As an asset class, private debt has experienced considerable growth in recent years. This growth has largely been fuelled by investors gradually recognizing the potential for enhanced risk-adjusted return that private debt can bring to the portfolio relative to typical corporate bonds. As per Scott Tominaga, investing in debt provides a great opportunity to target yield through interest payments. It is a lower-risk asset class than equity.
Scott Tominaga marks a few advantageous aspects of investing in private debt
Private debt implies to loans to companies that are provided by private markets, instead of banks or public markets. Debt finance is widely used to finance buyouts in established markets like the US or Europe. It is also used as expansion capital or to finance acquisitions.
There are many reasons to invest in private debt, such as:
Potential for superior risk-adjusted returns: Private debt provides more flexibility to a borrower than a traditional lender would be willing to provide. This does not always mean an increase in risk. As companies are prepared to pay a higher interest rate, the targeted return tends to be higher. This helps create a more attractive risk-adjusted return. Certain direct private debt deals might even include a small equity share in the company. This share is not as much as a full private equity deal, but a degree of ‘equity kicker’ might be present to further enhance returns potential and share in any upside as the company grows with time.
Target reliable income streams: Choosing to invest in debt may provide investors with a predictable stream of income through regular, scheduled, contracted repayments.
Reduced volatility: Investment returns from private debt generally take the form of regular repayments. Therefore, this asset class can be used for lowering the overall volatility of a portfolio that includes equities and where the timings of returns, through exits and realisations, are not too predictable.
Portfolio diversification: Private debt offers valuable opportunities to investors to diversify sources of return and risk for their investment portfolio with the help of a differentiated asset class. Contractual repayments on a loan are generally unaffected by the market for acquisitions and mergers. They are also not generally impacted by certain other exit routes like a stock market listing which holders of equity in a private company tend to target. Private equity is widely used for providing diversification from equities.
Diversified sources of income: Investing in a wide range of private debt opportunities helps spread risks. Diversity of income sources might be achieved by not only investing through multiple companies but also varied entry routes to the asset class. These routes can be direct investments, co-investments and investments in private debt funds that may target companies of distinguished sizes, in varying sectors and with the use of differentiated private debt strategies.
In the opinion of Scott Tominaga, in times of inflation and rising interest rates, traditional fixed-income investments like bonds may experience a decline in returns. However, certain private debt strategies invest in floating-rate loans, where returns adjust relative to a benchmark rate rather than being fixed. This approach can serve as a hedge against rising inflation and provide more resilient returns in such economic conditions.