Investor’s choices in public securities have declined over the past 20 years. Successful pension funds had the foresight to take advantage of this trend by changing from a 60/40 equity and debt allocation into an allocation strategy that incorporates a heavy weighting to alternative assets. In recent years yielding assets have made this shift with the move away from the public bond markets into private credit.
The number of operating companies trading on the Toronto Stock Exchange declined to 712 at the end of 2023 from around 1,200 at the turn of the millennium. The same phenomenon has been noted in most developed markets. U.S. listings have fallen from 8,000 in the late 1990s to ~4,300 today. During this same window, bank interest in certain loans decreased due to increased regulation, which reduced the supply of credit more acutely for small and medium-sized businesses.
Well-diversified portfolios have come to include illiquid, semi-liquid, and liquid assets. These assets fall into two categories: debt and equity. Black swan events have proven that with negative volatility spikes, something that appeared to be liquid may suddenly become illiquid and lose value. Having a thoughtfully diversified portfolio inclusive of guaranteed liquidity (cash is king) built from reliable cash flow (loans and real estate), helps one to avoid baking in unnecessary losses and be well-positioned to seek out liquidity discounts. Diversification can also buy the investor time to see the benefits of mean reversion. Formerly, diversification meant 60% was invested in equities with 40% invested in a traditional bond portfolio. Unfortunately, we have learned that these two assets are more closely correlated than thought. This realization has resulted in sophisticated investors allocating to non-correlated alternatives. The empirical evidence shows that the construction of modern pension fund portfolios has resulted in 50% alternatives, 30% equities, and 20% bonds (fixed income) portfolios. The fastest growing asset class in pension fund portfolios is private credit because it can sit in both alternatives and fixed income.
The chart above shows that the Canadian Pension Plan has been allocating to alternative assets aggressively. The results? As indicated in the following chart, they led all pension plans in annualized returns since 2013. CPPIB’s 2024 annual report indicates a 13% allocation to credit. Other pension funds are following suit to help generate higher returns, increase diversification, and hedge against inflation.
Private market alternatives are not new. In 1946, ARDC became the first institutional venture capital firm to seed post-war growth in Silicon Valley during the 1960s and 1970s. In 1978, KKR formed the first institutional private equity fund. According to the Carne Atlas 2024 report, private markets will increase from US$13.01 trillion to over US$21 trillion by 2030. Increased bank regulation following the 2008 global financial crisis has resulted in the private credit asset class gaining broad popularity. According to McKinsey, private credit has a total addressable market of $30 trillion in North America alone. Private credit is close to $3 trillion today, a tenfold increase during the past decade, as big institutional investors in search of superior returns, diversification, and lower volatility allocate a record aggregate sum of capital to large private credit investments.
Howard Marks recently said, “The prospective returns in this area (private credit) today are much higher than they were in the 2009-21 period and that investors should increase their allocations in this area if they are (a) attracted by returns of 7% (public credit) to 10% (private credit) or so, (b) desirous of limiting uncertainty and volatility, and (c) willing to forgo upside potential beyond today’s yields to do so. For me, that should include a lot of investors, even if not everyone.” Don’t be left behind.
About Bond Capital
Bond Capital is an award-winning private credit fund. As a direct lender, Bond Capital provides advice and money across the entire risk curve. Bond Capital secured structured credit financing enables business owners to maintain control ownership in exchange for yield and capital preservation. Across multiple cycles and for over 20 years, Bond Capital has advanced secured investment quality credit to lower middle market companies throughout North America.
