Alternative credit refers to debt investments outside of traditional bond markets. Private credit funds provide loans directly to companies, bypassing traditional lenders like banks. With increasing regulation and capital requirements for banks, private credit has grown rapidly as an alternative investment strategy. This article will examine examples and strategies for investing in private credit markets across leveraged loans, direct lending, distressed debt, and structured credit. We will explore how credit managers analyze borrowers, structure investments, and manage risk to generate attractive risk-adjusted returns. Properly implemented, alternative credit can provide portfolio diversification and yield pickup versus traditional bonds.
Leveraged loans for speculative grade borrowers
Leveraged loans are floating rate bank loans made to non-investment grade companies. Loan mutual funds and ETFs provide liquid exposure for retail investors. Direct private credit funds invest alongside banks in primary loan issuance and secondary trading. Managers exploit inefficiencies and earn an illiquidity premium by doing proprietary credit analysis on borrowers. Loans tend to have senior priority in capital structure versus unsecured bonds. Managers can reduce risk through conservative LTV ratios on collateralized loans and diversification across industries and borrowers.
Private lending to middle market companies
With banks constrained by regulation, private lenders are increasingly meeting financing needs of mid-sized firms. Private credit funds provide senior secured loans, preferred equity, and other customized financing. Managers source proprietary opportunities through industry networks and develop close borrower relationships. Conservative underwriting standards focus on cash flow coverage, collateral value, industry dynamics, and management strength. Private loans command illiquidity premiums versus broadly syndicated loans while offering higher loss recovery.
Distressed debt turnarounds
Specialty credit managers invest in bonds and loans of stressed and distressed firms. After in-depth research, managers acquire positions at steep discounts to potential recovery values. Active involvement includes negotiating debt exchange offers, new capital, and restructurings. The goal is to maximize value through reorganization or underlying business turnaround rather than liquidation. Distressed investing requires deep workout expertise but can earn substantial risk-adjusted returns.
Structured credit and asset-backed securities
Structured credit managers invest in securitized bonds backed by pools of loans. Securities are segmented into rated tranches based on seniority. Managers use fundamental analysis of underlying collateral combined with structural analysis of tranching protections. Cash flow stress testing quantifies expected loss across scenarios. Portfolios are constructed to achieve target yield and loss rates. Structured credit provides diversification from corporate credit with specialized sector expertise needed to properly analyze complex securities.
Alternative credit encompasses a range of private strategies that fill gaps left by banks’ reduced role. Well-executed approaches allow qualified investors to increase portfolio yield and diversification through exposure to corporate loans and structured products tailored to suit their return and risk profiles. The specialized due diligence and active management applied by alternative credit managers can capitalize on market inefficiencies while controlling default risks.