Exploring “Alternative” Fixed Income

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Many investors have long held a somewhat traditional allocation to fixed income, consisting primarily of Treasuries, Munis, and investment grade credit—essentially a core portfolio. Over the last decade or so, as global fixed income markets have grown and investing in categories like high yield and other “spread” product has become more common, we’ve seen investors expand their bond allocation beyond the core, to core “plus”—including emerging debt (EMD) and high yield bonds.

But there’s another stage in the evolution of the fixed income portfolio, into what we are calling “Alternative Credit”—essentially a group of below-investment grade investment strategies that includes leveraged loans, commercial real estate debt, event-driven credit hedge funds, mezzanine, and distressed debt. These alternative strategies may also answer many of the questions fixed income investors are concerned about (regarding rates, yields and inflation), and may fit well into the type of bond portfolio they are considering for the future.

“Alternative Credit” is not meant to replace, but to complement the traditional allocation to fixed income. Their corresponding characteristics present an interesting set of features and benefits.

Where traditional fixed income generally works in more liquid, actively traded, efficient markets, alternative credit tends to focus more on less liquid, and thus less efficient areas of the bond market—where fund managers often deal directly with corporate management on a confidential basis to negotiate private covenant terms.

While traditional fixed income faces its greatest headwinds in environments of rising rates and higher inflation, alternative credit is often floating rate or has other characteristics that could mitigate its vulnerability to both rising rates and inflation.

And where traditional fixed income attempts to provide market-based returns from clearly identifiable indices, alternative credit largely involves unconstrained, benchmark-free pursuit of value based upon market-agnostic, company-specific credit events.

For these reasons, alternative credit generally operates in a different arena than traditional fixed income and can tap opportunities the traditional portfolio may otherwise miss.