The goal of an investment portfolio for an endowment or foundation is ultimately to support both the immediate and long-term financial needs of the organization. Investments in traditional asset classes, like stocks and bonds, continue to be the foundation of many of these portfolios; however, an opportunity is emerging for more and more investors in the form of alternative investments, which have the potential to improve the risk and return profile of a portfolio and provide diversified sources that can contribute towards long-term investment success.

Alternatives have been utilized for decades by large institutional investors to diversify sources of return and ultimately drive long-term growth of their assets. Today, these benefits are becoming more accessible to and embraced by smaller organizations through a variety of asset classes, including private credit.

What is Private Credit?

Private credit, also referred to as private debt, at its core describes loans made privately between two parties, as opposed to traditional syndicated bank loans or bond issues that are more broadly available to fixed income investors through public markets. Another way of viewing the private credit market is an alternative to the traditional banking sector and capital markets. Instead of a business or organization receiving a loan from a bank, which can be onerous and/or expensive, they can instead choose to borrow money in the private markets. The opportunity for investors lies in providing capital to that private lender who then sets out to earn a return on those assets for themselves and their investors.

With accessibility increasing for this asset class, private credit can play a valuable role in non-profit portfolios of all sizes in a variety of ways.

Diversification to Mitigate Risk

For endowments and foundations, diversification is key to managing investment risk and achieving long-term financial goals. Private credit enhances diversification by introducing assets that are less correlated with traditional equity and fixed income investments. This can help reduce overall portfolio volatility and potentially improve risk-adjusted returns.

Private credit, and investment in private markets more broadly, can provide an attractive alternative to the volatility that comes with publicly traded assets. While the asset class is certainly not without risk of its own, the day-to-day ups and downs of traditional public market investing are broadly avoided.

Tapping Into Private Market Premiums

Private credit offers the potential for attractive risk-adjusted returns achieved through various premiums that can be earned in private markets. Firstly, by providing capital to borrowers who might not have access to traditional financing, private credit often commands higher interest rates and fees which are then passed along as return to investors.

A premium can also be earned from the degree of illiquidity that typically accompanies investment in private markets. If an investor has the ability to give up some of their immediate illiquidity, they are compensated for that. Finally, a “complexity” premium can also be earned by investors. In other words, higher yields can often be generated from the complex work that goes into the origination, underwriting, structuring and portfolio management capabilities of private credit managers.

Impact on Income Generation

Endowments and foundations rely on the income from their investments to fund operations, grants, and other initiatives. Private credit can contribute to steady and predictable income streams through regular interest payments. This is especially valuable in times of economic uncertainty when traditional income sources might be under pressure.

Alignment with Long-Term Goals

Allocations to private debt are typically less liquid and have longer holding periods compared to publicly traded assets. This may align well with the long-term investment horizons of endowments and foundations. By matching the duration of investments with their long-term funding needs, portfolios can effectively leverage private credit to help achieve the organization’s objectives in a somewhat more structured and predictable manner.

Traditional asset classes will continue to serve important roles in portfolios, but investors would be well-served by evaluating the opportunity that private credit presents as it continues to become more accessible in delivering diversification, risk-adjusted returns, and stable income streams. While it requires careful consideration to understand the trade-offs of investing in private markets, the potential benefits make for a valuable addition to a well-rounded investment portfolio.

This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.