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CFA Level I · CFA Level I Exam · Investments in Private Capital: Equity and Debt

An investor holds a portfolio of public equities and investment-grade bonds and considers adding a senior secured direct lending fund. The diversification benefit from the fund is most likely overstated if the investor relies on reported correlations because:

Reported diversification is most likely overstated because private debt valuations are smoothed. Infrequent, model-based marks understate volatility and the correlation with public markets. Loans are not priced daily, and floating-rate loans do not consistently move opposite to equities, so the smoothing explanation is correct.

  1. Afloating-rate loans always move inversely to equities
  2. Bappraisal-based valuations are smoothed, understating volatility and correlationCorrect
  3. Cdirect lending returns are measured daily at market prices

Explanation

Private debt valuations are based on models or lender marks that adjust slowly, which smooths returns. This lowers measured volatility and correlation with public markets, overstating diversification. Floating-rate loans do not always move inversely to equities, and returns are not priced daily.

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