Similarly, indexing fixed income investments may limit opportunities for active managers to capture alpha that public markets can offer.

On the other hand, return expectations for publicly offered bonds are more modest relative to private credit historically. An aggressive investment grade fixed income risk budget that attempts to extract marginal incremental excess returns through exposures to sectors with elevated risk profiles may lead to negative excess returns and illiquidity. This portfolio outcome can be particularly damaging if it occurs when the historical resilience and liquidity of high-quality fixed income investments may have helped sustain overall portfolio performance.

Selecting the right approach (and manager) for investment grade fixed income assets

Underestimating the value of or oversimplifying approaches to complementing private credit allocations with public market investment grade bonds can be a disservice to the performance of a well-balanced portfolio against strategic objectives.

As an investment manager specializing in investment grade fixed income, Breckinridge prefers to construct resilient, high quality bond portfolios that provide stability to enable our clients and their consultants to more confidently consider private credit, where expected excess returns may be greater.

Our approach is intentionally balanced. We aim to incrementally enhance income while emphasizing high credit quality and disciplined duration management. The Breckinridge Investment Committee evaluates yield curve, sector spreads, credit markets and supply/demand dynamics to balance total return and yield considerations and inform portfolio structure.

Breckinridge recognizes the significant role that private credit can play within overall portfolio allocations. We also believe in the value of a well-structured, high quality fixed income portfolio as a crucial counterbalance, as investors and their consultants weigh the risks of private credit allocations.

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