A Guide to Higher Yields on Your Fixed Income Portfolio

If 2022 taught investors anything, it was that runaway inflation can wreak havoc on a bond portfolio if it’s filled with publicly traded funds and investments whose holdings drop significantly in value when rates move higher. Below we present an option for generating yield that can return more than almost anything available in the public fixed income markets, while also having less correlation to the moves and volatility public markets present. Here we are talking about Private Credit. 

In the quest for higher yields on fixed income investments, private credit has become a standout option. This asset class offers the potential for attractive returns, making it a key consideration for savvy investors. Let's delve into the world of private credit, exploring its benefits, risks, and how it can enhance your investment strategy. 

What is Private Credit? 

Private credit involves non-bank lending, where investment funds or private individuals provide loans to companies, usually those not listed on public exchanges. These loans come in various forms such as direct lending, mezzanine financing, and distressed debt. Unlike traditional bonds or bank loans, private credit offers higher yields and customized terms tailored to both lenders' and borrowers' needs. 

The Evolution of Private Credit 

The private credit industry has its roots in the aftermath of the 2008 financial crisis. As banks tightened their lending standards due to regulatory changes and risk aversion, a gap emerged in the market for alternative lending sources. This gap was quickly filled by private credit funds, which provided much-needed capital to mid-sized companies and other borrowers who could not access traditional bank loans. Over the past decade, the industry has grown significantly, with assets under management reaching over $800 billion globally by 2020. This rapid expansion reflects the increasing demand for non-bank lending solutions and the attractive yields offered by private credit investments. 

The Appeal of Private Credit 

Higher Yields 

One of the most compelling reasons to consider private credit is the potential for higher yields. In today’s rate environment, private credit funds often target annual returns between 8% and 12%. For instance, while the yield on investment grade bonds in the public market is currently below 5% in most cases, the private credit funds we use offer yields in excess of 9%. This can significantly boost your portfolio's performance, providing equity-like returns in the fixed income portion of your portfolio.  

Enhanced Diversification 

Private credit can serve as a powerful diversification tool. Since these investments typically exhibit low correlation with the stock market and traditional bonds, they can help stabilize your portfolio. According to a study by Preqin, private credit showed a correlation of just 0.48 with public equities from 2008 to 2020, highlighting its potential to provide a steady income stream during periods of economic volatility. 

Customized Investment Terms 

Private credit deals are usually bespoke, allowing for highly tailored investment structures. This flexibility means investors can negotiate terms that include protective covenants and favorable conditions. For example, loans can be structured with specific financial performance requirements for the borrower, adding a layer of security to the investment. High net worth clients of Fortis don’t need to do this negotiating on their own, we utilize the best managers in the world, including Goldman Sachs, Blackstone, Ares and Apollo to do this hard work for our clients. 

Exploring Private Credit Funds 

There are a handful of different types of Private Credit funds available. Let’s explore them in more detail: 

Direct Lending Funds focus on providing senior secured loans to mid-sized companies. These loans have a relatively lower risk profile compared to other types of private credit and offer stable, predictable returns. Data from the Alternative Credit Council (ACC) shows that direct lending funds delivered an average annual return of 9.2% over the past decade. 

Mezzanine Funds provide subordinate loans, which come with higher risk but also higher potential returns. These investments often include an equity component, giving investors a chance to benefit from the company's growth. The ACC reports that mezzanine funds have averaged returns of around 12% per annum, making them an attractive option for those seeking higher yields. 

Distressed Debt Funds invest in companies experiencing financial difficulties. These funds aim to profit from turnaround situations, offering high returns for those willing to take on more risk. Historical data indicates that distressed debt funds have achieved average annual returns of 10-15%, depending on market conditions and the specific investment strategy employed. 

Risks to Consider 

While private credit can offer attractive returns, it’s essential to be aware of the associated risks, such as credit risk, liquidity risk, and market risk. Mitigating these risks involves thorough due diligence and partnering with experienced fund managers.  

At Fortis, we choose to partner primarily with Goldman Sachs, Ares, Blackstone and Apollo as the highest quality and most experienced fund managers in the space in order to mitigate risk and achieve optimal returns.  

Conclusion 

Private credit offers a compelling opportunity for investors seeking higher yields and better diversification in their fixed income portfolios. By leveraging the expertise of seasoned fund managers and conducting rigorous due diligence, you can mitigate risks and unlock the potential of this asset class. 

At Fortis Financial Group we are dedicated to helping you navigate the complexities of private credit and other alternative investments. Reach out to us today to discover how private credit can enhance your financial strategy and contribute to your long-term goals.