How to access the private credit boom

Smaller retail investors can now take advantage of opportunities in a sector once the preserve of the wealthiest.

Investing in the booming private credit sector used to be the preserve of the ultrarich and institutions, but now the gates are wide open for smaller retail investors.

An easily accessed online account offering a fixed investment term can be set up for as little as $2000.

Such accounts aim to pay a monthly income at a fixed spread above the RBA cash rate.

Another option is a listed investment trust, which can typically provide a cash distribution yield of around 7 per cent paid monthly.

Wholesale investors can access higher returns, but this may involve a lock-up of funds, meaning reduced liquidity compared with a listed investment trust or online term account.

Compared to the US and Europe, where private credit has usurped the banks for mid-level corporate lending, the sector is much more limited in Australia.

Nehemiah Richardson, CEO of diversified funds management group Pengana, which has a reported $3.6 billion in funds under management, says investors “need to do some homework regarding the opportunities and risks in private credit”.

Bilateral loans

“If investors are clear on their risk, return and liquidity objectives and have a good understanding of the characteristics discussed, then the question of investment vehicle may come down to convenience,” he says.

Locally, private credit remains concentrated in commercial property and subordinated positions in asset-backed structured finance vehicles.

Syndicated loans are also commonly used to fund large merger and acquisition transactions.

Bilateral loans are “the purest form of private credit investing”, according to Richardson.

“Well underwritten bilateral loans have strong structural protections and information rights, and modest loan-to-value ratios, which result in low risk of default and loss,” he says.

Another tip is that it is important to find investment managers who demonstrate a solid track record of performance through several economic cycles and periods of market turbulence.

They should also have widespread relationships that bring in the best deals across different areas.

As with other investing, Richardson says: “Diversification across geographies, industry segments, managers, strategies, and individual loans is a key pillar of private credit investing.

“Leading global private credit offerings might invest in up to two dozen managers with 2000 or more underlying loans across the US and Europe as part of a highly diversified portfolio.

“Investors can be caught out if the private credit product is under-diversified, for example, more concentrated portfolios within the same strategy or by number of assets.

“In such cases, it is possible that one or a small handful of loans can make or break the performance of a fund.”

Local market

Richardson says the current “sweet spot” is to be found offshore by lending to US and European-based, middle-market companies, usually with a market cap of $US1 billion-plus.

“The best returns are going to come from the quality end,” he says.

Although international funds are coming into Australia, the local market does not have players with the same deep and impressive track records.

There is also no secondary market for under-performing loans, leading to a comparative lack of liquidity.

One of the largest and most established local lenders is Metrics Credit Partners, which has about $18 billion under management and has been expanding into direct lending.

Some other significant players are investment bank MA Financial, which reported more than $10 billion under management last year and Qualitas, which reported more than $9 billion.

The high returns being reaped have Australia’s mammoth $4.2 trillion superannuation sector looking for a slice of the action, which will deepen the pool of private credit.

IFM Inventors, an entity owned by 16 Australian super funds, has expanded its private debt portfolio by an annual 20 per cent over the past two years.

Meanwhile, Queensland government-owned QIC aims to double its $1.5 billion private debt business in the short term.

By David Southwell.

View the original AFR article here.