Portfolio Construction with Direct Lending
Direct lending has several investment characteristics that may complement other elements of the portfolio.
- Visual Guide
Tile 6.1
Opposites Attract: Direct Lending in the Portfolio
Direct lending can have powerful diversification benefits for the overall portfolio.
Direct Lending Matches Up Well with Other Assets (Volatility and Correlation Attractions)
For a More Efficient Portfolio: Direct lending has lower volatility than other traditional portfolio components, such as high yield and equities, and low correlation to most fixed income exposures
September 30, 2004–December 31, 2023. Direct Lending: Cliffwater Direct Lending Index. Leveraged Loans: Morningstar LSTA U.S. Leveraged Loan Index. High Yield: ICE BofA U.S. High Yield Index. U.S. Equity: S&P 500 Total Return. Commodities: S&P GSCI. U.S. REITs: Wilshire U.S. Real Estate Investment Trust Total Returns Index. U.S. Investment Grade: ICE BofA U.S. Corporate Index. U.S. Aggregate: Bloomberg U.S. Aggregate Index. Treasuries: ICE BofA U.S. Treasuries Index. Correlation is a statistical measure of the degree to which the prices of two securities move in relation to each other. A correlation of 1 means the prices always move in the same direction. A correlation of -1 means the prices always move in opposite directions. The correlation calculation is based on quarterly net returns. Realized Volatility (Standard Deviation) is a statistical measure of the dispersion of a data set relative to its mean. Annualized standard deviation is based on total quarterly net returns for the specified period.
For a Good Mix
- Because direct lending as an asset class is so distinct—with low volatility, no duration risk, consistently high yield and low correlations to traditional fixed income—we believe it complements other portfolio elements.
- Direct lending has a reasonably high correlation with other credit exposures (such as loans and high yield), equities and even real assets such as real estate and commodities; but it brings with it much lower volatility and a higher yield.
- We believe including direct lending in a portfolio can potentially reduce portfolio risk, increase its income potential and drive returns.
Tile 6.2
Biggest (Real Income) Bang for Your Buck
Middle market direct lending provides higher real yield than traditional sources of portfolio income.
Annualized Income & Inflation (Q4 2004 – Q2 2024)
Investors Get Real
- For clients focused on actual outcomes, we believe a portfolio’s real income (after inflation) is akin to looking at after-tax returns.
- We believe no other asset class delivers as much income “bang for your buck” as private direct lending.
- With a 9.3% annualized yield over the last 10 years, direct lending provides almost four times the yield of the U.S. Agg and almost twice that of public bank loans.
- With a “higher for longer” outlook for inflation currently, we expect that attending to a portfolio’s real yield may be impactful.
Tile 6.3
Giving Traditional Allocations an Income Boost
An allocation to Direct Lending may help achieve distinct investor goals; consider the income-oriented investor.
Direct Lending Can Help Build Better Portfolios
Illustrative Example: Moderate Risk Investor with an Income Orientation
Before: Starting Portfolio
After: Updated Portfolio
The Results:1
Note: Equities and bond returns are represented by the S&P 500 and Bloomberg US Agg respectively. DLs are represented by the unlevered CDLI index. Net NAV DL income and total return are reduced by estimated fund-level fees & expenses totaling 193 bps. Stock and bond income/total return are reduced by estimated fees = 42 bps and 37 bps respectively. Time period analyzed Q4 2004 (since CDLI inception) to Q2 2024, returns and volatilities presented on annualized basis. Suggested allocations will vary depending on constraints applied; recommended sourcing is derived from many factors, including relative correlations, volatilities, returns and income for each asset alone and in combination with the other two.
1. Results shown here are for illustrative purposes only and do not represent an outcome that any investor has achieved. There is no guarantee that such results could be achieved in any given market environment.
A Healthy Portfolio Additive
- Income-oriented investors often seek to drive higher yields from their portfolio without unduly sacrificing its potential for long-term growth.
- Starting with a traditional 60/40 stock/bond portfolio, we consider how the inclusion of direct lending could maximize income without giving up growth or taking on additional risk.
- The optimal range will depend on individual investor preferences, but a 20% exposure would raise total portfolio income by about 50%, from 2.4% to 3.5%.
- The inclusion of direct lending in that amount would also reduce risk by over 10%, from a standard deviation of 10% to a standard deviation of 8.8%.
Table of Contents
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Views expressed represent Golub Capital’s current internal viewpoints and are based on Golub Capital’s views of the current market environment, which is subject to change. Certain information contained in these materials discusses general market activity, industry or sector trends or other broad-based economic, market or political conditions and should not be construed as investment advice. There can be no assurance that any of the views or trends described herein will continue or will not reverse. Forecasts, estimates and certain information contained herein are based upon proprietary and other research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve. Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of, future events or results. Private credit involves an investment in non-publicly traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss.
This presentation has been distributed for informational purposes only, and does not constitute investment advice or the offer to sell or a solicitation to buy any security. This presentation incorporates information provided by third-party sources that are believed to be reliable, but the information has not been verified independently by Golub Capital. Golub Capital makes no warranty or representation as to the accuracy or completeness of such third-party information. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
Past performance does not guarantee future results.
All information about the Firm contained in this document is presented as of May 2025, unless otherwise specified.
The Morningstar Indexes are the exclusive property of Morningstar, Inc. Morningstar, Inc., its affiliates and subsidiaries, its direct and indirect information providers and any other third party involved in, or related to, compiling, computing or creating any Morningstar Index (collectively, “Morningstar Parties”) do not guarantee the accuracy, completeness and/or timeliness of the Morningstar Indexes or any data included therein and shall have no liability for any errors, omissions, or interruptions therein. None of the Morningstar Parties make any representation or warranty, express or implied, as to the results to be obtained from the use of the Morningstar Indexes or any data included therein.
“Cliffwater,” “Cliffwater Direct Lending Index,” and “CDLI” are trademarks of Cliffwater LLC. The Cliffwater Direct Lending Indexes (the “Cliffwater Indexes”) and all information on the performance or characteristics thereof (“Cliffwater Index Data”) are owned exclusively by Cliffwater LLC, and are referenced herein under license. Neither Cliffwater nor any of its affiliates sponsor or endorse, or are affiliated with or otherwise connected to, Golub Capital, or any of its products or services. All Cliffwater Index Data is provided for informational purposes only, on an “as available” basis, without any warranty of any kind, whether express or implied. Cliffwater and its affiliates do not accept any liability whatsoever for any errors or omissions in the Cliffwater Indexes or Cliffwater Index Data, or arising from any use of the Cliffwater Indexes or Cliffwater Index Data, and no third party may rely on any Cliffwater Indexes or Cliffwater Index Data referenced in this report. No further distribution of Cliffwater Index Data is permitted without the express written consent of Cliffwater. Any reference to or use of the Cliffwater Index or Cliffwater Index Data is subject to the further notices and disclaimers set forth from time to time on Cliffwater’s website.
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