Private Credit and the Death Knell of the 60/40 Portfolio

Published on
September 17th, 2020
Duration
50 minutes


Private Credit and the Death Knell of the 60/40 Portfolio

The Interview ·
Featuring Udayan Mitra

Published on: September 17th, 2020 • Duration: 50 minutes

Udayan Mitra, former head of investments at Altera Investments, joins Real Vision managing editor, Ed Harrison, to discuss the state of fixed income investing in a world with near-zero interest rates. Mitra argues that yield hunger will force investors further into alternative credit strategies. Mitra lays out the various players in this space – private equity and credit funds, direct lending firms, as well as special purpose acquisition companies (SPACs). Mitra then tells Harrison about how higher yields come at the price of reduced liquidity, and the pair weigh this trade-off. Lastly, Mitra shares specific opportunities and risks he sees in this space. Filmed on September 15, 2020.

Comments

Transcript

  • RJ
    Raoul J.
    18 September 2020 @ 08:46
    Not sure how this is helpful for the retail investor
    • JK
      John K.
      18 September 2020 @ 17:03
      Yea me neither lol. I skipped it. It’s hard enough to buy bonds
  • DN
    D N.
    18 September 2020 @ 01:01
    How does this work under the idea that the bond portfolio allocation is really meant to be a positive yielding put option, whereby its value goes up on a capital appreciation basis in a drawdown event due to lowering rates. In a drawdown event wouldn't we not see this function in private credit due to spreads going up? Or is the assumption that the CB backstop credit going forward, defacto creating a new safe asset.
    • VS
      Varvara S.
      18 September 2020 @ 07:00
      But I guess the assumption here is that bond and equity prices are no longer negatively correlated. Hence, portfolios should rather be protected against high-interest-rate environment which would likely coincide with fall in equities. Floating rates in private credit take care of the interest rate risk. Correct me please, if I have misunderstood the value proposition of such allocation.
  • DN
    D N.
    18 September 2020 @ 01:01
    How does this work under the idea that the bond portfolio allocation is really meant to be a positive yielding put option, whereby its value goes up on a capital appreciation basis in a drawdown event due to lowering rates. In a drawdown event wouldn't we not see this function in private credit due to spreads going up? Or is the assumption that the CB backstop credit going forward, defacto creating a new safe asset.
  • KI
    Ken I.
    17 September 2020 @ 20:08
    I've invested in 2 middle market debt-oriented funds.(LPs) with very limited success. The main drain on the returns is the management fee and the fund expenses which tend to be high because off the amount of credit analysis, collection, etc. It is similar to the expenses incurred by a small/middle market bank. In many of these private equity funds (or hedge funds), the fees absorb the majority of the return and you have to ask yourself whether the fund exists to benefit the LPs or the management company.
  • GB
    Gregory B.
    17 September 2020 @ 19:12
    Good general overview of the credit opportunity set. Would have liked more specifics around strategies. Alternatives can range from run of the mill leveraged loans (ie private credit) to more interesting non-traditional strategies. I liked that he mentioned Interval Funds, which are more accessible to retail investors, ticker listed and solve many of the PE liquidity issues due to a daily NAV. Interval funds are becoming an increasingly popular fund type for investment managers to deploy private alternative credit strategies, which are seeking to solve the income problem Udayan articulates. These funds tend to exhibit lower correlations to stocks&bonds with higher yields.
  • DL
    Dan L.
    17 September 2020 @ 14:01
    I really appreciate the clear language, despite the fact that such clarifications (e.g. what is meant by "liquidity") slowed things down a bit. While I'm no expert in fixed income, on an intuitive level, the idea of a "treasury replacement" seems stuck in an old paradigm. This new, post-GFC, post-Covid, Fed-centric regime is calling for a fundamentally different approach to asset allocation, and that interests me more than "alternative" retrofitting. Overall, a great interview though, since it helped me to clarify my own thinking.
  • SC
    Sam C.
    17 September 2020 @ 13:33
    The last question seemed a bit redundant because he just spent 40min talking about "Where the opportunity was" chapter 3-5. We got it. I would have like to see more comparison to emerging market debt. Like why would a Kenyan bond not be slightly better than some mid-market US company? Anyway still enjoyed it since its a topic is of huge personal interest. 🤙 Thanks Ed!
  • HK
    Henrik K.
    17 September 2020 @ 12:21
    Great interview thanks. I know this interview was focused on the Credit side of Private Equity but unless you have access to the most experienced managers with a long term track record in distressed/opportunistic credit (e.g. Apollo, Oaktree etc.), I think the most attractive investable place in the market right now is in more traditional top tier Private Equity funds. As a former PE executive I am clearly biased but consider the following: 1. As Udayan Mitra rightly points out corporate bond and HY yields just do not reflect the not insignificant credit risk they are facing right now; making fixed income very difficult to invest in; 2. Public equity valuations, at least in high quality companies (e.g. the WHOLE tech sector) are just too divorced from earnings and growth potential to make sense at the moment. As a previous RV guest, Vincent Deluard, pointed out, these companies will NEVER grow into their current valuations. Just do the cashflow analysis on any of the big names and you will not get a reasonable inflation adjusted (e.g. 2% discount rate) cash on cash return in your investing lifetime at current valuations; 3. Yesterday’s market reactions, as pointed out in today’s RVDB: (i) consumer growth disappoints and markets go up (hurrah, this must mean more stimulus…); (ii) Fed declines to announce further stimulus as maybe the current recovery is OK and market goes down! The equity market is now like a drug addict who can only feel better by taking more drugs. This does not end well and there are probably only two ways out: (i) OD (substantial market crash) or (ii) Recovery which any addict will tell you is a long drawn out and painful process to get the poison out of the system as valuations slowly adjust and/or earnings recover through inflation or otherwise to a point where fundamental analysis finally makes sense again; and 4. Re-emergence of SPACs (anyone remember Jellyworks or Knutsford in the UK?) and insane IPO day 1 gains (Snowflake, the Hut Group etc.). A little too reminiscent of 1999 for my liking… If you agree with the above and with Raoul Pal’s view of a coming “insolvency phase” (or an impending “balance sheet recession” as defined by Richard Koo) then it follows that valuations should come down and interesting opportunities should emerge in the coming 1-4 years for those with dry powder available to invest (and PE firms have record amounts of dry powder right now). Combined with the fact that financing/debt is now almost free (thanks to the Fed again), this should mean the Private Equity funds will have a golden vintage ahead in terms of investments being made in the next few years. With respect to the democratisation of Alternative Assets, as mentioned by Ed Harrison, I would recommend that European investors check out Moonfare: https://moonfa.re/36Op4RX (I think there are also some equivalents in the US). This is the main European platform allowing private investors and small family offices to invest in top tier PE funds at a more reasonable minimum ticket of $1-200k per fund. They charge a small management fee on top of the PE fund's underlying fee which broadly should come out at 2&20 all in. The returns net of all fees of these top tier PE funds have consistently outperformed public indices across time and cycles (despite what many critics argue; the numbers are there for all to see...). For the sake of full disclosure, I am a very small investor in the platform (less than 1%) but more importantly is a significant user/customer myself and have invested in 7 of the funds on the platform (with more to come). As always, be careful out there!