Alternative credit investment refers to investing in non-traditional credit assets beyond government and investment grade corporate bonds. It encompasses a range of private debt strategies like direct lending, distressed debt, leveraged loans etc. After the 2008 financial crisis, alternative credit has seen strong growth as banks reduced lending. Institutional investors moved to fill this gap. Alternative credit provides portfolio diversification and potential for higher risk-adjusted returns compared to traditional fixed income. However, these investments also tend to be less liquid and have higher complexity. This article will analyze the role, return drivers and implementation approaches for alternative credit investment.
Alternative credit provides diversification for investor portfolios
Adding alternative credit can significantly improve portfolio diversification compared to traditional stocks and bonds. For instance, securitized home loans provide direct exposure to consumer credit risk – an asset type missing from typical allocations. Alternative credit also has much lower correlation with broader markets during times of crisis compared to stocks or high yield bonds. According to Barclays Research, despite representing 25% of global debt markets, alternative credit only comprises around 5% of institutional investor portfolios currently. As understanding grows, there is substantial room for increased allocation going forward.
Multiple factors drive returns for alternative credit strategies
Investor compensation within alternative credit comes from various risk premiums – default risk, interest rate risk, inflation risk, illiquidity premium etc. The wide range covers unique exposures unavailable in traditional markets. For instance, private debt funds earn an illiquidity premium by providing long term loans to businesses. Allocations to alternative credit have historically enhanced returns or reduced risk at the overall portfolio level. Customized implementation based on specific needs is key to harnessing the advantages of these diverse strategies.
Direct access and fund investments cater to different priorities
Institutional investors can implement alternative credit exposure either through specialized private debt funds or via co-investing directly into loans and securities. Direct investments allow greater control over asset selection and terms but require significant research capability. Allocating through funds enables leveraging external manager skill but has lower transparency and liquidity. Larger investors like pension funds and endowments increasingly combine both to optimize implementation. Overall, alternative credit presents a compelling option for investors to meet portfolio objectives across changing market environments.
Alternative credit has moved from a niche to mainstream after the financial crisis as traditional lenders pulled back. Return enhancement, diversification and matching long-term liabilities make it an attractive option. Evaluating the full menu of alternative strategies and appropriate access vehicles is key to success.