Private Debt

CHAPTER 17Portfolio Construction

Portfolio construction is often not well understood by investors. It refers to the construction of a single portfolio or group of portfolios to maximize long‐term risk‐adjusted return. Risk can be an absolute value, measured by standard deviation of return, or the risk of varying from a benchmark return, measured by the standard deviation of differences between portfolio and benchmark returns, the latter definition also referred to as benchmark risk or tracking error.

DIRECT LENDING BENCHMARKS

Almost without exception, institutional investors will select a benchmark against which to evaluate performance as a first step in portfolio construction. As fiduciaries, they require a means to measure the performance of managers to whom investment discretion is being given and fees paid. With private asset portfolios there are generally three possibilities, none of which is ideal.

The first option is to find the publicly traded index that is most representative of the private asset portfolio in question. For private real estate this is a real estate investment trust (REIT) index. For private equity it's the Russell 3000 Index or similar index. The closest public equivalent index for corporate direct lending is either the S&P/LSTA Leveraged Loan Index or Credit Suisse Leveraged Loan Index. Private assets can generally outperform these public equivalent indices over longer periods of time, but over the short term there can be wide discrepancies between ...