So far, 2022 has been the worst year for fixed income markets since the Great Depression. The US Aggregate Bond Index (our fixed income benchmark) has lost 10.75% through August with the Global Aggregate Bond Index down 20.4%.
Fortunately, our large allocations to Private Real Estate (+7.4% ytd return) and Private Credit (+1.1% ytd return) have helped us outperform the fixed income benchmark this year. Last week, we sent out our latest thinking on the real estate investment so this week it will be Private Credit.
As a reminder, we are invested in a fund that loans money to private companies (companies that are not publicly owned or traded). These loans are floating rate, meaning that the amount of interest we are paid is tied to SOFR (Secured Overnight Financing Rate) which has replaced LIBOR in lending markets. As interest rates increase, we are paid a more, helping to offset inflation or default. The loans are also secured by the assets of the borrowers and have first priority in the event of default. The most similar public market is the Leveraged Loan market which can be tracked through the S&P/LSTA Index.
The public Leveraged Loan market is down 1.45% this year. Losses have come through a combination of defaults and credit spread increases offset by the yield on the loans (5%). Credit spread is the extra interest lenders receive over SOFR. As investors have become more worried about recession, credit spreads have widened. Since the beginning of the year, credit spreads have increased by a little over 1.0 percentage points.
Our Private Credit investment has done much better than the public loan markets this year. While credit spreads have widened by a similar amount in private lending markets, default rates have been 0% so far and the yield on the loans is much higher. Year to date the NAV of the fund is down by about 3.5% due to credit spread widening but has been offset by distributions leading to a positive return of 1.1% through August.
Remember these loans are floating rate and SOFR has increased this year from 0% in January to 2.3% in August. This increase in interest rates has really hurt the bond markets but our fund recently announced a 12.5% increase in the monthly distribution (8% to 9%) beginning in October.
We continue to like this investment given the current uncertainty around Fed interest rate increases and inflation. We also like the modest leverage in the underlying loans with portfolio wide Loan to Value at only 43%. This should help offset any uptick in default rates as our portfolio has a large buffer from loan losses.
