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Determining the relative value of a particular market segment or capital structure through the credit cycle requires a closer look at its performance over time. This provides an investor with the necessary information to decide which portfolio rotations are sensible given a specific market outlook. To demonstrate the importance of a good positioning in the capital structure as the cycle evolves, we analysed distributions of IRRs and loss rates for pre- and post-GFC periods.

Using the resampling methodology, we randomly selected 100 loans from our proprietary private debt database to build a portfolio. We then calculated the IRR of each randomly selected portfolio and repeated this process 100,000 times to obtain the IRR distribution for each strategy.

Exhibits 9 and 10 illustrate the importance of a good positioning through the cycle. The pre-GFC period is characterised by a platykurtic IRR distribution for second-lien/mezzanine loans, demonstrating the sector’s higher risk profile, particularly in periods of market stress. Such a distribution also complicates portfolio construction, since expected returns are harder to derive and less robust.