Private Credit Fails To Beat Public High Yield Bonds

In Brief:

Savina Rizova, co-chief investment officer and global head of research at $790 billion Dimensional Fund Advisors, delivered a sobering assessment of private credit during her appearance on Bloomberg's The Credit Edge podcast. The University of Chicago finance PhD and two-time Barron's 100 honoree challenged the private credit boom with hard data, revealing that historical analysis from 1980-2022 shows private credit funds have failed to outperform public high-yield bonds when properly benchmarked. Despite average 10% IRRs that sound appealing on paper, Rizova's research using MSCI data demonstrates that public market equivalent measures consistently favor high-yield indices over private credit returns. Her findings come as the private credit market has exploded in size, with many investors potentially overpaying for illiquidity without receiving adequate compensation through superior risk-adjusted returns.

Big Picture Drivers:

• Performance Illusion: Private credit's attractive headline returns disappear when compared to appropriate public benchmarks rather than investment-grade indices

• Transparency Crisis: Private markets lack the price discovery and real-time information that enable effective risk management and valuation

• Liquidity Premium Questioned: Investors may not be receiving adequate compensation for giving up daily liquidity in private credit vehicles

• Market Structure Risks: Secondary market discounts of 10-15% on private equity stakes suggest pricing reliability issues that could affect private credit

Key Topics Covered:

• Benchmark Methodology: Why comparing private credit to high-yield indices rather than investment-grade shows no outperformance

• Diversification Limits: How private markets cannot provide the same level of diversification available in public bond markets

• ETF Innovation: The emergence of private credit ETFs and questions about their viability and structure

• Academic Research: Dimensional's systematic approach to analyzing private fund performance across four major asset classes

Key Insights:

• Benchmarking Reveals Truth: When private credit is compared to high-yield public bonds instead of investment-grade indices, all performance metrics favor the public markets, eliminating the apparent alpha that drives private credit marketing.

• Diversification Disadvantage: Private credit investors cannot achieve the broad diversification available in public markets because "we cannot all own parts of all private companies," creating concentrated risk exposures.

• Liquidity Mismatch Risk: Private credit may be unsuitable for investors with potential short-term liquidity needs, as the asset class requires long-term capital commitments without the flexibility of daily redemptions.

• Price Reliability Concerns: Secondary market trading in private assets typically shows 10-15% discounts to reported values, indicating that private credit pricing may not be as reliable as public market pricing.

• Operational Complexity: Private credit investments come with significantly less available information compared to public markets, making due diligence and ongoing monitoring more challenging for investors.

• Limited Economic Function: While private credit serves a legitimate economic purpose by funding companies that cannot access public markets, this doesn't automatically translate into superior investment returns for institutional investors.

Memorable Quotes:

• "There is no outperformance relative to high yield public bonds, which comes to tell you that private credit is, at least historically, has been a way to get exposure to high yield, below investment grade credit." - Savina Rizova, summarizing her firm's key finding on private credit performance

• "It's not by accident, it's called private. Also, lack of adequate diversification because ultimately, we cannot all own parts of all private companies." - Savina Rizova, explaining structural limitations of private markets

• "People who might have short-term liquidity needs, etc., who cannot have a long horizon and afford not to touch that part of money for a long term might not be prepared for private investments." - Savina Rizova, cautioning about investor suitability

• "You typically see haircuts of like 10, 15 percent, which speaks to prices might not be as reliable as they are in public markets." - Savina Rizova, discussing secondary market discounts as evidence of pricing issues

• "It's very important what you compare private to. Many people might compare private to the global or US AG, i.e. Investment Grade Index. There you would see outperformance. If you compare to high-yield, you don't see outperformance." - Savina Rizova, emphasizing the critical importance of proper benchmarking methodology

The Wrap:

Rizova's data-driven analysis represents a significant challenge to the private credit industry's growth narrative, suggesting that much of the asset class's appeal stems from inappropriate benchmarking rather than genuine outperformance. Her findings indicate that investors may be sacrificing liquidity and transparency without receiving adequate compensation through superior returns. As private credit ETFs emerge and institutional allocations continue growing, Rizova's research suggests investors should carefully evaluate whether they're being properly compensated for the additional complexity, illiquidity, and concentration risks inherent in private markets. The implications extend beyond individual investment decisions to broader questions about market efficiency and the true economic value of the rapidly expanding private credit ecosystem.