Talk Your Book: Investing in Public and Private Credit

Episode Summary

Executive Summary: Animal Spirits interviewed PIMCO’s Jason Duco on how fixed income has become more complex, with public and private credit, securitized products, and active duration management creating new opportunities and risks. The discussion covered the macro outlook, tight credit spreads, the role of private credit, agency MBS, CLOs, and how PIMCO sees value in parts of the market that offer better risk-adjusted returns and liquidity.

Main Topics: Macro outlook and Fed path (Priority: 5/5): Duco said PIMCO expects growth to slow modestly in late 2025 due to tariffs and policy effects, then reaccelerate in 2026 as fiscal and monetary policy become more supportive. He also expects further Fed cuts this year and sees labor weakening as a key risk to watch. Why bonds are 'back' (Priority: 5/5): The conversation emphasized that after the painful rate shock of 2022, fixed income now offers real yields and a better margin of safety. Duco argued that duration is again functioning as a diversifier, making core bonds attractive in portfolios. Public vs. private credit competition (Priority: 5/5): Duco described how direct lending, bank loans, and high yield are competing for the same borrowers and capital, compressing spreads and weakening structures. PIMCO sees less value in direct lending today because liquidity and transparency are limited while compensation is no longer compelling. High yield and bank loan market shifts (Priority: 4/5): He explained that the high yield market has become higher quality over time as bank loans and private credit have taken share, which helps justify tighter spreads. Beneath the surface, lower-quality issuers still face stress, especially in triple-C names. Agency MBS and securitized opportunity (Priority: 5/5): PIMCO sees value in agency mortgage-backed securities because spreads remain historically wide, banks and the Fed are not strong buyers, and the asset class can perform well in a Fed cutting cycle. PYLD is used to express these relative-value views outside the benchmark. Private credit, liquidity, and interval funds (Priority: 4/5): The discussion stressed that private credit can reduce defaults and provide flexible financing, but investors often underprice the illiquidity and valuation opacity. Interval fund structures help managers deploy capital, but they do not eliminate the risk of gating and stale marks during dislocations. AI and private investment grade debt (Priority: 3/5): Duco said hyperscaler data-center and infrastructure buildouts are creating a new private debt opportunity, with large, high-quality borrowers seeking financing that can earn lenders extra spread over public markets.

Key Arguments: PIMCO thinks growth will slow to about 2% in Q3 and roughly 1% in Q4 before improving in 2026 as policy support offsets tariff drag. The consumer and corporates have been more resilient to tariffs than expected, but some of the pressure is showing up in labor weakness, keeping the Fed in play. The 2022 bond selloff made fixed income painful, but now real yields are positive and core bonds offer much better forward returns and diversification. Direct lending/private credit is crowded: spreads have compressed, structures have loosened, and investors are not being paid enough for illiquidity and opacity. High yield spreads look tight, but the market’s quality has improved, so lower spreads are partly justified; still, single-B and CCC credits can be vulnerable. Agency MBS stands out because spreads are wide, technical demand is weak, and the asset may benefit from the early stages of Fed easing. CLO AAA securities are more transparent than direct lending and may offer attractive spread with low impairment risk, though investors must still understand they are taking credit risk. AI-related infrastructure financing could become a meaningful secular source of private investment-grade opportunities as large asset managers fund data centers, power, and related assets.

Data Points: PIMCO assets under management: about $2 trillion - Duco described PIMCO as one of the largest active bond managers. Q2 2025 GDP revision: 3.8% - The hosts and Duco referenced the upward revision as evidence of resilience. PIMCO GDP forecast for Q3: around 2% - Expected deceleration in the second half of the year. PIMCO GDP forecast for Q4: closer to 1% - Further slowing expected into year-end. PIMCO growth outlook for 2026: mid-plus 2% - Expected recovery as policy turns supportive. Federal Reserve cuts expected in 2025: 2 more cuts - Duco said PIMCO anticipates additional cuts after the first cut earlier in the month. Tariff revenue annualized: $350 billion - A chart mentioned by the hosts suggested tariffs are generating substantial government revenue without major economic slowdown. Treasury rate range: roughly 4% to 4.25% - Duco said the 10-year has been range-bound for years despite shocks. Barclays Aggregate year-to-date return: 6.25% - Used to illustrate the rebound in core fixed income. Core fixed-income returns: high single digits - Duco said most core fixed-income products were returning strong year-to-date results. High yield return: approaching 8% - He cited a solid year for high yield despite tight spreads. High-yield default rate: less than 2% for two years - Presented as evidence of a healthy credit backdrop. Size of high yield, bank loan, and private credit markets: about $1.5 trillion each - Duco noted the three markets are now similarly large and competing for the same deals. CLO AAA market size: about $700 billion - He described AAA CLOs as a large and transparent market. Liquidity compensation for private credit: at least 200 basis points historically - Duco said current private credit compensation often falls short of this benchmark. Additional spread in private investment grade AI deals: 100 basis points or more - He said private financing for hyperscaler projects could earn this premium over public markets.

Pivotal Quotes: "the bonds are back" — Jason Duco: Duco’s central thesis on why fixed income is now more attractive after years of low yields. "you're not being paid to take risk right now there" — Jason Duco: His view on direct lending/private credit where spreads and liquidity compensation have compressed. "I think that amount of capital, think about the success of the direct lending product... there's a little bit of this urge or necessity to deploy" — Jason Duco: Explaining why capital inflows can pressure structures and returns in private credit.

Implications: For investors, the message is to be selective: core bonds and agency MBS look more attractive, while direct lending demands caution due to thin liquidity compensation. Private credit remains important, but public markets and securitized products may currently offer better risk-adjusted value.