As an investor in the private debt asset class, or one considering private debt investments, you are likely familiar with the most common segment: sponsored debt, where private equity (PE) firms secure financing for the companies they own or control. Sponsored debt has driven much of the market’s growth since 2010 and is projected to nearly double over the next six years (Source: PitchBook | Geography: Global | *Historical AUM and forecasts generated on April 19, 2024)
However, the private debt market is far more diverse than just sponsored debt. Beyond this core category lies a spectrum of established and emerging segments offering unique opportunities. The diagram below highlights these segments, organized from yield-oriented strategies on the left to capital appreciation-focused strategies on the right. Nearly 25 sub-segments are grouped under five broad categories, showcasing the breadth of opportunities within private debt.
Sponsored private debt, where many investors are already focused, occupies the Direct Lending box in the upper left corner of the chart. While sponsored debt is often seen as the “core beta” of private debt investing, the broader market offers significant opportunities in complementary non-core strategies that may enhance diversification and returns.
There is significant opportunity for growth in many private debt segments in the years to come, asset-backed financing (ABF) being a prime example. As shown in the chart below, private credit currently represents only a small portion of the $5.5 trillion ABF market, leaving substantial room for expansion:
Source: Oliver Wyman Estimate
Are you looking at these other growing segments of private debt? Are you invested in them?
A multi-strategy approach to private debt, which is commonly applied in other assets classes, offers an effective avenue for gaining exposure to a broader range of debt types while providing additional benefits that go beyond diversification.
Overall, a structure that combines several types of private debt in one allocation, along with broader exposure noted above, provides three important benefits:
1 – Ongoing Refreshment of the GP Roster
With so many non-core strategies available, and with more continuing to come to market, investors who allocate to only the largest five managers are limiting their opportunity set. A multi-strategy approach provides access to a wider range of debt structures including:
⦁ Non-sponsored
⦁ Lower middle market
⦁ Litigation finance
⦁ Portfolio finance
⦁ Consumer receivables
⦁ Canadian infrastructure
⦁ Business development companies (BDCs), and more.
2 – Liquidity and Capacity Management
The lifecycle of private debt funds – openings, closings, and capital returns – does not always align with LPs’ preferences. A multi-strategy approach allows for allocations to be made according to an investor’s timeline. Different funds within the structure typically have staggered openings and closings, offering more flexibility. Additionally, liquid credit instruments such as senior bank loans and traded BDCs can serve as a liquidity supplement.
3 – Portfolio Construction and Risk Management
Combining complementary private debt styles may lead to better risk-adjusted returns through enhanced diversification. By including multiple debt structures, portfolios benefit from reduced concentration risk. Furthermore, advanced multifactor risk models, incorporating factors such as credit spreads, volatility, and interest rates, can contribute to improved portfolio construction and overall performance.
Finally, a multi-strategy approach lies in its ability to combine distinctive private debt styles, diversifying across sector, type, and market to achieve a more balanced and resilient portfolio as demonstrated in the diagram below:
This approach exemplifies how a thoughtful mix of complementary styles can optimize portfolio construction while leveraging the full spectrum of private debt opportunities.
To illustrate the potential benefits of diversification, we analyzed the long-term returns of two distinct private debt funds, as shown in the charts below. Each chart depicts the quarterly returns of a representative fund relative to a proxy market benchmark. The chart on the left represents a fund investing primarily in sponsored debt and the chart on the right represents a fund investing primarily in non-sponsored debt.
MVBDCTRG: MVIS US Business Development Companies Gross Total Return
Fortress Lending Fund I: 2019Q4-2024Q2
MPG Funds IV-VIII: 2017Q1-2024Q2
The Representative Sponsored Private Debt Strategy chart highlights a strong correlation with the market, while the Representative Non-Sponsored Private Debt Strategy shows minimal correlation, not only with the market but also with the sponsored debt fund. This lack of correlation underscores the diversification potential of combining these strategies.
As basic portfolio theory suggests, combining assets with lower correlations reduces overall portfolio risk, ceteris paribus. Over the observed period, the strong returns from both sponsored and non-sponsored debt strategies demonstrate how a blend of 70% sponsored and 30% non-sponsored debt can achieve a higher absolute return compared to sponsored debt alone. This diversified approach also enhances the portfolio’s risk-adjusted performance, as reflected in the improved Sharpe ratio, shown in the chart below.
Multi-strategy funds have been embraced by investors in the US and globally for their ability to provide attractive risk/return profiles by reducing single-strategy risks, providing the flexibility to capitalize on the best opportunities, and permitting a fund manager to allocate to ‘best of breed’ managers across distinct and complementary investments. For these reasons, multi-strategy hedge funds of all types have seen strong growth in recent years, with assets under management nearly doubling in the last five years, from US $355 billion in 2020 to US $709.9 billion through Q3 2024, (Source: Backstop Solutions Group, LLC).
We believe that a great deal of otherwise untapped opportunities, alongside substantial benefits, can be obtained by investing broadly across the full spectrum of private debt instruments – in short, a multi-strategy private debt approach offers investors an effective and efficient means of accessing enhanced diversification, reduced risk and improved returns.
A SAVAS Capital Marketplace publication, January 2025.
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