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Yield Matters: Finding Yield In The Fixed Income Universe

The fixed income universe is a vast and diverse landscape comprised of numerous unique segments, each offering its own set of opportunities and considerations. From fixed income securities like government bonds backed by sovereign credit to private credit strategies involving non-public entities, the breadth of options is immense. These fixed-income sectors vary in terms of the issuers, accessibility to different types of investors, regulatory oversight, and the transparency of information available. By evaluating the intricacies of each segment, we can identify the most fitting opportunities to enhance our portfolios, striking the right balance between risk and reward, enabling us to make informed decisions that align with our investment goals and risk tolerance.


What Are The Main Differences Within Fixed Income?


Private fixed income involves lending to non-public entities with potentially higher yield income streams to compensate for a range of risks, primarily accessible to institutional or accredited investors. Public fixed income involves debt issued by public entities, offering more accessibility to a wider range of investors, transparency, and generally lower risk and returns.


World of Fixed Income Map

World of fixed income, private credit, public credit

Source: Piton


Public Credit Summary

  • Issuers: Involves debt issued by public entities, usually government entities (sovereign debt) or publicly-traded corporations. This includes government bonds, corporate bonds, and other debt securities issued in public markets.

  • Accessibility to Investors: More accessible to a broader range of investors, including retail investors. Government bonds and corporate bonds are traded on public exchanges, making them accessible through brokerage accounts.

  • Regulation and Transparency: Subject to more extensive regulatory scrutiny, especially for bonds issued in public markets. Companies issuing public bonds are required to provide detailed financial disclosures, and these securities are traded in transparent public markets.

  • Risk and Return Profiles: While typically offering lower returns relative to private credit, public fixed-income is considered more liquid and generally has a lower default risk, particularly for investment grade credit. Government bonds, in particular, are often seen as relatively low-risk investments.


Private Credit Summary

  • Issuers: The borrowers or issuers are typically non-public entities, such as privately-held companies, middle-market businesses, or specific projects or niche assets that are seeking financing. Private credit includes direct lending, mezzanine financing, trade finance, and other forms of debt provided to these non-public entities.

  • Accessibility to Investors: Generally less accessible to retail investors. It's primarily available to institutional investors, such as pension funds, insurance companies, private equity firms, and accredited high-net-worth individuals. The limited accessibility is due to regulatory restrictions and the nature of the investments.

  • Regulation and Transparency: Transactions are often subject to less regulatory oversight compared to public credit. The terms and conditions of the deals can be negotiated between the lender and the borrower, providing more flexibility. However, this also means that there may be less publicly available information about these deals.

  • Risk and Return Profiles: Many offer higher potential returns, as it often involves lending to non-public entities that may have higher growth potential or unique investment opportunities. However, it also comes with higher risk, as private transactions are less liquid and may have a higher risk of default given their credit profile, operational risk, and country risk.


Yield matters, returns matters

Fixed Income Investments: Private Credit In Depth


What Is The Size Of The Private Credit Asset Class?


By September 2022, the global private debt surged to approximately $1.5 trillion, a significant increase from the approximately $300 billion recorded in 2010, and is projected to reach an estimated $2.2 trillion by the year 2027, according to Bloomberg and Preqin. Private credit fixed income products are a popular choice for investors seeking to diversify their portfolios and generate steady returns that exhibit a lower correlation to public markets. (1)


The Advent of Private Credit


Private credit has experienced significant growth in the last decade, driven by a combination of factors, including low-interest rates, increased regulatory oversight and capital requirements of banks, and a growing demand for alternative sources of financing. The Global Financial Crisis was a key catalyst for the growth of private credit, as banks were forced to exit certain business lines and limit their exposure to middle-market lending due to regulatory and consolidation reasons. This created a financing gap, which private credit funds were able to fill by providing capital to borrowers that banks were no longer able or willing to provide.


This funding gap and the resulting opportunity set for non-bank lenders has attracted a range of investors, including institutional investors, high-net-worth individuals, and family offices. These investments offer the potential for higher yields and diversification, but they also come with higher risk and longer investment horizons compared to more traditional fixed income products.


What Is Private Credit?


Private credit is a diverse set of investment strategies offering various potential returns and risks. Private credit investments often offer a legal obligation of the return of capital and payment of interest or other contractual returns with a specific maturity date. This feature provides investors with greater certainty and predictability in their returns. Regardless of whether a private credit strategy is focused on generating income or capital appreciation, the contractual element remains a key aspect of the investment, which can potentially mitigate interest rate risk versus public fixed-income investments. In addition, these investments can serve as a risk mitigation tool relative to equity and public fixed-income holdings. While equity prices can be highly volatile, a diverse portfolio of debt investments can help to stabilize returns and provide a "floor" for returns in that portion of the portfolio.


Private Credit Strategies And Goals


Private credit sub-strategies help with building diversified portfolios and can be broadly divided into two categories: capital preservation and return maximization. The effective asset allocation of these sub-strategies can help investors achieve their desired risk and return objectives.

Investment return targets by fixed income strategies private credit

Note: Figures are intended to be directional.



Capital Preservation Private Credit Strategies


Investors focused on capital preservation are primarily concerned with protecting their principal investment. They seek predictable returns and relatively stable and low risk opportunities. Senior direct lending funds fall into this category. The emphasis on established companies, predictable income, and security in the capital structure aligns well with the capital preservation objective.


Return Maximization Private Credit Strategies


Return maximization strategies in private credit aim to achieve capital appreciation with the potential for greater gains, but they also come with an increased level of risk. Investors seeking to maximize returns are willing to take on higher risk in exchange for potentially higher yields and equity upside through warrants and other forms of economic upside. However, it's important to note that private credit, even in return-seeking strategies, often prioritizes downside protection as a fundamental principle. Specialty finance and distressed strategies fall into this category. Distressed strategies involve investing in distressed assets, such as debt from financially troubled companies that have fundamental sound business models, with the potential for price appreciation. Specialty finance involves investing in niche lending markets or specific sectors that might be underserved by traditional financial institutions. These markets can offer higher yields due to their unique risk profiles. More specifically, trade finance investments can provide higher yields and typically have short-term maturities. Trade finance transactions are often backed by the underlying assets or receivables of the trade, providing a level of security for investors.


Opportunistic Or Niche Specialty Finance Strategies


Opportunistic or niche specialty finance strategies may not fit neatly into either of the first two categories. The potential return prospects of these funds should be evaluated on a case-by-case basis. Some may be classified as capital preservation strategies, while others may be categorized as return maximization strategies. However, what unifies these specialty finance funds is that they tend to exhibit a diversifying return stream relative to other private credit strategies. This is due to the idiosyncratic nature of the underlying assets in these funds, such as aircraft assets or healthcare royalties, which are often asset-backed and have a significant portion of their returns driven by execution risk rather than credit risk.


Yield matters, returns matters

Finding Yield In The Fixed Income Universe


In the intricate expanse of the fixed income universe, we traverse a realm rich with possibilities and complexities. This journey reveals the divergent pathways of government bonds and private credit strategies, each offering unique potentialities and risk profiles. This analysis underscores the importance of dissecting each sector's intricacies, aligning investments with tailored goals, and navigating the equilibrium between risk and reward. From public credit's accessibility and transparency to private credit's allure of higher returns and lower correlation, the universe of fixed income products offer a wide avenues to fortify portfolios.


The trajectory of private credit, a growth fueled by a confluence of historical low rates, shifting regulations, and evolving financial paradigms, ignited by the aftermath of the Global Financial Crisis, has paved the way for institutional investors, high-net-worth individuals, and family offices to explore yields in private credit. With carefully evaluation, we are equipped to not only understand the fixed income universe but to harness its intricacies for strategic advantage. To better make these investment decisions consult a trusted advisor or manager to help navigate the complex landscape that align with your investment objectives.


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