InvestingRetirementTax Tips
Private Credit vs. High Yield Bonds: Capturing the 10% Illiquidity Premium
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Result: Private Credit generates +$3,000/year Alpha with lower perceived risk.
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Private Credit vs. High Yield Bonds: Capturing the 10% Illiquidity Premium
CORE INSIGHTS
- Structural Alpha: Institutions outperform by harvesting the 2-4% “Illiquidity Premium.” You get paid extra for locking up capital.
- Volatility Dampening: Private loans are not “Marked-to-Market” daily. This reduces portfolio volatility (~5% vs 9% for bonds).
- Seniority is King: Private Credit is “First Lien Senior Secured” (70% recovery). Junk Bonds are unsecured (40% recovery). You get paid first.
For top investors, Public High Yield (Junk Bonds) is a bad trade. You take equity risk for capped returns. The “Smart Money” has moved to Private Credit. The question is “how” to access it efficiently.
The Sharpe Ratio Math
- Private Credit Yield: ~10.5% (Floating)
- High Yield Bond: ~7.5% (Fixed)
- Spread: +300 bps (Illiquidity Premium)
*Low correlation to S&P 500 enhances diversification.
What-If Scenario: $100k Allocation
| Asset Class | Annual Yield | Drawdown Risk |
|---|---|---|
| Public HY Bonds | 7.5% ($7,500) | High (-15%) |
| Private Credit | 10.5% ($10,500) | Low (NAV Pricing) |
Visualizing the Risk/Reward Frontier
*Figure 1: Efficient Frontier. Private Credit (Blue) offers the “Sweet Spot” of high yield and low volatility.*
Strategic Action Steps
1
Select Vehicle
BDC (Liquid): Trades like stock. Volatile. Interval Fund (Stable): Priced at NAV. Limited liquidity (5%/qtr). Better for long-term.
BDC (Liquid): Trades like stock. Volatile. Interval Fund (Stable): Priced at NAV. Limited liquidity (5%/qtr). Better for long-term.
2
Audit NII Coverage
Net Investment Income (NII) must cover the dividend >100%. If a fund pays 10% but earns 8%, they are returning your principal (ROC). Avoid.
Net Investment Income (NII) must cover the dividend >100%. If a fund pays 10% but earns 8%, they are returning your principal (ROC). Avoid.
3
Income Bucket
Treat as “Equity Replacement,” not Cash. Allocate 10-20% to replace underperforming bonds or defensive stocks.
Treat as “Equity Replacement,” not Cash. Allocate 10-20% to replace underperforming bonds or defensive stocks.
The Bottom Line: Who Should Choose What?
- Accredited: Use Interval Funds or Private REITs to capture pure credit performance.
- Retail: Use Public BDCs (e.g., ARCC), but buy only near NAV. Don’t pay premiums.
Frequently Asked Questions
What is the ‘Illiquidity Premium’?
It is the extra 2-3% return investors demand for locking up capital. Unlike public bonds, Private Credit assets are held to maturity, avoiding daily volatility.
Why is Private Credit ‘safer’ than Junk Bonds?
Seniority. Private Credit is usually ‘First Lien Senior Secured’ (70% recovery). High Yield Bonds are often unsecured (40% recovery). You get paid first.
BDC vs. Interval Fund?
BDCs offer daily liquidity but high volatility (stock-like). Interval Funds offer stable NAV pricing but limited quarterly liquidity (5-25%). Choose based on your timeline.
Disclaimer: This content is for informational purposes only. Private Credit involves illiquidity and default risk. Consult an advisor.
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