The Private Credit Illusion

Private credit has become one of the fastest-growing corners of Australian finance. With more than 100 managers now active in the market, capital is flowing into non-bank lending at a pace not seen in decades (RBA, 2024₁).

But amid the boom lies a reality that headline figures tend to obscure: the quality gap between managers is vast, and most investors aren’t looking at the right things.

Is Every Private Credit Manager Created Equal?

No. Established operators often lend to institutional standards, but a wave of newer entrants lack deep credit experience. Industry observers sometimes call them “private credit tourists”: managers drawn to the market by opportunity, without having navigated a full credit cycle.

ASIC’s 2024 review of private credit₂ flagged that some fund managers, particularly those targeting wholesale investors, exhibited conflicts of interest, opaque fee structures, and less robust risk management. The concern is straightforward: a rising market can mask these differences in quality until conditions turn.

How Are Some Managers Chasing Yield and Why Does It Matter?

With competition intensifying, some managers pursue higher returns at the expense of safety.

Common risky practices include:

- Subordinated lending: High second-mortgage exposure (loans ranked behind the first mortgage for repayment) rather than first-mortgage positions, which leaves investors more exposed if a borrower defaults.

- Stretched LVRs: lending a higher percentage of a property’s value, sometimes justified by optimistic “on completion” valuations (estimated values once the project is finished) rather than current market prices.

- Concentrated exposure: over-weighting a single property type, geographic region, or borrower, amplifying the impact of a localised downturn.

- Loose covenants: offering borrowers fewer protections, which limits the manager’s ability to intervene early when a loan deteriorates.

These strategies can generate attractive short-term returns. But when the cycle turns, loans with thin equity cushions and lower priority are far more vulnerable to loss.

What Does Disciplined Lending Actually Look Like?

Institutional-grade managers tend to share a set of common practices:

First-mortgage priority: senior secured loans with first claim if a borrower can’t repay.

- Conservative LVRs: typically 80% and below, based on independent, current-market valuations (“as is”); not projections (“as if complete”), such as property development.

- Diversification: spreading the loan book across geographical areas, loan size, and loan structures to limit concentration risk.

- Transparent governance: independent third-party valuations, clear fee structures with no hidden charges, and detailed portfolio reporting that includes loan-level performance data.

- Alignment of interest: avoiding related-party lending and ensuring the manager’s incentives match the investor’s objectives of income and capital preservation.

According to RBC Wealth Management₃, the managers with the strongest track records of capital preservation are those that maintained credit discipline through multiple cycles, not those that chased the highest headline yield. When credit standards slip, it is investors who bear the cost through loan losses and impaired returns.

Mortgage Funds (A Major Segment of Private Credit), Are They All the Same?

No, and the structural differences matter as much as the manager’s track record. As a major segment of Australian private credit, mortgage funds come in several forms, each with a different risk, liquidity, and return profile:

- Pooled vs Contributory: In a pooled mortgage fund, investor capital is combined and spread across a diversified pool of loans selected by the manager. This offers built-in diversification and often more regular liquidity, with some funds allowing periodic withdrawals. In a contributory (or “select”) mortgage fund, by contrast, investors commit to individual, specific loans identified by the manager. This gives investors more control over which deals they back, but it comes with two key trade-offs: their capital is typically locked in until that specific loan is repaid, and because their investment is concentrated in a single loan rather than spread across a portfolio, a default on that loan has a direct impact on their returns.

- Registered vs Unregistered Schemes: Mortgage funds open to retail investors in Australia must be operated as registered Managed Investment Schemes, which means they are registered with ASIC as well as overseen by a licensed Responsible Entity and hence, subject to stricter disclosure and compliance requirements. Unregistered schemes are typically limited to wholesale or “sophisticated” investors and have more flexibility but less regulatory oversight in areas like reporting and governance. For example, the ASIC review noted that many wholesale-targeted funds exhibited weaker practices in valuation and transparency, since they are not held to the same retail investor protection standards.

- Open-Ended vs Closed-Ended Funds: Neither open-ended nor closed-ended fund structures are inherently superior. Their success depends on how well liquidity risks and redemption terms are managed. Open-ended funds continuously accept new investments and permit periodic redemptions, generally offering investors better liquidity. This flexibility can work effectively when paired with strong liquidity management practices; for example, maintaining cash buffers, aligning redemption cycles with loan maturities, and rigorous stress-testing, so that even under stress, withdrawals won’t force asset fire sales or frozen redemptions. Regulators including the ASIC and RBA have emphasized that prudent design and governance are key in open-ended fund liquidity management. Closed-ended funds, by contrast, lock in capital for a fixed term and generally don’t allow interim withdrawals; this avoids redemption pressures but sacrifices investor flexibility. Ultimately, industry research indicates that fund outcomes hinge on portfolio construction, liquidity buffers and governance rather than structure alone. A well-managed open-ended fund with robust risk controls can provide investor liquidity without undue fund risk, just as a closed-ended fund allows investors direct investment choice, but with less withdrawal flexibility.

Each structure suits different investor needs. The key is understanding which trade-offs you’re accepting.

Is Well-Managed Private Credit Risk-Free?

No. Even the most disciplined private credit manager carries inherent risks that investors should weigh:

- Liquidity risk: private loans are not traded in liquid markets, so withdrawals from the fund may be limited, particularly during market stress.

- Default risk: borrowers can fail to meet their obligations. Strong underwriting and collateral (such as first mortgages with conservative LVRs) reduce the probability of capital loss but cannot eliminate it.

- Valuation risk: without daily market pricing, loan values rely on periodic appraisals and models, which can sometimes lag reality.

Investors should look beyond headline yields to examine a manager’s transparency, governance, and track record, and ensure they understand both the strategy’s risk profile and its redemption terms.

The Bottom Line

Private credit’s rise in Australia has created genuine opportunities for investors seeking yield and diversification beyond traditional bank products. But one private credit fund is not interchangeable with the next.

By understanding the different fund structures and scrutinising a manager’s lending practices from mortgage position and LVR discipline to governance and regulatory status, investors can separate institutional-grade operators from the “tourists”.

The next article in this series examines the structural forces driving private credit’s growth, and why the shift away from traditional fixed income may be more permanent than many expect.

Sources:

₁RBA, Growth in Global Private Credit
₂ASIC, Private Credit-Findings and Observations, 2024.
₃RBC Wealth Management, Our take on the public pillorying of private credit

Disclaimer: This article is general information only. It does not constitute financial advice or a recommendation to invest in any particular product. Investors should read the relevant Product Disclosure Statement (PDS) and consider whether an investment is appropriate for their circumstances before making any investment decision. All investments carry risk, including the potential loss of capital.