Michael Cibelli, CFA®, Product Specialist, Alternatives: So now that we’ve gotten to know private credit, especially as it relates to direct lending, what’s the potential benefit to investors?

In this video, we’ll explore the case for investing in BDCs (business development companies) that make private loans to companies in the U.S. and around the world.

This is Lord Abbett Explains: Private Credit.

Performance and Yield

As we’ve discussed, direct loans to corporations are not publicly traded. That means they’re considered illiquid investments that cannot be easily or quickly converted into cash. Because of that, investors need to be compensated for giving up that liquidity. The term for that is the illiquidity premium. That’s the extra yield investors can earn for holding onto loans that aren’t easily sold. At the time we recorded this, that premium was around 200 basis points, or two additional percentage points above publicly traded loans.

Now, beyond the extra yield, direct lending has also historically offered attractive risk-adjusted returns. Public loans change hands all the time, with investors constantly buying and selling based on their views of value. That can lead to more frequent price swings. Private loans, on the other hand, are not traded, and therefore don’t experience the same price volatility. Instead, they are valued periodically by third party valuation services. This combination of high income and low volatility has historically resulted in a compelling risk-reward profile.

This scatterplot shows where direct lending lands on the risk/reward spectrum. Here, it is compared to the Bloomberg Aggregate Bond Index, floating-rate loans, and high yield bonds. Anything that plots up and to the left signals a historical record of greater return with lower risk and lower volatility.

How Can this Work in an Investment Portfolio?

Direct lending strategies can be an effective complement to traditional stocks and bonds. It can help reduce overall portfolio volatility, enhance yield, and diversify exposure, especially alongside other alternative strategies like private equity, infrastructure, commodities, real estate, or hedge funds.

Let’s Recap

So, to recap…

  • Direct lending portfolios offer an incremental yield premium as compensation for giving up liquidity.
  • Private loans aren’t traded and therefore don’t experience the price volatility of publicly traded loans.
  • The combination of high relative income and low volatility has historically resulted in attractive risk-adjusted returns.

Thanks again for joining us on this installment of Lord Abbett Explains: Private Credit.