This article was produced in partnership with Pengana as part of ‘The Adviser’s Guide to Investing in Alternatives’. Download the full guide here.
The noise surrounding private credit in Australia is loud but in other parts of the world, where markets are mature and exponentially bigger, the occasional bad debt barely rates a mention. Like bank loan defaults, they are part and parcel of credit investing and their impact in a broadly diversified portfolio is generally immaterial, such is the size and scale of the global market with many established managers in this space.
In the past decade, global private credit assets under management have quadrupled to US$2.1 trillion ($3.4 trillion). North America accounts for 63 per cent of these assets and Europe accounts for 27 per cent.
Australia, with around $40 billion in private debt outstanding, is only a fraction of the global opportunity set. According to Statista, the value of outstanding debt securities from Australian corporates (including both public and private credit) totalled approximately US$1.77 trillion at the start of 2024, compared to US$33.6 trillion globally.
That’s not to say that there aren’t attractive opportunities here, only that the opportunity set is more limited given different structural dynamics in Australia. The global opportunity set is exponentially greater, providing exposure to different sectors and themes, and critically important scale and diversification benefits to meet investor requirements around income stability, capital preservation, risk/return and liquidity objectives.
Size aside, the structural dynamics that have underpinned the strong growth and performance of global private credit since the Global Financial Crisis are also very different to the factors at play locally. This is reflected in the investment options available. In Australia, 90 per cent of all credit is funded by the banks, either on a bilateral basis or through funding within non-bank securitisation vehicles. Consequently, Australian private credit is concentrated in the 10 per cent of the market that the banks don’t touch, given their risk-return and regulatory capital requirements. As a result, Australian private credit predominantly comprises of:
- Commercial property loans;
- Subordinated positions in asset-backed vehicles such as mortgages, small to medium enterprise (SME) lending and unsecured consumer finance; and
- Event-driven corporate credit including syndicated loans to finance large M&A transactions.
The limited size and depth of the Australian private credit market means there is limited scope for diversification, not only by number of underlying loans but across managers, strategies and industries.
Global private credit is a vastly different proposition. In the US and Europe, which represent 90 per cent of the market, banks finance just 15 per cent of mid-market corporate loans due to regulatory capital constraints. As a result, asset managers fund 85 per cent of credit.
Private v public
Over every meaningful timeframe, private credit has outperformed public credit on a risk-adjusted basis. This reflects the quality of the origination and management of loans in private credit, where managers gain access to detailed information in the underwriting process to allow them to secure appropriate structural protections to minimise the risk of loss. These are critical given the hold-to maturity nature of loans. By contrast, in public markets, covenants are typically not as stringent, as the credit is widely disbursed across many investors, and the securities actively traded and heavily influenced by the market’s perspective on interest rates, credit spreads and valuations, which can change daily.
Private credit is a much simpler and less volatile proposition. Fund managers lend money to companies and are responsible for managing loans to maturity. Performance is driven by their ability to originate good deals and manage portfolios, including helping struggling companies to turn around performance.
If a company is unable to pay back a loan, the fund managers may have to step in and take control. In recent times, a small number of troubled transactions made by Australian investors have raised questions about the transparency, risks and sustainability of private credit returns. This scrutiny and attention should be seen as good thing. Not only does it reflect strong and growing interest, it also provides an opportunity for the industry to build understanding of the asset class and its role in a diversified portfolio.
Nehemiah Richardson is managing director and CEO of Pengana Credit.
This is an edited abstract from the Professional Planner Adviser’s guide to investing in alternatives. For insights on opportunities in private markets, download your copy here.
