When it comes to fixed income, high yield bonds have historically been the go-to asset for investors seeking an enhanced level of income. They tend to offer substantial yields compared with government bonds or investment-grade debt, albeit with higher risk. In recent times, however, private credit has emerged as a compelling alternative. Here, I take a look at each asset class and debate the pros and cons of each.

Readers will be very familiar with high yield bonds. Often referred to as "junk bonds" they are simply corporate debt with credit ratings below investment grade. Companies that issue high yield bonds often have higher levels of debt or less stable financial conditions than their investment-grade counterparts. Despite their riskier profile, high yield bonds can play a vital role in diversified fixed-income portfolios due to their return potential and ability to perform well in strong economic conditions.

Private credit is perhaps less familiar. Also known as direct lending or private debt, it involves non-bank institutions providing loans directly to companies - often mid-sized or privately held firms. Unlike traditional bank lending, private credit is usually structured as bespoke, negotiated agreements that offer higher interest rates in exchange for flexibility and tailored solutions for borrowers.

Private credit includes various forms, such as mezzanine debt (one of the highest-risk forms of debt which bridges the gap between debt and equity financing), unitranche loans (a hybrid loan structure that combines senior debt and subordinated debt into one loan), and special situation financing.

It has gained popularity in recent years due to regulatory constraints on banks, which have made it harder for certain businesses to access traditional financing. Private credit funds, managed by investment firms or alternative asset managers, have stepped in to fill this gap, offering customised lending solutions to companies in need of capital.

Both high yield bonds and private credit offer attractive yields and serve as alternative investment opportunities. However, their structures, risk profiles, and benefits differ significantly. Below is a comparison of some of the pros and cons of each.

High yield bonds can be issued by a variety of companies across different industries, allowing investors to build a diversified portfolio and mitigate sector-specific risks. They are also traded on public markets, making them more liquid (but more volatile) than private credit investments. Investors can buy and sell them relatively easily, providing flexibility in portfolio management. They are, however, sensitive to economic conditions and market sentiment, so behave more like equities.

If the issuing company improves its financial standing, its bond rating may be upgraded, leading to price appreciation of the bond in the secondary market. However, since these bonds are issued by companies with weaker finances, they carry a higher risk of default than their investment grade counterparts and, in the event of bankruptcy, bondholders may receive limited recovery, particularly if the bond is unsecured. High yield bonds are, however, less sensitive to interest rates because they have shorter-dated maturity and higher coupons than investment grade bonds.

While private credit investments are not publicly traded and are illiquid in nature as they are harder to sell before maturity, they are at the same time shielded from daily market fluctuations and are therefore more stable over time. Private credit loans also typically offer higher interest rates than high yield bonds to compensate for this illiquidity and because they require investors to commit capital for extended periods.

Because they have customised structuring, lenders can also negotiate loan terms, which means they have greater flexibility in structuring agreements that align with both investor and borrower needs. This is particularly true for non-investment grade private credit which is less competitive and less standardised than investment-grade private placements. Because of the more bespoke and complex structuring, investors can get enhanced returns through higher spreads and from arrangement fees. Private loans also include stringent covenants and collateral backing, offering greater protection against default risks.

One of the most striking statistics I’ve come across of late, is Gravis’s annualised loss ratio of its private credit infrastructure assets. At just 0.41%, it is significantly lower than the 2.11% of unsecured high yield bonds offering a similar level of return to that Gravis has achieved*. And even when things go wrong, infrastructure debt recovery rates are relatively high: 68%** according to Moody’s vs 33.7%*** for unsecured bonds.

High yield bonds and private credit both provide opportunities for enhanced returns, but they cater to different investor preferences, particularly in terms of liquidity and volatility. In my view they can be complementary.

*Source: Moody’s Average loss rate for unsecured bond and Speculative grade for 2011-2023 and Gravis, calculated as IRR on infrastructure loans exited across GCP Infrastructure Investments and GCP Asset Backed Income Ltd as of 30 June 2024.

**Source: Moody’s investor services Infrastructure Default and Recovery Rates 1983-2023, 29 July 2024.

***Moody’s Annual default study, corporate default rate to fall below its long term average in 2025, 28 February 2025.

Important information

This article is issued by Gravis Capital Management Ltd (“GCM”), which is authorised and regulated by the Financial Conduct Authority. The registered office address of GCM is 24 Savile Row, London, United Kingdom, W1S 2ES. GCM is registered in England and Wales under registration number 10471852.

GCM does not offer investment advice and this article should not be considered a recommendation, invitation or inducement to invest in any fund associated with GCM (or any of its affiliates).  

This article has been prepared by GCM using all reasonable skill, care and diligence. It contains information and analysis that is believed to be accurate at the time of publication but is subject to change without notice.

Past performance is not a reliable indicator of future results.

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