Even as asset owners increase allocations to private credit, investors have been warned that the ultimate test of the asset class has yet to come.
The Investment Magazine Private Credit Forum on Tuesday has heard that a proliferation of lenders in the private credit space might or might not indicate the asset class is in a bubble, but what’s not in doubt is that their skills will be tested if things start to go wrong.
“Private credit as an asset class being talked about in articles and at conferences is probably in a bubble, but in the asset class itself you’re still getting rewarded for the risk you’re taking,” Resolution Life chief investment officer John Lucey said.
“At the end of the day this is lending. It’s been around a long time, and as long as you’re getting rewarded for the risk you’re taking, then my view is you’re not in a bubble, it’s just a different characteristic of the actual lenders that are taking advantage of the opportunities.
“One thing about lending is it’s very easy to grow a lending business, and to put money to work. You’re giving out money. The trick is getting it back, and I think in Australia, that’s probably a little bit untested around some of the newer funds that we’ve seen pop up, or some of the super funds that are setting up internal structures, and the like.
Emergency response
ICG Australia head of Australian senior debt Matthew Turner said that when things start to go wrong with a borrower, a private credit manager must “test for a few things really quickly”.
“You make sure the borrower got cash; you work out how long it’s got cash for; and then you get advisers and into those businesses very quickly,” he said.
Turner said a manager must be “prepared to use all of the tools in your kit bag to, in the first instance, negotiate a sensible outcome for all parts of the capital structure”.
If that doesn’t work, a manager must “sit on boards, work with management teams, structure up short-term and long-term incentive plans to get management into the businesses and run them”, Turner said.
“That’s critically important. And I don’t think we’ve seen that from the market yet.”
Mine Super chief investment officer Seamus Collins said that in some respects, while private credit is attracting a lot of attention and in some quarters is thought of as a “new” asset class, in reality “this is repackaging a very old asset class”.
“At the end of the day, everyone knows the risks,” Collins said.
“We talk a lot about credit spreads, and whether you’re getting rewarded and whether, because when you get too much money chasing [opportunities] that’s when you’re going to start to not get the reward for risk.
“You’re alive to that, you’re alive to the other areas where people start to compete, on covenant structures and underwriting quality and those kinds of things.”
Collins said private credit managers generally can be “a bit more nimble, a bit more targeted” than traditional banks, which are “kind of lending to the whole economy”.
“What we like is they’ll dive into specific thematics, or opportunities, where they just see dislocation mismatch,” he said. “And they’ve been quite effective at that.”
Collins said Mine Super has about 4 per cent of its assets invested in private credit with plans to grow,
“We’re still adding through to that up to around five to 6 [per cent],” he said.
“We’ll top out then at around $700 million. And at that point, it’ll essentially be fully regenerative. We’ll get cash flows and we’ll be recycling, and that was one of the real decision drivers.
“We like that with private credit – that kind of five- to seven-year certainty on the capital recycling [and that it’s] immediately accretive on day one. At the time, it was reasonably well benchmarked against Your Future Your Super, which we felt it was pretty important to us because we had some historic underperformance against the regulatory benchmark that we needed to address.”
Selective partnerships
Collins said assessing private credit managers isn’t only about the returns they might generate, but is also about “at the back end, when something goes horribly wrong, how good is their workout? How good is their restructuring?”.
“Generally speaking, workout and restructuring comes with scale, institutional depth and institutional maturity,” he said.
“Generally speaking, scale has been important to us in that selection process.”
While working with asset management firms is common for asset owners investing in private credit, AustralianSuper head of mid-risk portfolio strategy and research Jessica Melville said the fund is in the process of internalising that capability, which initially grew out of its internalised infrastructure and real estate capabilities.
“When we started to internalise and started to do more [infrastructure and real estate] transactions direct, we had brought in people who knew how to do transactions, had done so in previous organisations, and also had some debt experience,” she said.
“Some of the first deals that we did were actually on the infrastructure debt side, and that was as a function of interfacing with that market. We recognised that was clearly an adjacent capability and started to look at what it would look like to start to build out a real asset debt strategy.”
Melville said the first step in any internalisation of management capability starts by working with a partner.
“We’re not so naive or arrogant to think that we can start and internalise on day one,” she said.
“We’ve worked with selected partners in Australia, Europe and the US to work alongside them. We start to think about internalisation in terms what part of the value chain we want to internalise – what makes the most sense to us.”
Melville said it’s clear the opportunity set in private credit is much larger outside Australia than in it, and AustralianSuper’s allocation of resources and pace of internalisation will mirror that.
“Origination, underwriting and asset management is 100 per cent internalised in Europe,” she said.
“The US is the newest office in the Australian super suite of overseas offices. It’s been up and running for nearly three years now so we’re much earlier in growing out that capability, notwithstanding that we do have a decent part of our loan book there.
“Australia will always be a part of the portfolio, but I think the extent to which we internalise that will be a function of how much of our team we can actually have based here in Australia. The decision as to how much we internalise will be driven by do we need more resources in Australia versus overseas and, ultimately, the opportunity set.”
