Mega-bond-manager PIMCO has long championed market timing (aka relative value) as its value proposition in managing bonds. So, it is not surprising that the major business news outlets today featured PIMCO’s announcement that private debt is now overvalued, claiming that a 2% yield spread (their calculation) between private and public credit securities is insufficient to justify private debt allocations.1
Our own research finds no such yield anomaly. Instead, today’s yields are consistent with historical patterns that should allow private debt investors to earn a 9-10% total return over the next five years, or 5 percentage points above public debt investors.2
PIMCO’s pronouncement is also a reminder of the failed track record of those predicting market inflection points, both top and bottom. No investment organization, to our knowledge, has ever achieved long-term success based on that approach.3 Instead, investors should decide upon a long-term target allocation to private debt at some level appropriate for their objectives, diversify across the best lenders, and rebalance to their target over a market cycle. This has been the playbook for successful investing for private debt and all other asset classes.
Exhibit 1: Yield Comparisons for Private Debt (CDLI4), Public Credit (Morningstar LSTA US Leveraged Loan 100 Index), and 3-Month Treasury Bills
Exhibit 1 displays a current yield comparison for three broadly used indices reflecting private debt (CDLI), public credit (Morningstar LSTA US Leveraged Loan 100 Index), and cash (3-Month T-bills). Data is through June 30, 2024.
Several observations are worth noting:
- Absolute yields are currently elevated across the three indices, driven by high cash yields.
- Absolute yields are persistently higher and more stable for private debt, compared to public credit, consistent with the lower volatility of private debt returns, compared to public credit returns.5
- Spreads for both private debt and public credit are lowest (highest) when T-bill yields are highest (lowest).6
- The June 30, 2024 current yield spread between private debt and public credit equals 2.86%, which is below its long-term average but consistent with lower historical private-public spread when T-bill yields are high.
In summary, current and historical data does not undermine the private-debt-for-the-long-run investment thesis.7 Neither does it support the notion that private debt is currently overvalued.
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Stephen L. Nesbitt, CEO
Disclosures
1 As one example, see PIMCO Says Private Credit Is Overvalued as Complacency Spreads, https://www.bloomberg.com/news/articles/2024-10-17/pimco-says-private-credit-is-overvalued-as-complacency-spreads.
2 See Cliffwater Research, “Go Private, Not Public Credit”, (August 19, 2024).
3 PIMCO itself must recognize the challenge of relative value investing. Its flagship PFLEX interval fund, which invests in both public and private credit, returned just 3.44% for the five years ending June 30, 2024.
4 Cliffwater Direct Lending Index.
5 See “Cliffwater 2024 Asset Allocation Report”, (January 22, 2024).
6 This is consistent with credit theory. See Private Debt: Yield, Safety and the Emergence of Alternative Lending, by Stephen L. Nesbitt, (Wiley Finance, 2023), page 76.
7 See Cliffwater Research, “Direct Lending for the Long Run”, (June 12, 2024).
Disclosures
Statements that are nonfactual in nature, including opinions, projections and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Further, all information, including opinions and facts, expressed herein are current as of the date appearing in this presentation and is subject to change without notice. Unless otherwise indicated, dates indicated by the name of a month and a year are end of month.
All third party information has been obtained from sources believed to be reliable but its accuracy is not guaranteed. The information herein may include inaccuracies or typographical errors. Due to various factors, including the inherent possibility of human or mechanical error, the accuracy, completeness, timeliness and correct sequencing of such information and the results obtained from its use are not guaranteed by Cliffwater. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this presentation. Cliffwater shall not be responsible for investment decisions, damages, or other losses resulting from the use of the information herein.
Performance data represents past performance, which does not guarantee future results. There can be no assurance that any expected rate of return, risk, or yield will be achieved. Rate of return, risk, and yield expectations are subjective determinations by Cliffwater based on a variety of factors, including, among other things, investment strategy, prior performance of similar strategies, and market conditions. Expected rate of return, risk, and yield may be based upon assumptions regarding future events and conditions that prove to be inaccurate. Expected rate of return, risk, and yield should not be relied upon as an indication of future performance and should not form the primary basis for an investment decision. No representation or assurance is made that the expected rate of return, risk, or yield will be achieved. Performance data is net of fees.
This presentation may include sample or pro forma performance. Such information is presented for illustrative purposes only and is based on various assumptions, not all of which are described herein. Such assumptions, data, or projections may have a material impact on the returns shown. Nothing contained in this presentation is, or shall be relied upon as, a representation as to past or future performance, and no assurance, promise, or representation can be made as to actual returns. Past performance is not indicative of future returns, which may vary. Future returns are not guaranteed, and a loss of principal may occur.
References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time (each, an “index”) are provided for information only. Reference to an index does not imply that a portfolio will achieve returns, volatility or other results similar to the index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change over time. Investors cannot invest directly in indices and, unlike an account managed by Cliffwater, an index is unmanaged.
Cliffwater is a service mark of Cliffwater LLC.
i PFLEX investment strategy is, under normal circumstances, allocating across a wide array of global credit sectors, including corporate, residential mortgage, commercial real estate, and consumer credit markets, and has the flexibility to invest in both public and private credit sectors. The fund seeks relative value across the capital structure and liquidity spectrum of global credit markets. (Source: PFLEX Fact Sheet October 18, 2024)
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