Private Credit in the Spotlight: A Strategic Opportunity for Investors

In recent years, private credit investment has emerged as a frontrunner in the investment landscape. Private credit has topped the private markets globally in terms of both funds under management (FUM) growth and overall performance, capturing the attention of investors seeking stability in uncertain times. Private credit funds generate returns by acting as non-bank lenders, providing financing to businesses, and passing on the interest income from loans to investors.

In an era where volatility dominates equity markets and traditional fixed income yields are declining, private credit offers a compelling alternative. As the market expands, investors now face more choices than ever, making it essential to understand the fundamentals before investing.

The Growth of Private Credit in Australia

As banks tighten lending criteria and reduce exposure to certain market segments, non-bank lenders have stepped in to fill the gap, particularly for small and medium-sized enterprises (SMEs). These businesses often turn to private credit due to the faster access to capital compared to traditional finance.

According to Preqin, global private credit is expected to grow at 11% annually over the coming years. In Australia, the market has doubled just in a few years to approach $200 billion. Despite this growth, private credit still only accounts for about ~12% of the total business loan market in Australia, compared to higher penetration in the U.S. and Europe. This highlights the untapped potential for further expansion in Australia.

Why Private Credit is an Attractive Choice for Investors

Given today’s economic environment—marked by inflation, rising interest rates, and market uncertainty—private credit offers several key benefits for investors:

1. Enhanced Yield: Private credit often delivers higher returns compared to traditional fixed-income products, particularly in property-backed lending.

2. Consistent Income: Regular interest payments provide a steady income stream, appealing to those seeking predictable returns.

3. Portfolio Diversification: As a non-correlated asset class, private credit can help stabilize a portfolio during market fluctuations, acting as a buffer against equity market volatility.

4. Capital Preservation: Property-backed private credit, in particular, is attractive for its focus on capital preservation. Loans are often secured by tangible assets, meaning in case of default, the lender can recoup losses through the sale of the asset.

   
   

What to Look for When Investing in Private Credit

For investors considering private credit, like any investment it’s important to do your homework. Key areas of due diligence include:

1. Risk Management & Loan Structure: Understanding the Fund’s Loan-to-Value Ratios (LVRs) is critical to assess the level of buffer above your investment. Lower LVRs suggest more conservative lending, while higher LVRs indicate more risk but potentially higher returns. It is also critical to ensure the lender uses quality, independent valuations, and has thorough due diligence processes in place.

2. Asset Security: Security and collateral backing the loans are key to mitigating risk in private credit investments. Property-backed loans, for example, are considered less risky because the physical asset provides a safeguard in the event of default. Even within property-backed loans, risk is a spectrum between different asset classes – for example, a construction loan in a regional area is riskier than a bridging loan on a completed build in Inner Sydney.

3. Transparency & Due Diligence: Investors should prioritize transparency and strong governance in private credit funds. This includes clear documentation on loan selection and management practices, as well as a proven track record from the fund manager.

4. Liquidity Considerations: Private credit investments tend to be less liquid than public markets. Investors should be aware of any lock-up periods and redemption processes.

   
   

Looking Ahead: The Future of Private Credit in Australia

The future of private credit in Australia looks promising, with the market showing no sign of slowing down in growth and performance. For investors, private debt stands out as a resilient and lucrative option. Its capacity to offer high returns with enhanced security makes it a compelling choice for investors looking to diversify and stabilise their investment portfolios in uncertain times.

Disclaimer: This article is prepared by Frances MacDonald. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.