'Alpha is Over' in Private Credit: DoubleLine's Cohen

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00:00Robert, I am curious about this. I know a lot of people are fretting about some of the recent

00:03borrowing that we've seen as people sort of chase these AI dreams. But we'd be remiss in not

00:08pointing out that at least so far, the vast majority of these borrowers are coming into this

00:13with incredibly healthy balance sheets by pretty much any metric that you would normally see.

00:18Does it give you concern at all about the level of borrowing or the type of borrowing that's being

00:22done? I think the borrower matters. You mentioned that many of these are from very high quality

00:29companies. So Alphabet, Microsoft. Spending money on data centers isn't really a problem.

00:37Oracle's balance sheet, on the other hand, has been increasing in debt and they've gone cash flow

00:43negative. And then as you go down the credit spectrum, you start to see more and more speculative

00:48borrowing. And the markets pretty much figure this out. The risk tiering is pretty efficient.

00:52So investment grade credits yield, I don't know, high fives to maybe six for credits in the AI space.

01:00And then in high yield, you see anywhere from high sixes to over 10 percent. And so it really depends

01:06on how close you are to one of these so-called hyperscalers. For credits that are well supported

01:11by them, spreads are tight and their credit risks are relatively contained. When you are on your own

01:17without the support of one of the major players, so-called hyperscalers, you become a lot more

01:22speculative. And you see that in the spreads that the market demands for those credits.

01:27Well, I'm curious, given the uptick in activity, and obviously you get paid a lot to sort of sort of

01:31sift through all of this, separate the weak from the chaff, if you will. But the big theme, certainly

01:36in public markets all year long, has been AI. To a certain extent, it's been M&A activity. And that,

01:40of course, is also the big theme that we've seen, at least in the second half of the year,

01:44with regards to the credit space. Does that continue through 2026?

01:50Oh, I think the party just got started here. We've gone through a period of basically credit

01:55creation being in decline, meaning that the amount of credits have actually been shrinking.

02:00Corporate credit has been in decline, really across fixed income. The size of the markets have been in

02:05decline. Now we're seeing an uptick. M&A has been below trend since the pandemic. And I think this is

02:11really just the very beginning. So while people are pointing to a few transactions here and there,

02:16I think 2026 is going to look a lot different, where we have growth in M&A and growth in credit

02:21creation. And so there's going to be a lot more to see as we turn the page into next year.

02:27Well, looking forward to next year, one of the points that you make in your notes that you sent

02:30over to our producers is that you would expect that credit returns could be competitive with equities

02:36next year. Robert, that feels like a big call. Does that say something about the equity market,

02:41perhaps in a downdraft? Or does that say more about credit really outperforming here?

02:47Well, if you take out AI, it's not a big call because the S&P equal weighted is up about 10%.

02:53High yield corporates and investment grade credit are nearly tied at about 8% total return for the year.

02:58So you gave up. If you didn't buy the S&P equal weighted and you bought high yield, you would have

03:04given up 200 basis points, which is something, but not a whole lot given the volatility differences.

03:10And so the point being, if you strip out all the AI stuff, the returns aren't that different.

03:15And I think next year, the story about equities broadening out, the returns being from more stocks

03:23beyond the MAG-7, I think that could, if that ends up happening, you'll have a diluted sort of

03:28return profile, let's say high single digits. That sounds like something you could do in credit.

03:34So volatility adjusted, I think equities versus high yield or some forms of credit, credit seems

03:41very attractive. If you think about the fact that we could certainly have volatility next year,

03:46people forget we've, you know, we're ending the year pretty well, but we had something in the

03:50middle called tariffs. There was one pretty large bout of volatility in the midyear, and

03:56credit did better through that than equities. And of course, we had all the technology stuff

04:02take off and people forget that there was volatility. So I think if you consider that

04:07volatility is certainly a possibility for 2026, I think credit can be quite competitive with

04:13equities. Yeah, the tariff tantrum, it certainly feels like a long time ago. So when you're talking

04:17about credit returns in 2026, I assume you're talking about public credit. How does private

04:22credit wrap into that conversation around returns? Yeah, well, I think quite simply the private

04:29credit trade, the alpha is over in private credit. It was a tremendous opportunity in 2020 during the

04:34pandemic when public markets were shut down and private credit is the only source of capital. But

04:39now we're seeing the returns converge. So I don't think there really is any advantage in private

04:44credit. You could actually argue that there's a pretty good chance that private credit does worse

04:49than public credit next year because of the low credit quality and concentration. Most, and I'm

04:56generalizing, but most private credit portfolios are over 80 percent B minus or below, and they're

05:02highly concentrated in sectors like technology. They can be as much as a third or more in the technology

05:08space. That is not analogous with the public markets that are broadly diversified, that are diversified

05:14not only by sector, but by rating cohort. And most, well, let's just take high yield. High yield is

05:20mostly double B. So you're comparing a double B index versus a B minus index. Depending on your outlook

05:27for risk, they're going to perform very differently. I think our view here is that the weakest areas of

05:33credit, the lowest credit tiers are the most exposed to losses or at least poor performance. And so under that

05:39scenario, the up in quality characteristic of the high yield index just looks a lot more attractive

05:44for similar yield. Well, then I am curious. I mean, obviously, that's the existing portfolio out there

05:50with regards to new issuance. Do you also anticipate it will be much higher quality overall?

05:57Well, it's hard to anticipate what will happen in the future. All I know is so far, high yield and

06:02investment credit credit have been improving in credit quality. And there hasn't been much in the way,

06:07well, triple C's actually have been dropping in terms of issuance over time. They've been going

06:11to the private credit market. So what happens next year? I don't know. It is certainly possible

06:16that we see a re-emergence of lower quality credit in the high yield market. But it would take some time

06:24for it to deteriorate into looking something like private credit. I just don't anticipate that at all.

06:30And you're starting from such a high quality level that I don't think it's an issue really to consider

06:35right now, maybe as we get into 2026 and into 2027, is when we start to worry about things.

06:41And I'd also just point out that for any sort of, you know, talk about bubbles and things like that,

06:46excess is billed when you have a high degree of issuance and M&A transactions. And we haven't had

06:52that. When I talk about issuance, I mean net new issuance. And so I think next year is the year

06:56maybe beyond watch, but nothing really alarming immediately as we end the year here.

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