Private Credit: What's All The Buzz About?

Private credit has become an increasingly popular asset class offering investors the potential for attractive yields and portfolio diversification, while providing businesses with flexible financing alternatives outside traditional banking channels. While many will talk about the positives to a portfolio, it is pertinent to be across the nuances of this growing asset class.

Let’s break down what it is, why it’s growing, and what it could mean for you as an investor.

What is Private Credit?

Think of private credit as when your neighbour lends you a lawn mower because the local shop is out of stock. In finance, it’s when non-bank lenders (like private funds or asset managers) give loans directly to businesses that might not fit the banks’ usual requirements. These loans aren’t traded on the stock market, so they’re called ‘private’. The deals are often customised to suit the borrower’s needs—like a tailored suit instead of one off the rack. In Australia, this sector has been gaining traction, offering both borrowers and investors alternative avenues for financing and returns.

A Glimpse at the Growth

Private credit has exploded in Australia over the past decade. Back in 2016, the market was worth about $33 billion. Fast-forward to 2024, and it’s hit a whopping $205 billion. Globally, the private credit market is even bigger, topping US$2.5 trillion and expected to keep climbing. Notably, commercial real estate loans constitute a significant portion, highlighting the sector's role in property development and infrastructure.

Why is Private Credit so popular?

Tougher bank rules: After the global financial crisis, banks became pickier about who they lend to. Private lenders stepped in to fill the gap.
Custom loans: Private credit can be tailored to suit unique business needs.
Better returns: Investors often get higher interest rates than from bank deposits or government bonds.
Portfolio diversification: Private credit doesn’t always move the same way as shares, so it can help balance your investments.
Unique opportunities: Access deals that otherwise would not be available in public markets.

Key things to know about Private Credit

Types of Private Credit: It covers everything from direct business loans, property development finance, and infrastructure debt, to more exotic stuff like mezzanine debt and distressed loans.
Floating rates: Many private credit loans have floating interest rates, which means your returns can rise if rates go up—a handy hedge against inflation.
Regular income: Well-managed private credit funds often pay out steady, reliable income, even when share dividends get cut.
Illiquidity: Unlike shares, you can’t always sell your investment quickly. Private credit is often a “set and forget” investment for a few years, think more along the 5-7 year time frame.
Risks: The main risk is that a borrower can’t pay back the loan. That’s why picking experienced fund managers with good track records is crucial.

The Investor's Perspective

For everyday investors, private credit can mean higher returns (often 7–12% per year) and a smoother ride when share markets are bumpy. But remember, these investments aren’t risk-free. Sometimes, businesses can’t repay their loans, especially in tough times. That’s why it’s important to know what you’re investing in and to trust the people managing your money.

In recent times we have seen local managers take over businesses or developments with an aim to see out the project, to provide a return to investors, better (or higher) than simply writing it off.

The sectors and activities that are captured under the Private Credit moniker are varied and it is important to know what are the underlying loans and businesses/developments that are being funded. There are different types of risks related to the various forms of loans and who the borrower is. Some managers provide a specific sector or niche of lending, and others opt for a more diversified approach. It is important to know what you are exposed to or want to be exposed to when reviewing investment opportunities.

Risks to Consider

While the prospects are enticing, it's essential to approach private credit with a balanced view:

Liquidity concerns: Unlike publicly traded assets, private credit investments can be less liquid, meaning funds might be tied up for extended periods (5-7 years is a fair expectation).
Transparency: Transparency in this part of the market is generally quite poor. Whilst the lack of transparency can be part of the appeal given the specialised nature of lending and unique deals, it also comes with risk including lack of disclosure, updates, and potential fraud.
Higher risk of default potential: These loans are often made to companies that may not qualify for traditional bank financing - there is potentially a higher risk of borrower default.
Valuation challenges: Determining the exact value of private loans can be complex, given the lack of a public market. E.g. leaving asset valuations unchanged despite broader market downturns, are assets valued regularly and appropriately? The implications here are that new investors could be purchasing units at inflated values or investors selling units are at stale valuations.
Regulatory oversight: The sector's rapid growth has prompted discussions about the need for increased transparency and regulation to protect investors. To date there has been limited focus of regulators on this sector relative to others, and the opacity of this market does make it harder to govern diligently.
Understanding the fee structures and credit ratings: Increasing interest rates and financing costs can expose low-quality assets. Managers predominantly use self-determined credit ratings instead of independent ratings from third party agencies. This can involve bias and lack independent oversight thus exposing those managers with inferior credit assessment. Fee structures can be somewhat complex as well, with establishment fees, management and performance fees all being part of the cost structure. It is important to review how these are charged and what is passed through to the investor.
Conflicts of interest: issuers retaining upfront fees as opposed to passing them through the fund/vehicle for the investors benefit. This may encourage the manager to prioritise deals with higher upfront fees over those with the best long-term risk-adjusted return for investors.

Final Thoughts

Private credit is carving out a significant niche in Australia's financial landscape, offering both opportunities and challenges. For investors seeking diversification and potentially higher yields, it represents an avenue worth exploring. However, as with all investments, due diligence and a clear understanding of the associated risks are paramount. As mentioned, the rapid growth in this area in more recent years, does mean this sector is less tested through a full economic cycle, and particularly at this scale, and with more varied investors through significant market downturns and poor market conditions.

There is potential for this to be additive to an overall well diversified portfolio, however we implore advisers and investors to be well versed in the intricacies and nuances of this type of investment and the expectations of the investment experience over time, particularly the investment horizon of the loans versus the purported liquidity features of the products in this space.

What's good?	What to watch out for?
Higher returns vs. Traditional bonds	Harder to sell quickly (illiquidity)
Steady income	Risk of borrower default
Diversification	Less transparency
Access to unique deals	Higher fees

The Investment & Research team at PSK are always monitoring market conditions and data points to ensure portfolios align with our overall long-term objectives. If you’d like to discuss any of the points raised, please contact your Adviser or call us on (02) 8365 8300.

Share on Facebook

Share via Email

General Advice Warning - Any advice included in this article has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider whether it's appropriate to you, in light of your objectives, financial situation or needs.

Insights