The rise of public and private credit opportunities in the evolving multi-asset investing world

Multi‑asset (MA) investing has come a long way since the 1950s advent of the 60/40 model portfolio, with 60% allocated to U.S. equities and 40% to U.S. bonds, as a means to optimize portfolio allocations. MA managers now have significantly more tools to tailor portfolios to meet client needs—allocation targets have evolved, becoming more agile than in the past and oftentimes encompassing a vast array of asset types, including increased utilization of real assets and alternatives.

The evolution of multi‑asset investing

After a decade of near‑zero interest rates, bond yields have been at elevated levels relative to much of the post-global financial crisis recovery, and we believe fixed income presents an attractive opportunity for investors. Beyond its income generation potential, fixed income offers investors diverse sector options that support a range of goals and risk tolerances, providing opportunities for both defense and capital appreciation. The fragmented nature of this asset class means that what drives one sector of the market is different from what drives another, so there’s often a wide dispersion among sector returns. This provides flexibility to choose sectors that suit distinct needs—generating consistent income, capital appreciation, or defense against equity market volatility.

Increased yields have also led to higher discount rates for pension liabilities and improved funding ratios, offering defined benefit managers opportunities to potentially increase fixed income allocations in an effort to reduce risk while maintaining their expected return on asset assumptions. As shown in Figure 1, the percentage allocation to equity required to meet targets has fallen notably amid higher yields.

Public credit markets

Public fixed income markets encompass government, corporate, and securitized debt from both investment-grade and high yield issuers across developed and emerging markets as well as less rate-sensitive assets like bank loans. In general, public credit markets offer a measure of liquidity. The investment universe is vast, with each segment offering unique characteristics. For instance, government bonds are generally considered high‑quality, so liquidity is higher in this space. Investment‑grade corporate bonds, meanwhile, can benefit from both duration and credit spread components. High yield and emerging market corporate bonds, on the other hand, present potential opportunities for capital appreciation due to their higher yields but they come with greater credit risk.

Even within each segment there is significant variety. Take the securitized debt space, for example, subsectors such as asset‑backed securities (ABS), which are backed largely by consumer credit, including credit cards, student loans, and auto loans, typically have shorter-duration profiles. This characteristic makes them less sensitive to interest rate changes than commercial mortgage‑backed securities (CMBS), which are backed by loans on assets such as shopping malls and office buildings. As a result, their duration profile tends to be longer.

As each segment within the asset class is unique and driven by different factors, there’s often a wide dispersion among sector returns in fixed income. At different times, different sectors may be in or out of favor.

Expansion of private credit markets

Regulations imposed on the banking industry led to disintermediation over time. During the 1980s, widespread failures of savings and loan institutions (S&Ls) led to increased regulation of S&Ls and removed barriers between S&Ls and commercial banks. The increased challenges from regulations led to consolidation among both S&Ls and commercial banks, leaving a void in medium‑sized lending. Between the mid‑1980s and the global financial crisis of 2008, the number of S&Ls and commercial banks decreased from a total of about 18,000 institutions to around 8,000. Alternative credit providers stepped in, and this area of credit has increased in size and diversity ever since.

This trend accelerated following the global financial crisis with additional regulations on banks. The total number of institutions fell to under 5,000 by 2023. Private credit largely began with direct lending to small to medium-sized borrowers. Over time, as the private credit market grew, larger borrowers have sought private lending solutions as well, so the market has diversified to incorporate larger borrowers, investment‑grade lending, and—increasingly—asset-backed financing. Bank disintermediation also led to innovations in public markets with the advent of more esoteric asset‑backed instruments, such as whole business and data center finance.

Private credit could present additional diversification opportunities as performance drivers tend to be less correlated to public market returns. Private credit assets tend to be less liquid and offer an illiquidity premium to investors who can withstand some illiquidity.

An example in practice: Incorporating flexibility

MA investors incorporate a variety of asset classes in an effort to optimize returns, diversify risk, and reduce volatility. By incorporating uncorrelated assets like equities and fixed income, the idea is that when one asset class declines, another can buffer the fall. The year 2022, however, illustrated a period when fixed income and equity returns uncharacteristically moved together. Sharp declines in equities and much higher yields led to the worst performance for traditional 60/40 portfolios on record.¹

Managers who had incorporated alternative investments in their MA portfolios largely experienced less volatility during this unique period when bonds and stocks exhibited correlated performance. This is partially due to less frequent repricing, but the reduced volatility was reassuring to some investors.

It is important to note, however, that manager selection is crucial because not every MA manager utilizes their mandate’s flexibility to the same extent or with the same skill.

From an MA perspective, the flexibility to allocate to both public and private credit investments can provide opportunities to tactically adjust allocations based on our relative value views, and the flexibility can be an important tool in constructing portfolios that meet our clients’ needs.

Looking forward: Opportunities in credit for multi‑asset investors

Both public and private credit managers are excited about growing opportunities in asset‑backed financing. In addition to traditional public ABS like those backed by auto loans or credit cards, the growth of esoteric ABS with innovative collateral, such as data centers and music libraries, is an increasing opportunity set. Similarly, private structured finance products could represent a growing market.

We believe elevated yields have led to increased opportunities in fixed income, and MA investors can look to reassess their fixed income allocations after over a decade of near‑zero yields.