Quick Takes: The Power of Diversification in Private Credit
Text on screen: PIMCO
Text on screen: PIMCO Quick Takes: The Power of Diversification in Private Credit
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Text on screen: Max Gelb, Product Strategist, Client Solutions & Analytics
Gelb: As the saying goes, diversification may be the only free lunch in finance. But diversification is underused in private credit.
In just the past five years, private credit assets have more than doubled to over $1.3 trillion dollars. However, the majority of investments focus on corporate strategies. We’re constructive on private corporate credit, but believe that private credit portfolios can be enhanced by non-corporate exposures.
FULL PAGE GRAPHIC: TITLE – Diversified private credit is more attractive than a single-sector approach
The half circle graphic shows the myriad sectors and subsectors within the private credit universe. From left to right it reads as follows: Residential Real Estate – Self-employed, Re-performing, Bridge loans; Commercial Real Estate – Transitional, Developmental, REIT debt; Specialty Finance – Niche sectors, Asset lending, Consumer; Corporate Lending – Direct lending, Mezzanine and Distressed debt.
In fact, over the next five years a big portion of the returns we forecast for diversified private credit comes from residential and commercial real estate debt and specialty finance.
Another reason to diversify across private credit sectors is to reduce risk. The risk factors for asset-backed, real estate, and consumer debt differ from those for corporate lending. And that can reduce estimated volatility in a well-balanced portfolio
Recent stress in the banking sector has made the case for diversifying into non-corporate private credit even stronger. Historically, US regional banks were major providers of real estate debt and specialty finance.
FULL PAGE GRAPHIC: TITLE – Non-corporate opportunities are enhanced by banking sector stress
The graphic shows two charts. The chart on the left is titled Regional bank balance sheets are dominated by non-corporate risk…The subtitle is Small and medium-size banks’ share ($ value) of all outstanding bank loans, by type. The first bar shows Total Loans with a 38% share at $4.62 trillion. The second bar shows Commercial and industrial with a 28% share at $782 billion. The third bar shows Residential Real Estate with a 37% share at $1.45 trillion. The fourth bar shows Commercial Real Estate with a 67% share at $1.25 trillion, representing the biggest share of total outstanding bank loans. The fifth bar shows Credit cards with a 27% share at $165 billion. Lastly, the sixth bar shows Auto loans with a 15% share at $91 billion. The chart on the right is titled …However, private credit dry powder is concentrated in corporate lending. The chart subtitle is Private credit industry dry powder breakdown; Total dry powder equals $569 billion. Dry powder represents capital which has been committed but not yet called into private credit strategies. The first bar shows Direct Lending with a share of 37% at $213 billion. The second bar shows Mezzanine with a 12% share at $68 billion. The third bar shows Distressed with a 16% share at $90 billion. The first three bars are comprised of largely corporate strategies. The fourth bar shows Special Situations with a 14% share at $79 billion. The fifth bar shows Real Estate with a 14% share at $77 billion. Lastly, the sixth bar shows Infrastructure with a 6% share at $36 billion. The chart excludes 1% of dry powder in Venture debt.
As these banks offload this risk and limit new originations, private investors are likely to gain more access to attractive real estate and specialty finance loans. Yet most of the capital that has been committed to private debt funds will focus on corporate lending. It may fail to capture the full opportunity.
That makes the power of diversification even more appealing.
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Past performance is not a guarantee or a reliable indicator of future results.
Private credit involves an investment in non-publically traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Alternatives involve a high degree of risk and prospective investors are advised that these strategies are appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. Diversification does not ensure against loss.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
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