Credit Markets in Transition: Public–Private Credit Portfolios

What It Covers

PGIM's Greg Peters and Tom McCartan explain how to construct portfolios combining public and private credit assets. They address challenges in valuation, liquidity assessment, and asset allocation frameworks. The discussion covers illiquidity premiums, volatility measurement issues, and why private credit markets have grown three and a half times larger while high yield bonds remain unchanged over the past decade.

Key Questions Answered

• •Private Credit Growth Asymmetry: High yield bond markets have remained flat or slightly smaller over the past decade, while private credit markets have expanded to three and a half times their previous size. This shift requires moving away from siloed allocation approaches toward integrated public-private portfolio management that treats credit as a continuum rather than binary categories, enabling more levers for alpha generation.
• •Illiquidity Premium Framework: The illiquidity premium is not a static 150 basis points but varies based on total portfolio composition. Moving from zero to one percent private allocation requires different premium considerations than moving from 99 to 100 percent. The premium matters most in below investment grade corporate credit and asset-based finance, where structural differences and collateral subordination provide better diversification than comparing similar public and private companies.
• •Volatility Mapping Methodology: Private assets create artificially high Sharpe ratios due to stale pricing and lack of secondary market trading. PGIM maps private investment grade corporates to triple-B public indices and uses listed BDC structures as gateways to understand true private asset volatility. This prevents optimizers from incorrectly allocating 100 percent to assets with understated volatility, creating more honest portfolio construction.
• •Three-by-Three Asset Allocation Matrix: Portfolio construction uses a framework with three levels each of illiquidity tolerance and risk tolerance. Low liquidity needs with high risk tolerance can support up to 70 percent private allocation. Investment grade portfolios sit at low risk, fully below investment grade at high risk, with blended approaches in between. This customized framework incorporates client liability needs rather than generic mean-variance optimization.
• •Cash Flow Self-Liquidation Advantage: Private credit generates continuous liquidity through amortizations, prepayments, coupons, and maturities, unlike private equity which locks capital without cash flow. This self-liquidating nature enables tactical rebalancing and offsets the J-curve effect by allowing public market positions to replicate risk during private investment ramp periods. The dynamic cash generation provides more flexibility than investors typically perceive when comparing private credit to private equity.