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Bruce Richards discusses the importance of diversifying your portfolio with quality private credit assets
Key Takeaways
- It is important to build a diversified portfolio with a focus on quality assets, including public equity, private equity, and private credit.
- Balancing your portfolio with private credit may help lower portfolio risk. For instance, elevated interest rates increase financing costs, which is negative for private equity, but because of floating rate lending, can benefit private credit managers.
Transcript
Hello, I'm Bruce Richards, the CEO, Managing Partner, and Chairman of Marathon Asset Management. Founded the firm 25 years ago with Lou Hanover, we're a global credit manager focused on investing in the credit markets throughout the world, with 180 professionals in six different offices.
My advice to investors, RIA community, and institutions is to build out a diversified portfolio, not for diversity’s sake, but quality assets. And so, having the proper allocation to the public equity markets and private equity, and within private equity, everything from leveraged buyouts to venture capital, is an important component of the portfolio. But when you look at the big picture globally, the equity market is over $100 trillion in size, and the credit market and fixed income markets is over 100 trillion in size. They're about equal. When you're focused here in the United States, the equity market is around 50 trillion and the fixed income and credit markets is also around 50 trillion. It makes perfect sense to add in private credit with private equity to have a balanced, diversified portfolio.
Of course, you want to select top-quartile managers for your portfolio. Private credit is the grease that allows private equity to exist. It's a leveraged buyout, and when you do a leveraged buyout, you need financing. And so we think that when the Fed had rates at zero and you were getting paid a very low rate of return, there was an inordinate amount of benefit going to private equity managers. They're paying very low financing cost to make that acquisition. Today, they have to pay very healthy, relatively high financing cost to private credit managers such as Marathon. And so, we believe that one should balance their portfolio between private equity and private credit.
And in fact, when you think about your portfolio at these higher rates of return, what you'll notice is from venture capital to private equity, the pacing is slowed down. The managers themselves have been investing less because the opportunities aren't what they were previously. And the reason why is financing costs are so high. And so to do a leveraged buyout, you have to finance that leveraged buyout. And the rate that we make on that leveraged buyout by financing that is significantly higher than what it was before the Fed increased rates 525 basis points. So we're making extra return, and that is simply a money tranche that the EBITA and the free cash flow that the company was generating, some of that money now from the free cash flow is going to the creditors because of $1,000,000,000 of debt that financed that LBO at a 6% rate, they were paying $60 million.
Same company, same risk. Now they're paying perhaps double that, $120 million, to finance that acquisition. And so that extra income is being generated by the private credit managers at the expense of the companies that now have to service that debt. And so you want to balance your portfolio so you can generate with a lower level of risk, investing in the credit markets than the equity markets.
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