An asset class that offers combination of competitive returns and capital preservation must be attractive to investors. Add to that a debt portfolio with senior secured collateral backing and it’s understandable why private debt has something concrete to offer the investment community, write MIKE DAVIS and TIM MARTIN.

In today’s “brave new world” of investing, to borrow Aldous Huxley’s famous phrase, private debt’s double digit returns places it, historically, in that space occupied by the top quartile of private equity while still having a far less risky position in the capital stack. How should investment in private debt be viewed? From our perspective, it’s a subset of the fixedincome asset class, with a focus on preservation of capital. It has a low correlation to publicly traded asset classes, as well as a low volatility return profile. Loans are traditionally secured against the borrower’s assets.

In addition, a conservative buffer between the loan and the value of the assets is built-in as added security if the loan goes sour. In terms of cost, borrowers pay about 5 per cent or more over the bank bill rate plus fees for a three-year loan, the usual maturity period. Private debt emerged from the provision of asset-backed debt finance to companies occupying the SME space that did not have enough property collateral to satisfy the mainstream banks. Before the initials GFC meant more than the Geelong Football Club, this market had grown to be worth about $500 billion a year in Australia, and was providing valuable funding for companies in this space. Like other assets, it wasn’t immune to the hubris of the last bull market, but investors found that they were typically able to achieve capital preservation and reasonable returns if the loans were allowed to run their course.

Today, a more conservative approach to the term, payment structure, advance rates and collateral backing is the name of the game while achieving low double-digit returns in this historically low interest rate environment. That said, there continues to be a strong demand for private debt from SMEs. In post-GFC Australia, these companies are struggling to compete for funding as bank regulatory capital constraints get tighter. It’s not just a regulatory issue. Quite simply, banks are not setup to service the non-property security needs of the middle market as effectively as non-bank lenders offering private debt solutions. Mike Davis and Tim Martin are principals of Causeway Asset Management that manages the Private Debt Opportunities Fund.

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