Alternative credit investments refer to debt investments in private credit markets rather than traditional public fixed income securities. This asset class has seen rapid growth since the 2008 financial crisis as banks pulled back lending to middle market companies, opening opportunities for private lenders. With higher yields, lower volatility compared to equities, and low correlation to traditional assets, alternative credit presents an attractive option to diversify portfolios.
Private debt fills the lending gap left by banks
After the 2008 financial crisis, banks were forced to pull back lending to middle market companies, leaving a gap that alternative lenders have stepped in to fill. Private credit now accounts for over $800 billion in capital compared to under $50 billion before 2008. Strong demand exists from both borrowers and institutional investors looking to fill portfolios.
Institutional investors drive growth in private lending
Pension funds, insurers, family offices and more have been increasing allocations to private debt. The ability to enhance portfolio yield and diversification along with large volumes of dry powder make private lending attractive. Additionally, barriers to entry like manager access and domain expertise have started to erode, opening the doors to more investors.
Lower volatility and higher Sharpe ratios
While generating yields similar to high yield bonds, private lending tends to have lower volatility and loss rates, resulting in higher risk-adjusted returns. According to Preqin, private debt funds have produced a 1.66 Sharpe ratio over the past decade compared to 0.47 for US high yield bonds over the same period.
With strong historical returns, attractive yield and diversification benefits, alternative credit represents an overlooked option for fixed income investors to consider. As the asset class continues institutionalization, it will likely take up a larger portion of investor portfolios going forward.