One of the biggest benefits of self-directed IRAs (SDIRAs) is the ability to diversify your portfolio by investing in alternative assets. These include real estate, precious metals, private equity and more.
One alternative asset class that is becoming more popular is private debt. STRATA’s 2021 investor survey report unveiled 13% of investors leveraged private debt in their SDIRA portfolios. Private Debt is now the third-largest alternative asset class behind private equity and direct real estate with nearly $1 trillion in total assets. Private debt allows additional diversification opportunities and attractive returns for retirement investors seeking higher yields than currently available with traditional investment grade debt securities.
What is Private Debt?
As the name implies, private debt is capital invested in debt held by private companies. This is in comparison to private equity, which is capital invested in ownership shares in private companies. Private debt isn’t traded or issued in the open markets and capital can be loaned to both listed and unlisted companies and to real assets like real estate and infrastructure.
There are a number of different sources of private debt, including banks, private debt funds, hedge funds, high-yield bonds, collateralized loan obligations (CLOs) and business development companies (BDOs).
There are two main categories of debt within a corporation’s capital structure. Subordinated debt is debt that’s owed to unsecured creditors. If there’s a liquidation, it is only repaid after the claims of secured creditors have been paid. Unsubordinated debt is owed to secured creditors who are paid first in a liquidation, so it is less risky.
Why Invest in Private Debt?
Private debt is generally considered to be a low-risk option in comparison to other types of alternative assets and an attractive alternative to fixed-income investments. It offers additional portfolio diversification, low correlation to public markets, predictable and attractive risk-adjusted returns in a low-rate environment, and less risk than private equity.
The recent popularity of private debt is due largely to historically low interest rates worldwide, which have lowered liquid government and corporate bond yields, along with lower borrowing costs. Many investors are now looking for higher yield alternatives to government and corporate bonds while demand for private loans has increased among both corporations and consumers.
Private debt may offer higher returns than liquid bonds due to a premium for illiquidity — it isn’t traded daily and pricing is not transparent. The breadth of offerings from the underlying loans offers a diverse spectrum of industry exposures and risk/return profiles.
Private debt investments are usually made through commitments to unlisted private debt funds. These funds differ based on their strategy (e.g., direct lending or fund of funds) and the type of debt provided (e.g., senior, subordinated or mezzanine debt).
Private Debt Statistics and Data
According to the most recent Preqin Ltd. Quarterly Update, there are pockets of strength and weakness in the private debt asset class as we emerge from the pandemic-induced economic hit. With many investors looking for ways to mitigate the impact of inflation on returns, floating rate private debt becomes more attractive.
High levels of private equity deal activity offer another avenue of support and potential route to deployment, notes the update. “While pockets of weakness remain, should the macro backdrop stay relatively benign, the longer-term outlook for the asset class is positive,” it states.
Private debt funds that closed in the third quarter of this year raised a total of $41 billion, according to the update. There are now 691 private debt funds in the market, targeting an aggregate $291 billion. The internal rate of return for direct lending funds’ one-year horizon was 12.7% to March 2021.
Private debt fundraising accounted for the vast majority of private debt fundraising in the quarter, followed by special situations, distressed debt, mezzanine, venture debt and private debt fund of funds.
The Right Investment for You?
If you’re seeking higher yields and more diversification in your self-directed IRA, private debt might be what you’re looking for. Private debt can also offer investors steady interest income and capital appreciation, as well as access to sectors such as real estate, renewable energy, building products, construction machinery, healthcare, technology, and much more.
STRATA Trust supports investors, financial professionals, and investment sponsors nationwide with the custody of private debt for self-directed IRA investors.
The information provided in this article is educational content and not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.