For decades, traditional investing has primarily involved three types of investments, and the main decision has been determining how much money to put into each category:
- Stocks
- Bonds
- Cash
What are the Risks with Stocks and Bonds?
Stocks offered the highest return potential but had the greatest amount of risk given the volatility of stock prices.
Bonds were expected to provide some steady income and stability when stocks declined in value during periodic “bear” markets. But bonds had their own risks: namely, credit and interest rate. In recent years, bonds have failed to provide the stability we used to expect. In 2022, bonds were down a record amount—about -13% for intermediate term bond funds.
In that same year, major stock indices were down between 20-30%, but some alternative investments were profitable.
What are Alternative Investments?
“Alternative investments” refers to investment options that are not based on stocks or bonds. And these alternative investments have become increasingly popular with individual investors. Some of these investments have provided a welcome source of stability for portfolios experiencing whiplash from traditional stocks and bonds.
One alternative investment JourneyTree has found compelling is private credit.
What’s Private Credit?
Private Credit is one type of alternative investment that we believe presents the potential for a favorable risk/return profile. Previously only available to large institutional investors, private credit mutual funds now allow individual investors to participate in this asset class.
Simply put, private credit funds make loans directly to companies. The funds thoroughly vet each company and stipulate the terms of the loan. Many of these fund companies have decades of experience in this area through their past work with institutional investors and are skilled at evaluating potential loans and helping to contain the damage if a borrower runs into financial difficulty.
Are Alternative Investments High Risk?
Yes and no. With private credit, a type of alternative investment, the primary risk is that some of the companies in the portfolio may not be able to repay the loan as originally intended. This could result in default. When this happens at least some of the loan payment is typically recovered. Default rates for private credit have been quite low historically and the current rate is under 2%.
Another risk is illiquidity. Most private credit funds only allow investors to withdraw a small portion of the fund once a quarter, so investors do not have daily access to their money.
But in return for this illiquidity, investors typically receive a high level of income with private credit funds providing yields of 8-12% currently. Another advantage is that private credit loans generally have adjustable rates which greatly reduce the interest rate risk that bonds face and increases the income from the fund when interest rates rise (as they have done in the last few years).
Are Alternative Investments Worth It?
Overall, skilled and well-managed private credit funds may offer investors stock-like returns with much less risk than stocks. And these alternative investments can often provide greater returns than bonds with very little interest rate risk. As such, private credit investments can give investors valuable diversification from both bonds and stocks.
Disclaimer: Alternative investment strategies may not be suitable for all investors. Before making any investment decisions, consult with your investment advisor.
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