Why Choose Private Debt Investments vs Public (Bonds)?
Private debt offers better returns than public debt, but often at greater risk. Learn about how Capstone’s Growth Fund balances returns and risk.
Debt investments can be an excellent way to produce returns, but the risk involved can vary widely. The rights of a lender or investor in the event of default are among the most important factors determining how much risk a debt investment presents. Additional factors include the identity of the debtor and whether the debtor has pledged assets to secure the debt. A debt investment can be public or private. With public debt, the debtor is the government. This gives the investor considerable protection, often in exchange for comparatively lower returns. Debtors in private debt investments are private individuals, businesses, or organizations. Higher returns can mean greater risk, but hard assets like real estate can significantly improve the security of private debt. Read on to learn more about the different types of debt investments, the returns they may produce, and the associated risks.
Photo from National Archives at College Park on Wikimedia Commons [Public domain]
What are public debt investments?
Governments can take on debt by borrowing money from banks, other financial institutions, and institutional and individual investors. They often borrow money from investors by selling bonds and other types of securities. The terms of these instruments may vary from a few months to many years.
A famous example of public debt from U.S. history is the war bond. During the lead-up to U.S. involvement in World Wars I and II, Congress authorized the Treasury Department to issue bonds to raise money for military expenditures. World War I-era bonds were known as “liberty bonds.” The bonds that raised money for World War II were officially known as Series E bonds. Everyone simply began calling them “war bonds” after the attack on Pearl Harbor drew the U.S. into the war. Bonds were available in denominations ranging from $25 to $10,000. They continued to accrue interest for 30 to 40 years.
A wide variety of public debt instruments are now available to investors, including the following:
Savings bonds: The U.S. Department of the Treasury (DOT) issues two types of savings bonds. Series EE bonds developed from World War II-era Series E bonds. They pay interest at a fixed rate for 30 years. Series I bonds also mature in 30 years but may adjust their interest rate every 6 months based on inflation. Unlike some other forms of public debt, savings bonds are not “marketable.” This means you can not sell a savings bond before its maturity date.
Treasury bills: Also known as “T-bills,” these instruments may mature in 4 to 52 weeks. The DOT holds regular auctions to sell T-bills.
Treasury notes: Notes have longer terms, typically maturing in 10 years.
Treasury bonds: At 30 years, Treasury bonds have the longest terms of DOT debt investments.
Municipal bonds: Local and state governments may sell this type of bond to raise money for capital projects and other functions.
Government bonds, notes, and bills are relatively secure investments that yield predictable returns. Investors trade higher returns for the reliability of a security backed by the full power of the government.
Public debt investments are not completely free of risk. The federal government has never defaulted, and defaults by local governments are rare. It is possible, however, for a government to default on its debts and fail to make payments to investors. The risk of the federal government defaulting is behind every debt ceiling fight in Congress. Other risks with public bonds include vulnerability to inflation and lack of liquidity.
What are private debt investments?
Private parties, including individuals, businesses, and organizations, can raise money by selling debt securities to investors. This includes bonds issued by corporations and other businesses. It also includes other types of debt investments.
The simplest form of private debt investment is a loan with interest. The borrower makes regular interest payments to you as they repay the principal. At the end of the loan term, you have more money than you had at the beginning.
Photo by john antoni, derivative work by Kürschner on Wikimedia Commons [Creative Commons]
Private bonds
Business organizations have been selling bonds to raise money for centuries. Corporate bonds function in a similar way to government bonds. Owning a corporate bond entitles you to regular interest and repayment of the principal upon maturity.
Corporate bonds vary in terms of their maturity dates and interest rates. Maturities may range from a few years to more than a decade. Interest rates are often based on the perceived risk associated with a bond:
Investment-grade bonds: Corporate bonds with a high enough credit rating are deemed “safe” for most investors. This typically means that crest rating agencies expect the corporation to be able to pay its bonds on time.
Non-investment-grade bonds: Also known as high-yield corporate bonds or “junk bonds,” these bonds have lower credit ratings because of the risk of default. They make up for this by paying higher interest rates.
Other private debt
Many other forms of private debt are based on the simple example above of loaning someone money in exchange for interest. The example is not so simple, however, when you factor in the work involved. Loaning money directly to a borrower means you are responsible for receiving payments and dealing with late payments or default. This can take time, which limits your options. If you are responsible for everything, it’s not feasible to make a loan unless it’s big enough to be worth your time.
An important difference between both public and private bonds and other types of debt investments involves security. Bonds, by definition, are unsecured debt. If a government or corporation defaults on its obligation, you can’t seize a particular piece of property to satisfy the debt. A secured loan has collateral. A mortgage, for example, is secured by a home. If the borrower defaults, the mortgage lender can foreclose. Other real estate loans, such as hard money loans, also use real property as security.
Capstone’s Growth Fund is a private debt investment that allows you to invest without worrying about the administrative details. You can invest a comfortable sum and let us handle payments, collections, enforcement, and other matters. The loan is secured, so you know an asset is there to cover the debt. All you have to do is collect your share of interest payments.
Image by Winsor McCay on Wikimedia Commons [Public domain]
What are the expected returns for public vs. private debt?
As a general rule, investing in public debt instead of private debt means trading returns for stability. Government bonds have a long track record of reliability, but they often pay less than private debt investments.
The DOT gives the following as the expected interest rates as of early June 2024:
10-year Treasury notes: 4.375%
30-year Treasury bonds: 4.625%
Private debt investments can have much higher returns, albeit at greater risk. Moody's Aaa Corporate Bond, which provides an index of Aaa-rated corporate bonds, has a return of 5.13% for the same period. Capstone targets returns of 8 to 9% net annual yields with its debt investments.
Comparing private debt vs. bonds
| Public bonds | Private bonds | Other private debt | |
|---|---|---|---|
| Term | 4 weeks to 30 years | 1-2 years to 10+ years | Anywhere from several days to a few years |
| Expected return | Typically 3-5% | 5% and up | 9-10% |
| Risk level | Low | Moderate to high | Low |
| Security (collateral) | None | None | Real property |
Learn more about Capstone’s private debt investments
Real estate debt investments offer good returns with a minimum of risk. Capstone Capital Partners offers hyperlocal trust-deed and first-lien investments for Texas investors. Please contact the Capstone team today through our online contact form to learn more about our investment opportunities.
