Wholesale and retail investors are increasingly turning to alternative sourced of stable yield for their defensive sleeves, including looking at private debt as a source of credit according to Lonsec senior investment analyst Ron Mehmet.
Speaking with Conexus head of institutional content Alex Proimos as part of Investment Magazine’s Market Narratives podcast series, Mehmet said that QE has “basically squashed” the volatility seen after the initial pandemic developments in March, causing investors to focus more on yield than capital growth.
“Post this period the search for yield has become intense,” he said. “It’s been a difficult time for advisers to meet monthly private pension income targets, and a real double whammy for retirees.”
As a result, Mehmet says, investors are turning to alternative sources of credit, which private equity has been increasingly willing to facilitate.
“A lot of the lending that has traditionally been done by banks is now being done by private equity firms, [and] they’re offering better terms and conditions than bank loans,” he said.
Instead of being put off because the debt is less secure, Mehmet reckons investors are just getting more savvy about the debt they pick up. “Just like the analysts do on the equity side, it goes on the people’s skill to make sure they pick the right private debt lines, the securities are being picked at the top of the structure and they’ve done the correct analysis,” he explained.
More labour, more costs
Mehmet says the private equity push into debt is set to continue, but it faces challenges.
For a start, he says, private equity has to work harder in going to market than incumbent corporates. “It’s very labour intensive.”
When a company like BHP or CBA launches senior debt such as corporate bonds in to the market they’re already rated by the major agencies, Mehmet explains. As they’re publicly listed, with all the financials and relevant information listed on the ASX, it’s easy for credit teams to make a decision on whether to participate in the issuance almost immediately. “It all happens in virtually 24, 48 hours,” he said.
That’s in “complete contrast” to what happens in the private debt market, Mehmet reckons, “where you have little or not information”.
“You know about the company but if you want to know more you’ve got to ask for permission to look at the financials, you’ve got to negotiate virtually a loan contract and clauses and covenants and what triggers loan defaults and the expectations on the company to meet regular payments,” the analyst explained.
“All that takes several weeks of analysis, interpretation, negotiations and meetings to occur before there’s even a loan document finalised that both sides agree to. And then the debt can be issued into the private debt market,” he adds, noting that the increased resources required also raise the costs involved.
“And then the people that lend the money have got to make their own estimation of how much of the loan they want to participate in, how they rate the loan, and where do they want to price it at.”
Domestic debt hunger
Despite the handicap in getting to market, private equity’s push into debt markets will continue because of what Mehmet describes as an “increasing appetite” for the deals.
“Traditionally it’s been at the institutional level but now it’s becoming more prominent at the retail and wholesale level, getting access to this type of lending in order to diversify from traditional types of cash and fixed income that’s more publicly traded,’ he said.
The domestic market is actually undersupplied, he continued, and waiting on more private equity players to jump on board.
“In recent times there hasn’t been enough to go around and a lot of the private institutions have gone to the US and Europe,” he said. “But our market has been growing.”
The lending market in Australia has historically been on the conservative side, he noted, but more domestic fund managers are putting this type of asset in their portfolios for unitholders and clients.
“So there’s been increased supply, but there is more demand than supply,” he said.