Unpacking the hot topics investors are asking about private credit
Private credit is now on most investors' radar if not already a part of their portfolio. However, many investors want to better understand the asset class’s rapid rise, the risk profile of its often equity-like returns, the liquidity of their investments and transparency of reporting. In a recent webinar, Alex Hone, Managing Partner, and Chris Cuffe, Board Member, discussed these hot topics for investors, what they are seeing in the market and their views on how private credit fits into a diversified portfolio for wholesale investors.
Taking a wide angle – what’s happening generally in private credit
For many investors, it appears like private credit is a new asset class. The reality is that private credit has been around for decades and is a much more mature sector offshore, particularly the US but also Europe. Over the last 5 years or so, Australian wholesale investors have access to a greater variety of funds and opportunities in private credit thanks to structural shifts in the lending landscape. These structural shifts mean private credit currently is and increasingly will be a valuable part of the economy. It’s here to stay.
What about the banks?
Banks currently control about 90% of the lending market in Australia compared to 60% to 70% control in offshore markets. For banks, lending is about volume and efficiency. Efficiency for a bank comes from standardised loan terms, regulatory compliance that dictates how much capital(mostly mums’ and dads’ on-call deposits) can be lent against, and long loan processing time frames (for the approval processes and loan terms). There is also banks’ propensity to take sector-wide decisions that means they will not lend to a particular sector at all, regardless of the attractiveness of a specific borrower’s capital requirements.
These are structural factors which are highly likely to endure and which provide a gap in the market which provides of private capital can fill.
Equity like returns – but what’s the catch?
Performance figures in some areas of private credit show equity-like returns. Understanding how those returns are possible isn’t so much a question of risk. Rather investors are well served to look at the expertise of the team managing the loan book and the types of transactions within the portfolio.
Key attributes when assessing a fund manager include:
1. Expertise – The expertise of the team is paramount, particularly given private credit can involve solving for complexity, whether that’s the complexity of the borrower’s business or situation, or the bespoke structuring of the covenants that will protect investors’ capital.
2. Experience – With the rapid rise in the number of private credit fund managers, it’s important to understand the team’s experience, particularly when it comes to underperforming loans. The out comes they’ve been able to achieve during difficult times speaks volumes.
3. Diversity of investments – Diversity should be measured in multiple ways: geographic, spread across sectors, mix of asset types (particularly beyond just property-backed where a lot of private credit focusses) and deal type (where highly competitive deal types e.g. private equity sponsored deals, can mean private credit providers are forced to be price- and terms-takers which often erodes the attractiveness of the transaction and potentially the protections for investors).
4. Number of loans within the portfolio – Related to the previous point is the diversity of transactions and borrowers within the fund.
5. Flexibility – The flexibility of a fund managers’ is particularly valuable in a market where opportunities can shift rapidly and the ability to pivot between sectors is crucial for maintaining strong performance.
Outsized returns for the risks involved are possible when manager’s possess the requisite skill, experience and flexibility. This is particularly true in opportunistic credit, Keyview’s specialty, where deals often involve solving for complexity, creating non-traditional structures, executing rapidly and staying focused on capital preservation. Keyview’s ability to move across sectors is a significant advantage. By being unconstrained by mandated industry or geography allocations, Keyview can capitalise on the best opportunities wherever they may arise.
The hot topics: fees, transparency and liquidity
Fees, transparency and liquidity are perennial topics in the private credit industry. Fees can vary widely across the sector, but for many what matters most is the after-fee returns.
Transparency in private credit has also improved significantly in recent years. Regular reporting is now the norm for most managers. However, there is still room for improvement in terms of industry-wide reporting and data availability.
Liquidity remains a challenge for private credit investors, as these investments are typically illiquid and lack a secondary market. However, the industry has made strides in reducing lock-up periods and offering more flexible redemption terms. This increased flexibility has made private credit more accessible to a broader range of investors, although it remains an illiquid investment relative to traditional fixed income.
Where does private credit sit in a portfolio
Private credit is still something of a square peg when it comes to portfolio construction. Investors did not always include private credit in their portfolios historically so those newer to it wonder in which asset class it should be allocated. The fixed income allocation has traditionally held cash and bonds, whether that’s government, semi-government or corporate bonds. The interest component of private credit means some will use their fixed income allocation for private credit. Conversely, others might use it is an allocation within their liquid or defensive alternatives allocation providing a means to lower equity allocations in portfolios. There does not seem to be an industry-wide consensus perhaps leaving the right answer to be “it depends” based on the individual investor’s objectives and profile.
The future of private credit in a diversified portfolio
As private credit continues to evolve, it is clear that the asset class offers significant opportunities for investors seeking good risk adjusted returns and portfolio diversification. However, it also requires a deep understanding of the risks involved and a commitment to working with experienced managers who can navigate the complexities of bespoke deals.
By considering experienced managers like Keyview, investors can tap into the opportunities that private credit presents while mitigating the risks associated with this dynamic and evolving asset class.
Watch the full webinar here.
Disclaimer:
Keyview Investment Management Services Pty Ltd (ABN: 15 667 825005) is a Corporate Authorised Representative (CAR No: 001304647) under the Keyview Investment Management Pty Ltd ABN: 24 665 351726 (AFSL No: 546 246). Keyview Investment Management Services Pty Ltd is the trustee of the Keyview Credit Opportunities Fund. Keyview Investment Management Pty Ltd (AFSL: 546 246) is the trustee of the Keyview Flagship Fund. The information is of a general nature only and does not take into account the objectives, financial situation or needs of any person. Before acting on this information, investors should consider its appropriateness having regard to their own objectives, financial situation and needs and obtain professional advice. No liability is accepted for any loss or damage as a result of any reliance on the information. Past performance is nota reliable indicator of future performance. Future performance and return of capital is not guaranteed. A copy of the Information Memorandum for each fund can be obtained at clientrelations@keyviewfinancial.com.
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