Private Debt Made Accessible

Private debt may offer attractive and stable risk-adjusted returns throughout market cycles and often outperforms public asset classes when markets are stressed.

Historically, access to private debt has been limited to large, sophisticated investors with substantial amounts of capital.

This is changing, thanks to evergreen funds, which make private debt available to a wider range of investors.

Why invest in private debt?

There are several reasons why an investor might allocate to private debt instead of simply investing in public credit or equities through straightforward ETFs.

Stable and attractive risk-adjusted returns

Direct lending has historically delivered attractive risk-adjusted returns relative to public markets (Figure 1).¹ There are several reasons why. 
 

Figure 1 | Return and volatility (1Q05-3Q24)

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Source: S&P 500 Index, Bloomberg High Yield Index, Bloomberg Investment Grade Index, LCD Morningstar Leveraged Loans Index and Cliffwater DL Index (based on broad Cliffwater Direct Lending Index, which includes 30–50% Junior Debt. Senior Debt is expected to have lower drawdowns), as of September 2024.
 

Floating rates: When central banks raise (or maintain) base rates during periods of elevated inflation, the coupon payments on direct lending loans also increase (or remain unchanged). Moreover, investors are less susceptible to duration risk because the coupon rate resets, often quarterly. 
Senior secured: Approximately 85% of the direct lending market comprises first-lien secured loans, offering enhanced investor security during economic stress. If a borrower defaults, senior lenders are repaid first. This maximizes recovery rates. 
Diversification: Unlike syndicated loans, which are concentrated in large-cap companies, direct lending provides exposure to the Middle Market, which comprises a broader swath of companies and sectors. This market has shown resilience in recent years, supported by strong earnings growth. 
Income-based returns: The majority of returns in direct lending come from cash coupon payments, delivering stable, regular and predictable cash flows over time, and contributing to consistent returns. 
Low volatility and drawdowns: The above features combined have allowed direct lending to deliver attractive risk-adjusted returns with low volatility and limited drawdowns.

Public markets are currently expensive

Examining the 12-month forward P/E ratio for the S&P 500 and the spread for high-yield bonds reveals that public market valuations are currently expensive (Figure 2). As of December 2024, the S&P 500’s 12-month forward P/E ratio stands at 21.7, placing it in the 90th percentile of data going back to 1990. Similarly, high-yield bond spreads are 287 bps, ranking in the 6th percentile since 2002. 
 

Figure 2 | Public market valuations

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Source: S&P 500 Index, Bloomberg High Yield Index, as of December 2024. 
 

Against this backdrop, public markets appear to present an unbalanced risk profile, with limited upside potential and significant downside risk in the event of market shocks.

As seen in Figure 3, recent gains in the S&P 500 have been heavily driven by the strong performance of the “Magnificent Seven,” which represents approximately one-third of the index. 
 

Figure 3 | Public equity market drivers

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Source: Bloomberg, as of December 2024. 
 

As a result, ETFs no longer provide the same diversification they once did; investors are disproportionately exposed to these large-cap tech companies, which could singularly trigger a correction in the S&P 500.

Uncertainty surrounding interest rates has materially increased in recent years. For investors, this implies that the risk related to interest rate moves is higher and could introduce additional volatility in their portfolios. For instance, a 1% move in interest rates could lead to a price change of nearly 7% for US investment-grade bonds, introducing significant volatility, as experienced in 2022. In contrast, direct lending removes the need to make “bets” on the future path of interest rates thanks to its floating rate, removing the volatility stemming from duration (Figure 4). 
 

Figure 4 | Duration risk

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Source: Bloomberg, as of December 2024 and StepStone analysis. 
 

Evergreen funds allow for a wider investor spectrum

Evergreen funds in private debt are expanding the range of investors able to participate in this asset class for several key reasons:

Subscription-based: Traditionally, accessing private debt required investors to commit to drawdown funds, which demand significant operational capacity (e.g., legal and administrative resources). This complexity has historically excluded investors with small back offices. Evergreen funds simplify this process with a subscription-based model, significantly reducing the operational burden of adding private debt to a portfolio.

Low minimum investment amount: Investments in traditional private debt drawdown funds typically require commitments that may be too large for some investors. Evergreen funds, which have lower investment minimums—sometimes as low as $10,000—open the door to a broader pool of investors, including individual investors.

Liquidity feature: Different investors have varying liquidity needs. While large institutional investors may be comfortable locking in commitments for extended periods, individual investors often require some level of liquidity in their portfolios. Evergreen funds solve this by offering a liquidity feature through redemption options, subject to fund terms, giving individual investors greater flexibility in their allocations.

Main considerations when investing in a private debt fund

• Diversification 
• Asset mix (i.e., share of private market assets in the fund)
• Fees and expenses
• Fund structure
• Fund leverage

Conclusion

Direct lending offers a more balanced risk-return profile in the face of overvalued public markets. At the same time, private debt evergreen funds are broadening access to the asset class thanks to a subscription-based model with lower investment minimums and more liquidity options. Individual investors can now benefit from the relatively stable and attractive risk-adjusted returns that private debt has offered.

1 Private debt encompasses an array of sub-strategies such as direct lending, opportunistic lending and specialty credit. Direct lending being the most prominent one, we focus on this strategy in this paper.