Investors underexposed to alternative credit – Towers Watson

Alternative credit and more illiquid strategies, in particular, could boost investors’ returns and reduced equity exposure risk, argues the investment consultant in a new report.

Private debt remains underinvested and misunderstood by many institutional investors, according to a report by investment consultant Towers Watson. 

The study, Alternative credit: credit for the modern investor, found that alternative credit (excluding illiquid credit) makes up more than 25 percent of credit markets, but more liquid alternative credit (such as high-yield and leveraged loans) only comprises 8 percent of the firm’s clients’ credit portfolios. 

The equivalent figure for illiquid alternative credit (direct lending, distressed debt and speciality finance) makes up less than 1 percent of those same portfolios. 

Chris Redmond, Towers Watson’s global head of credit, said: “Despite alternative credit strategies having been underexploited by investors at large, some of our clients have recognised the key part they can play in a portfolio’s strategic asset mix and an area where active managers can make a big difference. That said, institutional investors investment in alternative credit so far is a drop in the enormous roughly $40 trillion global credit-markets’ ocean.”

Investors can swivel money into private debt from either their existing credit allocations or from the equity bucket, but the consultant recommends that its clients make room for it from within their equity portfolio. This can help improve investors’ portfolio balance by reducing reliance on riskier equity risk premia at a time when equities are subject to stretched valuations and overly optimistic earnings growth projections, the report says. 

Towers Watson recommends that investors ask specialist active managers to seek the highest return potential in each of the market’s many sub-sectors. 

“In an environment where credit spreads are at historically low levels, skill and differentiation in approach will be necessary to add value,” the report says. 

Towers Watson has $2.2 trillion in assets under advisory as well as over $75 billion of assets under management.