What are we watching?
“May you live in interesting times” – Chinese proverb
Globally, the picture does appear to be getting more ‘interesting’ with market and currency volatility on the rise, yields falling – in some cases into negative territory, trade protectionism showing no signs of abating, and nationalistic rhetoric and geopolitical tensions escalating.
A key question that is often asked of us is “What are we watching?” Certainly there is no shortage of areas to watch – from global macro to very localised micro matters, from the superficial to the significant, from the obvious to the ambiguous. These are overlaid with the challenge of distilling volumes of data to distinguish trends from noise and headlines and determining their likely causation and impact.
As an Australian private debt manager, our key focus is on analysing the factors that may impact the performance of our Fund and its assets. We are seeing and factoring a number of key macro trends into our consideration of our portfolio’s current and future construct.
Interest rate environment –’ lower for longer’ certainly appears to be the theme here in Australia, with the cash rate at a record low of 1%, a majority of economists believing that this still could fall further and quantitative easing being increasingly contemplated at a central bank level.
Unemployment and underemployment remain robust – latest ABS statistics indicate unemployment remaining at a low 5.2% and forecast to remain broadly steady. However annual wage growth forecasts remain weak at 2.3% over the next 18 months. Additional headwinds including high household indebtedness, weakening consumer confidence and retail conditions are acting to constrain consumer spending. Regulation impacts are directly and indirectly continuing to work their way through the financial system impacting lending criteria, credit availability and turnaround times.
However, a strong trade balance ($8bn in June) and government spend is forecast to underpin a strengthening economic outlook with annual GDP growth increasing from 1.7% pa to 3% pa by mid 2021. So perhaps the economic outlook will be less ‘interesting’ here in Australia compared to other jurisdictions.
However in our view an analysis of the significance of these macro trends on the private debt market needs also to be coupled with a consideration of micro level performance drivers.
We are seeing increasing differentiation between lenders in the Australian private debt market, both in terms of underwriting quality and asset performance. As performance of a private debt portfolio is correlated to the performance of assets originated by its selected lenders this is something that we particularly focus on and monitor carefully. We expect this differentiation to increase if economic conditions become less benign.
The close monitoring of lending performance trends on a lender by lender and asset class by asset class basis over time – and the ability and appetite to take action accordingly – is a key factor in predicting future asset performance.
Additionally the increasing availability of data available as to likely repayment capacity and previous account conduct of potential borrowers (including increasingly through positive credit reporting and from 1 July 2020, Open Banking) coupled with an individual lender’s ability to analyse this to determine a borrower’s risk profile provides valuable competitive advantage for those lenders who can mine, interpret and act on this data to select borrowers carefully to grow a robust performing book.
This data comprehensiveness should only increase over time and thus should provide the basis for lenders to make better informed credit decisions about individual borrowers – thereby reducing unpredictability as to performance at the micro level, even in a time of increasing macro uncertainty.
A welcome trend indeed.