Diversifying beyond debt

PRIVATE debt is expected to remain an important component of institutional portfolios as investors seek alternative sources of income and diversification amid changing market conditions.

However, making the most of the asset class requires a different investment approach, with greater attention to loan vintages, lending strategies and borrower profiles rather than simply spreading capital across several fund managers.

For investors looking to build exposure to private debt, the challenge lies in understanding the risks that are less apparent when applying conventional portfolio construction methods.

According to Amundi Alpha Associates chief investment officer Petr Rojicek, many investors are missing these distinctions, potentially leaving their portfolios more concentrated than they realise.

“Private debt has a diversification problem. Not because investors ignore diversification, but because many apply the same portfolio construction logic they use in other asset classes.

“To be blunt, this approach fundamentally misunderstands the nature of private debt and is unlikely to make the most of a limited private debt allocation,” he says in a recent commentary.

False sense of security

Unlike publicly traded assets, private debt requires investors to consider several additional factors, including when loans are originated, the position of debt within a company’s capital structure and the size of the borrowers.

These considerations can have a significant bearing on risk and returns, yet are often overlooked when investors construct their portfolios.

Rojicek notes that the typical investment journey begins with backing a single specialist private debt fund.

For investors with limited expertise and resources to participate directly in loan deals, this appears to be a practical starting point.

However, a single fund generally holds about 25 to 40 loans, meaning even one default can have a meaningful impact on overall portfolio performance.

Investors are also dependent on one general partner, including its sourcing network, investment decisions and assessment of credit quality.

Some investors attempt to address this concentration by allocating capital to two or three established fund managers. While this appears to offer greater diversification, it can create a false sense of security.

“Well-known managers often chase the same deals in the same regions and sectors,” Rojicek says, pointing to the possibility of overlapping exposures despite having several managers in a portfolio.

Loan vintage

Beyond geographical and sector concentration, loan vintage is another important consideration.

This refers to the period in which loans are originated, which determines the prevailing economic, interest rate and credit conditions under which borrowers obtain financing.

The significance becomes clearer when looking at recent market disruptions, including the Covid-19 pandemic, the war in Ukraine and the fallout from the Iran war.

Funds deploying capital around similar periods may end up holding loans originated under comparable market conditions.

Consequently, an investor could hold several funds with different managers and underlying borrowers but still be exposed to similar credit-cycle risks.

Rojicek says vintage-specific factors can have a greater influence on returns than differences in manager selection.

One example is the substantial amount of capital raised for business development companies in 2025, which has compressed credit spreads considerably.

This creates another layer of risk, as the pricing of loans at the time of origination can influence the returns investors ultimately receive, regardless of how many fund managers they appoint.

The type of debt being held also deserves closer attention, particularly when investors assess whether higher yields adequately compensate for additional credit risk.

Rojicek points out that investors should not assume taking on more risk automatically translates into better returns.

For instance, senior debt yielding 8% and junior debt yielding 11% may appear attractive at first glance, but their positions in the capital structure make a significant difference when a borrower defaults.

Senior lenders rank ahead of junior lenders when claims are settled and therefore have a better chance of recovering their investments. Junior lenders, meanwhile, absorb losses after senior claims have been satisfied.

The additional three percentage points in yield may therefore not provide sufficient compensation for the substantially higher risk of capital loss.

Company size is another factor that challenges conventional assumptions about credit quality.

Larger borrowers are not necessarily safer, particularly when smaller companies offer stronger contractual protections and more favourable lending terms.

“A smaller company may offer senior secured debt with tighter covenants and stronger lender protections than a larger borrower, and may be easier to restructure following a default, while providing a similar or even higher yield because competition among lenders is less intense,” he says.

This makes diversification across different lending strategies and borrower sizes important, rather than concentrating investments in a particular segment of the market.

Dedicated team

So how can investors build a more balanced private debt portfolio without taking on the considerable cost of managing the process themselves?

One option is to establish an in-house private debt investment team, with specialists overseeing due diligence, portfolio construction and ongoing monitoring.

However, this can be difficult to justify when private debt typically accounts for just 2% of an overall investment portfolio.

Maintaining a dedicated team requires resources and expertise that may be better deployed across other asset classes, particularly when only a small number of private debt investments are being made.

Rojicek says the economics of an in-house capability make more sense for investors with significantly larger allocations.

For those able to commit capital to only two or three funds, building such a team is simply not feasible.

This leaves a multi-manager approach as a practical alternative for many investors. By accessing a broader network of GPs, an experienced multi-manager can spread exposure across eight to 12 managers while taking into account the differences between individual funds.

Dedicated investment teams can assess loan vintages, debt structures, sectors and geographical exposures before constructing portfolios that are aligned with individual investor objectives.

Importantly, this approach looks beyond the number of managers in a portfolio and considers how their underlying investments interact with one another.

It also allows investors to access a wider range of private debt opportunities without having to establish and maintain their own specialist investment capabilities.

For Rojicek, the distinction is particularly important because diversification at individual fund level does not necessarily translate into diversification at investor portfolio level.

“Three individually balanced funds can all be balanced in the same direction,” he says, highlighting why investors need to look at their combined exposures rather than assess each fund in isolation.

The challenge, therefore, is not simply gaining access to private debt but understanding how its different risks interact and ensuring that portfolio construction reflects the characteristics of the asset class.