Etienne Viljoen, Chief Investment Officer at Aurora Capital SA
Investors often turn to alternative investments, looking for something that the listed market cannot always provide. For instance, a different return profile, less exposure to daily market sentiment, and a better way to manage portfolio risk when conditions become more volatile.
That is understandable. Traditional portfolios have had to work harder in recent years. Equity markets can reprice quickly. Bond markets are sensitive to interest-rate expectations, inflation, fiscal risk, and capital flows. Cash may feel safe, but it does not always protect purchasing power over time. This has pushed many investors to look more closely at alternative asset classes.
Private debt
Private debt can play a useful defensive role within a diversified portfolio, provided the structure, counterparty, and liquidity terms are properly understood. At its simplest, it involves lending capital outside listed public debt markets, usually through privately negotiated instruments. When structured properly, these investments can generate predictable income streams, reduce exposure to daily volatility in the listed market, and provide a different source of return from traditional equities and bonds.
That does not make private debt risk-free. It simply means the risk behaves differently. An asset that is not priced daily may appear calmer than a listed instrument, but that does not remove risk. It changes how and when that risk becomes visible. In a listed share or bond, market sentiment can affect the price immediately. In private debt, the investor is usually more focused on the borrower, the cash flows supporting repayment, the instrument’s structure, and the protections built into the investment.
That is why private debt should never be viewed as a shortcut to higher income. It should be viewed through the lens of risk compensation.
The first question is not: what is the yield? The better question is: what risk am I taking to earn that yield, and am I being properly compensated for it?
In our view, the most attractive private debt opportunities are those with asymmetric return profiles. In plain language, this means the potential reward is meaningfully attractive relative to the risk being taken. That requires discipline. A high headline yield is not enough if the underlying risks are unclear, poorly priced, or difficult to recover from.
What to consider
There are a few features investors should look for. The first is predictable cash flow generation. Private debt is only as strong as the repayment profile behind it. Investors need to understand where the cash will come from, how reliable that cash flow is, and what could disrupt it.
The second is the quality of the management team or counterparty. In private markets, who you are dealing with matters enormously. Investors should understand the track record, financial position, governance, and operational credibility of the people or businesses receiving the capital.
The third is defensive industry exposure. Private debt linked to essential or resilient sectors can offer a different level of comfort from lending into businesses that are highly cyclical, speculative, or dependent on perfect market conditions. No investment is immune to pressure, but some sectors are better positioned to withstand weaker economic periods than others.
Investors should also pay close attention to the investment’s structure. Is there an asset backing? Are there physical assets that support downside protection? What legal rights does the lender have? What happens if the borrower does not perform as expected? How is capital returned at the end of the term?
These questions may sound technical, but they are practical. They are the difference between understanding an investment and merely being attracted to its yield.
As with traditional asset classes such as equities and bonds, this appears quite complex and intimidating to the average investor. Individual opportunities should not be seen in isolation, but rather as part of a well-constructed, robust portfolio. A specialised team is necessary to conduct thorough due diligence on the various counterparties. It is also more difficult and time-consuming as information is not as readily available as with publicly listed companies.
Keep liquidity in mind
Liquidity is another important consideration. Many private debt investments are long-term commitments. They cannot usually be sold overnight, as with a listed share or unit trust holding. For some investors, that is acceptable. For others, it may create pressure at exactly the wrong time. There are, however, asset managers such as Aurora Capital that specialise in constructing investable portfolios of private debt. Within these portfolios, liquidity is managed across different maturities, structures, and sectors. The result is that illiquidity premiums can be exploited with part of the investment, increasing portfolio yield while keeping liquidity in the overall portfolio at acceptable levels.
This is why private debt should be matched carefully to an investor’s broader portfolio and liquidity needs. Capital that may be required in the short term does not belong in an illiquid investment, no matter how attractive the return appears. It is important to get the necessary financial advice on the optimal blend between traditional and alternative assets. The combination can significantly decrease volatility, without increasing overall portfolio risk.
Counterparty risk is equally important. Before investing, investors should know exactly who they are dealing with and what risks they are exposing themselves to. Proper due diligence should consider not only the expected performance of the investment, but also whether capital can realistically be recovered at the end of the term, even if conditions change.
This is managed through the investment committee’s proper due diligence process on issuers. In portfolio construction, diversification also plays a significant role. The portfolio diversifies across sectors, revenue streams, risk factors and geographies where possible. Preference is also given to defensive sectors, such as agriculture, where cash flow is more predictable than in highly cyclical ones like mining.
When used properly, private debt can help reduce mark-to-market volatility, enhance yield relative to public credit markets, provide downside protection through asset backing, and lower correlation to listed equities and bonds. These characteristics can make it a valuable component in a diversified portfolio.
Private debt belongs in the conversation because it can solve real portfolio problems. It can support income generation. It can introduce a return stream that is less dependent on daily market movements. It can provide exposure to opportunities that are not always available through public markets.
Understanding the environment
The discipline lies in understanding the structure, the counterparty, the cash flows, the liquidity terms, and the protections available if things do not go according to plan. As with any alternative investment, private debt should be assessed in the context of the investor’s broader portfolio, liquidity needs, time horizon, and risk tolerance. That is where the real work happens.
For investors considering alternatives, private debt can be a useful option. But the objective should never be to chase yield for its own sake. The objective should be to identify well-structured opportunities in which the risks are understood, the return is appropriate, and the role within the broader portfolio is clear.
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