A stability play in fixed income

Each month at WP we focus on a particular topic of interest to advisors. This October we’re focusing on private assets and alternatives.

Private credit tends to appear calmer than its publicly listed equivalents. This is more a feature of market mechanics than the underlying assets, as public credit and bonds are subject to intraday price volatility while private credit assets are priced more periodically. Like a swan gliding gracefully over the surface of a pond while it paddles furiously just below the waterline, private credit can hide much of the volatility that equivalent public assets might show. While some might say the volatility is still there, just smoothed by pricing frequency, the question for advisors is whether that smoother ride is valuable in today’s more volatile fixed income environment?

Nayef Perry, Global Head of Direct Credit at Hamilton Lane, argues that this is a moment when advisors should be considering private credit. He acknowledges that the smoother returns seen in private credit are a feature of pricing frequency, but believes that can still have advantages for retail clients. He adds, too, that some of the shifting macro forces driving volatility in public fixed income, such as fiscal deficits, AI debt issuances, and high inflation, have not had the same driving impacts on private credit as it operates on a different end of the economy.

“In the public fixed income domain, a lot of the volatility is being driven more by macro and rate changes versus in private credit, it just tends to be a more calm space. And I think this tends to be one of the big draws beyond just absolute performance that investors appreciate about the asset class,” Perry says. “Part of the calmness, if you will, has to do with the cadence of valuation. And in more of the public fixed income domain, you see that daily value versus in private credit, it tends to be monthly or quarterly depending on the vehicle structure. And so that in and of itself creates an element of stability. I think the second piece is structural.”

Structural stabilizers in private credit

Perry argues that the mid-market deals that Hamilton Lane tends to focus on are key to that structural stability. He notes that in middle-market private credit, equity contributions as a percent of total capitalization is near historic highs. That points to more structural stability in these firms as borrowers. Perry adds that in his firm’s own deals, they include at least one financial maintenance covenant. As well, these deals have a floating rate, which can benefit when rates reverse course, and tend to come with duration benefits over long-dated government debt.

Perry acknowledges that private credit has seen some of its own recent challenges in the headlines with funds lending to software as a service (SaaS) companies pressured by AI disruption narratives. He says, though, that this wobble was more tied to investor confidence than underlying market fundamentals. He says that the broader default rate has stayed slow. Borrowing companies have largely benefitted from the continued expansion of US GDP, he says.

Perry also says that private credit can provide insulation against the growing presence of AI-related debt in public credit markets. Most AI-related debt issued by the hyperscalers has been at the investment grade level. Private credit, Perry says, tends to operate at credit ratings below investment grade, where far less AI-related debt has been issued. For investors and advisors concerned about how much of their equity and fixed income portfolios have been exposed to AI, this could be a valuable feature.

Using private credit for retail clients

Private credit has long been the domain of institutions, rather than retail investors, in part for the same reason its performance tends to appear so stable. Infrequent pricing means low liquidity which doesn’t suit an investor with a shorter time horizon. Perry says that’s changing, however, with evergreen and semi-liquid structures replacing the old model of a closed-end fund. Minimum investment amounts are now lower, too. Hamilton Lane’s own US-based Credit Income Fund has a minimum investment of $2,500 (USD), allowing investors and advisors to dip a toe into the space and see how it impacts their portfolio performance and their investment behaviour.

This shift towards a more retail-friendly format has largely resulted from the shift in lending from bank to non-bank channels. Perry explains that as more companies have gone to non-bank lenders, those lenders have built more retail investor friendly vehicles. Investors, therefore, have been able to access this asset class and the relative calm it can afford in stormy markets.

“We tend to think private credit is obviously a much more ‘calm’ part of the market relative to fixed income, where you tend to see a lot more volatility,” Perry says. “I think because of performance and access investors, particularly in the wealth space, are starting open their eyes to private credit and see it as a more permanent part of their portfolios.”