Portfolio diversification and rising interest rates are driving growth of private credit in Australia by institutional investors, including super funds.
Industry leader AustralianSuper has $6.5 billion invested globally in private credit, managed both internally and with external partners under the control of private credit chief Nick Ward. “These investments are a part of Australian Super’s broader private market investments. Private credit contributes to the fund’s overall diversified investment approach,” said a spokesman.
The $107 billion UniSuper is attracted to private debt particularly with credit spreads widening. UniSuper chief investment officer John Pearce said “private credit is something you can’t do half pregnant” which explains why he outsources to specialist managers.
Private credit fund manager Revolution Asset Management has $2.3 billion under management led by managing director Bob Sahota. Revolution was set up some four-and-a -half years ago by Sahota who previously ran a $9.3 billion private credit book for Challenger.
He told Investment Magazine the Australian market was small but growing fast to an around $25 to $30 billion market today. The biggest player is Metrics Credit Partners which has $12 billion of loans under management.
The provision of private credit by institutional investors opened up after the 2008 global financial crisis with the changes to capital adequacy rules introduced by Basel III which meant banks had to reserve higher capital buffers for risk-weighted assets.
Floating rate hedge
One of the key reasons for the growth in the market according to Sahota is the floating rate base for the debt which means the investment is protected from RBA and market rate moves. Private debt also provides portfolio diversification and the manager has security over the operating assets.
“Private debt is typically a floating rate and therefore can provide a level of inflation protection while the senior position in the capital structure provides defensive characteristics in the current market environment,” said Australian Retirement Trust’s head of private corporate assets Elizabeth Kumaru.
“The supply demand dynamics mean that there is increasing opportunities for private credit lenders,” she added. In its balanced fund, ART has 5.5 per cent allocated to alternative strategies which includes private credit private credit.
Sahota defended his practice of not marking assets to market and instead valuing them at par. The risk is values could plummet in a downturn but Sahota said if there was an impairment he would take that but there is no real secondary market to benchmark valuations and all his investments are for the life of the loan.
Speaking at JANA Annual Conference in Melbourne earlier in September, he said “we avoid cyclical industries because at some time in the cycle they blow up”. Favoured sectors include healthcare, consumer staples and mission critical software. Investors need a 10-year horizon he said noting the investments were essentially illiquid.
Difficult to achieve
Some fund managers are leery about the claimed benefits of private credit noting high return and low volatility is difficult to achieve, especially when the global economic outlook is weak.
One manager who declined to be quoted said “the key is private credit managers need to ensure they don’t make calls worse than the banks which means having skills and a team as good as the banks”. Tanarra Capital’s private credit head Graham Lees has around $800 million under management including an allocation from UniSuper which also invests in the class through Revolution. Lees said for loans under $200 million, banks are mainly chasing transactional lending or where they can have secondary relationships with the customer.
The number of asset owners who have exposure to private credit is growing, notwithstanding the risks. Colonial First State said it “has a small level of exposure to private credit through existing investment managers “. It added “we acknowledge the growing interest in the space and continue to actively explore increasing our exposure”.
TelstraSuper chief financial officer Paul Curtin endorsed the growing interest stating it was an opportunistic asset class. “Where banks are constrained, good returns are available and interest rates are rising,” he said.