With Banks Out, Investors Win in Credit

Institutional investors are making a permanent spot in their portfolios for credit, from private debt and structured products to emerging market corporate bonds, and are giving the asset class greater prominence in their overall allocations, according to a new research report that BlackRock will be providing to institutional investors in the coming weeks.

Credit was once buried within much larger core fixed-income portfolios that were designed to provide protection against stock losses in stressed markets. But as global credit markets have matured quickly and grown substantially in recent years, investors have jumped on the opportunity to invest in credit for the long term. They also have been separating their allocations to the strategy from their traditional fixed income portfolios, as these investments behave quite differently, the research shows.

BlackRock says the move by institutional investors to build credit portfolios has been driven by a number of factors, including substantial growth in the credit markets themselves. Today, the global public credit market is now worth more than $14 trillion, according to the report. In 2009, that number was about $8 trillion; in 2005 it was about $5 trillion. Global high-yield bonds and leveraged loans outstanding have more than doubled in size over the past ten years.

“Even if you liked the risk-reward characteristics of credit, big institutions couldn’t always invest at the scale they needed,” says James Keenan, chief investment officer and global co-head of credit, in an interview.

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Banks once owned the majority of credit assets, leaving institutional investors with limited access to these markets. Although the financial crisis accelerated the banks’ exit from many of these investments, the process had begun earlier in the decade.

Investors’ appetite for credit assets has also been driven by historically low interest rates. U.S. Treasury bonds offer less than a two percent return, far below what institutional investors need to earn on their assets. Credit, which is riskier as an asset class than government bonds, offers a premium. Private credit yields more than public, because of its illiquidity.

The credit markets are also now much more diverse than a decade ago, offering investors assets that are uncorrelated to other securities in their portfolios.

“Investors willing to look outside the realm of public credit can seek additional yield via the illiquidity premium that comes with private debt from middle-market companies or infrastructure or real estate projects. They can also target capital appreciation by investing in deeply distressed assets,” wrote the report’s authors, which include Keenan and Timothy O’Hara, global co-head of credit at BlackRock.

Credit can also offer exposure to large-cap companies and smaller private companies not available in the public markets. “Credit’s fundamental return-drivers are local, idiosyncratic, and highly customizable,” the authors write.