Changing Asset Allocation Strategies: The Rise of Private Credit

For decades, the 60/40 portfolio—60% equities and 40% bonds—was the cornerstone of traditional asset allocation strategies. This model provided a balance where bonds acted as a stabilizer when equities faltered. However, recent years have exposed the vulnerabilities of this approach. The convergence of equity and bond performance, exacerbated by rising inflation and interest rates, has disrupted this diversification dynamic. As a result, investors are seeking alternatives that deliver stability, yield, and diversification in a volatile economic environment. Private credit has emerged as a compelling solution, with evidence showing portfolios with a greater allocation of alternative assets perform better than traditional allocations.

A Shifting Landscape

The traditional 60/40 portfolio is being challenged. Historically, bonds provided a buffer during equity downturns. However, the dual impact of inflation and monetary tightening has created a positive correlation between these asset classes, diminishing their effectiveness as diversification tools, while yield of traditional fixed income has also declined. According to JP Morgan’s 2024 Long-Term Capital Market Assumptions, portfolios with exposure to alternative assets, including private credit, have outperformed traditional allocations in recent years.

The rise of private credit aligns with broader trends reshaping asset allocation strategies. McKinsey’s 2023 Private Markets Annual Review highlights that private credit was the fastest growing and best performing alternative asset class of the year. This growth reflects its ability to address the shortcomings of traditional portfolios by offering low correlation with public markets, attractive risk-adjusted returns, and resilience across economic cycles.

The Appeal of Private Credit

Private credit’s rise is underpinned by its unique characteristics. US Investment firm Blackrock recommends looking for the three “Ds” when looking at diversification – diversification (low correlation), durability (positive returns with low volatility), and defensiveness (low downsides). Private credit is a great asset class that provides these factors plus high yield returns to investors. KKR’s analysis underscores this, noting that private credit delivers consistent returns with lower volatility compared to public market equivalents, and recommends a 10% portfolio allocation to private credit.

Moreover, private credit’s security features enhance its appeal. Loans are often backed by tangible assets, ensuring capital preservation even in downturns. This attribute, coupled with its senior position in the capital stack, provides a degree of security rarely found in other asset classes.

Growth Drivers and Sustainability

Several factors have driven the growth of private credit. First, the retreat of traditional banks from certain lending markets, due to regulatory changes, has created opportunities for non-bank lenders. Second, the flexibility and speed of private credit providers have attracted borrowers seeking tailored financing solutions. Finally, its ability to weather economic turbulence has solidified its reputation as a resilient asset class.

Alternative asset research house PreQin predicts that both the performance and size of private credit FUM will continue to grow, with predictions the global AUM will rise from $1.5tn at 2023 to $2.6b by 2029, taking this investment class from niche to mainstream.

Key Considerations for Investors

While private credit offers substantial benefits, investors must approach this asset class with diligence. Evaluating a fund’s mandate, risk profile, type and ranking of debt, and due diligence processes is critical. Independent valuations, diversified portfolios, and experienced management teams are essential safeguards. Additionally, alignment of interests—such as co-investment by fund managers—ensures a shared commitment to performance.

The Road Ahead

As private credit cements its place in modern portfolios, it is redefining how investors approach diversification and yield generation. Traditional asset allocation strategies are changing, with proof that infusing a greater level of alternatives, including private credit, into portfolios delivers more robust results.

For those seeking to build resilient and diversified portfolios, private credit offers a compelling investment option. As always, careful evaluation and strategic alignment remain paramount to choosing any investment.

Disclaimer: This article is prepared by Frances McDonald. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.