Junk bond returns beat private debt, Dimensional says

When direct lenders pitch private credit to pension funds and insurance firms, many tout its ability to beat public debt returns. But Dimensional Fund Advisors isn’t buying it.

“There is no outperformance relative to high-yield bonds,” said Savina Rizova, Dimensional’s co-chief investment officer and global head of research, speaking about private credit on the Bloomberg Intelligence Credit Edge podcast. The Austin-based firm, with almost $800 billion in assets under management, often uses academic research to guide its investment strategy.

Using data from MSCI Inc., Dimensional studied the historical performance of private credit from 1980 to 2022, Rizova said. They found that the internal rate of return was “about 10 percentage points, which sounds appealing,” she said.

However, they found stronger performance in high-yield bond benchmarks, such as a Bloomberg index, when using a RECTA — risk-adjusted, excess, correlation, timing and alpha — framework.

To be sure, private credit didn’t resemble the asset class it is today until well after 2008, when regulations from the Great Financial Crisis caused banks to pull back from funding risky loans. In 2008, assets under management for private debt funds totaled around $260 billion, according to Preqin data. Today, it’s a $1.7 trillion universe.

Private credit returns aren’t typically compared to high-yield bonds. The Cliffwater Direct Lending Index — commonly used to track private credit performance — is usually compared to leveraged loans, using the Morningstar LSTA US Leveraged Loan Index.

Cliffwater’s latest research, published in March, shows private debt returns beating public debt returns by at least four percentage points over a five-year, 10-year and 20-year period. 

Even with Dimensional’s findings, Rizova said private credit offers diversification benefits, particularly as some issuers opt for private markets, meaning that investors solely focused on public markets could miss those opportunities.

Dimensional is the largest issuer of active exchange-traded funds, with around $180 billion in ETF assets under management, according to Morningstar data.