July 2024


Private debt: Risks returns and opportunities

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At the Markets and Financing Research Retreat in London last month, Josh Lerner, Jacob H. Schiff Professor of Investment Banking at Harvard Business School and State Street Associates academic partner, discussed the implications of the private debt asset class taking on an increasingly significant role in investor portfolios.

Increased interest in private debt investing has been driven partly by regulation and risk tolerance driving down bank lending since the global financial crisis of 2008-2009, and by the low interest rate environment since then – until the last two years – making public fixed income relatively low yielding and, therefore, unattractive.

“Is private debt a fad, or has it really delivered?” asked Professor Lerner. “Returns have been attractive, but not as attractive as private equity buyout or venture capital.”

“Assessing risk is challenging, but the band of best and worst performing private debt funds is narrower than for other asset classes, and it has a lower standard deviation than other private markets assets, suggesting less risk and making manager selection less challenging.”

He added that investments in private debt tend to pass a higher percentage of their total returns on to limited partner investors, with less going to the general partners who run the funds or arrange the lending deals.

Performance data also suggests the asset class can bring portfolio diversification benefits, according to Lerner, who cited data showing portfolios including private debt along with traditional public stocks and bonds tended to outperform standard 60-40 stock and bond allocations on a risk-adjusted basis.

However, he cautioned that the recent economic downturn has led to more defaults and corporate failures, which will not necessarily have filtered through into the overall picture of private debt performance yet. He also noted that rising interest rates, in response to inflation, will increase the attractiveness of traditional fixed income.

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