The Components of Private Debt Performance

Abstract

In an environment of near-zero yields for traditional asset classes and tightening bank regulation, debt in privately-arranged loans has become an interesting alternative to publicly-distributed bonds for borrowers and professional investors. Key questions for potential investors concern the expected return and risk inherent to such investments, and the diversification benefits they offer for strategic asset allocation. Due to the private nature of these markets, however, historical data are not available at a micro level. For most segments of the market, representative current yield figures for Europe can be only inferred from anecdotal evidence around current transactions or derived from central banks’ aggregate series. In this article, the authors analyze private debt interest rates and the features that are relevant for asset allocation decisions using a mix of non-public data, snap-shot data, and publicly available, highly aggregated historical data on bank loans. By means of regression analysis, the authors find that they can disentangle the main components of private debt rates over time, and assess the existence of a premium related to the illiquidity and complexity of private debt markets. Then, they look for possible diversification opportunities that private debt may offer in asset allocation, and observe that efficient portfolios obtained by investing in private debt are more diversified and achieve higher expected returns for any given level of expected risk than portfolios that do not invest in this asset class.

TOPICS: Risk management, fixed income and structured finance, portfolio construction, performance measurement