Private debt – its time in the sun?

 In Private Debt market


With stocks sitting at elevated values and with UBS quantitative analysis consequently predicting index returns of 3.1% per year over the next 10 years[1] many investors will be wondering whether increasing existing or even maintaining portfolio exposure to equities is a wise move, given likely low risk adjusted return and inherent volatility in such a strategy. Active management is certainly one option to try and ensure that any investment is on the ‘outperforming’ side of an index.  However, for every outperformer of an index, there will likely be an underperformer, plus fee budgets for active managers (a key contributor to net returns) are typically higher. So what can an investor do?

Although debt (and particularly private debt) as a recognised asset class in itself is only relatively recently seen to be coming of age, our view is that it provides an attractive asset class for consideration particularly in these times of elevated stock valuations. With contractual rights of repayment from the underlying borrower underpinning capital stability, annuity style income through regular interest payments, and markedly lower volatility compared to stocks, a debt fund becomes even more attractive. Yes, debt investments are less likely to command double digit annual returns than some stocks, but over the longer term a compound more stable return can eclipse a higher yielding but more volatile equity pattern of growth – investing $1 in a fund achieving RBA cash rate + 5% in 2000 would have produced a higher return to 31 December 2018 than investing $1 in ASX 200 financial stocks[2][3]

Access to credit is a key driver of economic activity and with the post-Royal Commission retreat from certain areas of lending by bank lenders this creates a bigger opportunity for other skilled and experienced lenders to grow to fill the gap. This thus translates into an investment opportunity for specialist private debt funds with the relevant expertise to select those lenders and assets that are likely to perform well over time in which to invest, whilst commonly negotiating credit protections adding to the capital stability proposition. As such, this bodes favourably for private debt as an asset class to continue the positive trajectory as described above – a trajectory that may place it firmly in the sun compared to other investment options.

 

 

[1] Source: AFR, 20/9/18 “Active managers set to shine over the next decade: UBS

[2] Including dividends, excluding fees and tax

[3] Past performance is not a reliable indicator of future performance

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