What role does public and private fixed income have in portfolios?

Investors are often framed as facing a choice between choosing to invest in public fixed income or private credit. We think that framing misses the point: each plays a distinct role, and the two are stronger together.

Public fixed income: Liquidity, income and ballast

Public "core" bond strategies remain the foundation of most fixed income allocations, in most cases giving investors broad – though not complete – exposure to US Treasuries, IG Corporates and some high-quality securitized assets. There are several pros to the asset class:

1. They offer daily liquidity, allowing investors to rebalance, meet cash needs or redeploy capital quickly;
2. After the reset in rates, yields are attractive, with core bonds offering income that was hard to find for much of the 2010s and;
3. High-quality duration has historically cushioned portfolios during equity drawdowns, particularly in growth scares, and more recently have been an effective hedge to AI driven equity volatility.

The trade-off, however, is interest rate risk. Core strategies typically carry duration of roughly 3 to 7 years, meaning a 1 percentage point rise in yields would reduce prices by about 3% to 7%, all else equal. And as 2022 showed, when inflation rather than growth is the shock, stocks and bonds can fall together, turning duration from a source of protection into a source of risk.

Moreover, public fixed income benchmarks are not about selectivity but rather represent the most indebted issuers. This is why active strategies are superior given managers can better manage issuer and/sector exposure. 

Private credit: More income, a different kind of risk

Private credit, primarily direct loans to middle-market companies, brings a different set of characteristics that can complement already existing public exposure. 

1. Yields are typically higher, compensating investors for issuer-specific risks and for locking up capital;
2. Most private loans are floating rate, with coupons that reset alongside short-term rates, leaving very little duration risk, meaning prices are far less sensitive to changes in yields and;
3. Because these loans don't trade daily, they are marked less frequently, which can dampen volatility, smooth out returns, and discourage selling at the wrong time.

Of course, higher yield is not a free lunch. The risk in private credit isn't embedded in duration but in credit. Borrowers are often smaller, more levered and below investment grade, so defaults, recoveries and the quality of manager underwriting drive outcomes. Manager selection is also key, as certain managers can provide exposure to sectors often not represented in public fixed income. 

Better together: A bond portfolio built for different shocks

Combined, public and private credit can deliver a bond portfolio that is both attractively yielding and resilient to different types of shocks. As the chart shows, shifting from an all-public fixed income allocation¹ toward adding a sleeve of private credit can help improve returns while lowering volatility. 

An 80/20 public/private mix, for example, has returned ~130bps more than a public bond portfolio, with less risk. That same portfolio is currently yielding ~6.3% vs. 5.3% in the public markets.

Just as important, each sleeve hedges a different risk. In a growth shock, when equities fall, high-quality duration tends to rally. In an inflation or rate shock, as in 2022, floating-rate private credit has held up far better, while the public sleeve's liquidity provides dry powder to rebalance when markets dislocate. This isn't about picking one or the other but embracing each for its strengths and sizing the mix to an investor's risk tolerance and liquidity needs. 

¹ Public fixed income: Bloomberg U.S. Aggregate Index. Private credit: Cliffwater Direct Lending Index. 

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