Don’t be fooled. Fixed income can also earn you an equity-like return.

We don’t tend to think of fixed income as a tool to gain growth and return in asset allocation. The reputation of bonds (government-issued ones especially) is that they are designed to protect your portfolio from the downside and volatility normally experienced in the equity markets. But private debt is different in a good way, says Andrew Lockhart, founding partner at Metrics Credit Partners.

Lockhart explains that private debt can serve two roles that other assets cannot:

1. It can provide a larger income without taking on drastically more risk
2. It can even serve as an equity market replacement, paying out good income without exposing your portfolio to the risk of dividend cuts or immense volatility

But it’s also true that private debt is difficult – near impossible, in fact – to access on your own as a retail investor. Lockhart has an answer for that too.

In this Expert Insights video, Lockhart tells us more about the roles that private debt can play in a portfolio as well as what to look out for in a good private debt manager.

Edited Transcript

What role does alternative fixed income play in a portfolio?
Lockhart: There are two roles for private debt in a portfolio, and it’s probably best described through our two ASX-listed funds. On one side of the spectrum, we use the Metrics Master Income Trust (ASX: MXT), and that’s really been designed to be a defensive alternative to traditional fixed income for investors who are looking for a more conservative position that is well-diversified, with reduced exposure to any one individual borrower, but getting the benefit of directly originated loans that drive that income, while limiting their volatility of capital through a well-diversified spread of loan exposures.
At the other end of the risk spectrum, I believe that private debt can play a role to replace equities in a portfolio. And so when we created the Metrics Income Opportunities Trust (ASX: MOT), it was really designed to be an equity market replacement.

Often, you get a lot of investors that hold portfolios of public market equities for the dividends or for the income, but the volatility of their capital can be quite extreme. I believe that you can deliver lower volatility in terms of investors’ capital, but attract or generate an equity-like income from private debt. And that might be income that’s generated through lending to mezzanine or subordinated debt purposes.

It might be where a lender’s negotiated warrants or options or taken an equity stake in a business. Our view is that access to alternative non-bank sources of capital is very important for most companies. And as a result of that, if we see an opportunity where we can negotiate for our investors to benefit from any potential upside, then we think that’s important to do. And that’s why I believe it can play two roles. One, the defensive part of a client portfolio. At the other end of the spectrum, an equity market replacement.

What makes for a good private debt manager?
Lockhart: My view is that if you’ve got an appropriate manager that is skilled, has deep relationships in the market, can originate loans, appropriately structure and manage credit risk, negotiate for and on behalf of an investor the appropriate return that they should receive for the risk associated with providing the loan, then I think that’s a really good opportunity for investors to gain access to a pretty attractive asset class.