A Private Credit Fund With Equity-Like Returns
At EPC we don’t hold excess cash in our portfolio, and we rarely spend time evaluating fixed income opportunities. We let our investors manage their exposure to equities vs. bonds, public vs. private asset classes, and so on. We focus on doing the best job we can with the allocation each of our investors have made to equities and to our approach specifically.
We personally hold virtually zero cash and generally don’t find credit opportunities that fit our investment criteria or return hurdles, mostly because interest rates have been so low until recently. That doesn’t mean there isn’t a place for fixed income in some or most investors portfolios, and occasionally we happen upon a credit-focused opportunity that is intriguing enough to spend some time on.
Fortunately, credit investing follows the exact same framework as equities investing and is often simpler. No matter what type of security you are dealing with, investing is nothing more than laying out cash today with the hopes of receiving more cash later, which is the definition of lending.
Howard Marks, who is a credit investor and one of our idols, rarely makes clear recommendations or blanket statements, especially when it comes to talking his own book. However, in a break from tradition he recently made no bones about the fact that he believes fixed income is much more attractive today than in most recent times. In a recent memo titled Ruminating on Asset Allocation, he explained,
“I want to make some important observations regarding one of Oaktree’s key sectors, non-investment grade credit (defined as performing non-government debt):
The prospective returns in this area today are much higher than they were in the 2009-21 period.
These returns, starting at roughly 7% on public credit and 10% on private credit, are competitive with the historical returns on equities and capable of helping many investors toward their overall return targets.
Because of their contractual nature, the returns from credit are likely to prove much more dependable than ownership returns.
In my view, the thought process set forth in this memo leads to the conclusion that investors should increase their allocations in this area if they are (a) attracted by returns of 7-10% 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.”
Marks’ sentiment is logical as 7-10% contractual returns can certainly provide a ballast to ones overall investment strategy. As discussed in a recent post, there’s a material likelihood that 7-10% credit returns will be substantially better than the broader equity market over the coming decade. Marks’ recommendation begs the question, for everyday investors without access to high minimum and long lockup private credit funds (the 10% end of fixed income returns), how can retail investors participate?
One publicly traded credit fund I spent some time studying offers a double-digit current dividend yield, trades at a 10% discount to NAV, possesses potential mid-teens total annual returns, and recently enacted a number of shareholder friendly policies.