Unpacking US private credit for beginners

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We answer some common FAQs around private credit and explain the key terms.

US private credit is attracting investor interest globally, yet there is nothing new about this type of investment.

Private credit has been around for decades though until now it has only been accessible for large institutional investors like super funds. With options for retail investors soon to be launched in Australia, it's time to shine a light on how US private credit works, and what investors should be aware of.

sponsored unpacking us private credit

What is private credit investment?

Private Credit comprises a range of asset types, which ultimately are portfolios of loans. It is a broad universe and comprises assets of differing quality, structures and returns.  In the market you will find simple strategies, complex strategies, high-quality strategies and low-quality strategies.

US Private Credit itself is an enormous universe.  Today, the US private credit market is valued at $US1.7 trillion ($2.6 trillion), just below the total for bank lending.

High quality, mid-sized corporations may simply choose to raise money using a loan, rather than, say, issuing a bond.  Private credit investment simply refers to investing in loans which don't trade on public markets.  This means, you'll typically invest into a portfolio of these loans via an asset manager.

How can I invest in US private credit?

Investors can tap into this asset class through a private credit fund.

Unlike banks, non-bank lenders don't normally offer savings accounts. Instead, funding for loans comes from the pooled capital of investors. This gives investors access to a broad cross-section of underlying borrowers and loan terms.

What's in it for investors?

US private credit offers several points of appeal including high yields, regular low-volatility income, and portfolio diversity.

'Yield' refers to the earnings generated by an investment expressed as a percentage of the amount you invest.

The strong yields associated with private credit reflect the willingness of borrowers to pay higher interest rates in order to access credit sooner, or secure a loan better tailored to their needs.

A key plus of US private credit is that the underlying loans usually have a 'floating' (variable) rate structure. This acts as a buffer against official rate hikes, and provides a hedge against inflation.

As private credit investment comprises portfolios of borrowers making loan repayments, investors can enjoy an ongoing flow of income.  A well-crafted portfolio of quality assets within US private credit can provide low volatility for your portfolio at all points along the economic cycle.

Investors can also use US private credit to boost diversification in their portfolio allocations. Take the US middle market, for example. Standalone, this would represent the third-largest economy in the world. Australia sits back in the pack at 12th. In addition to the portfolios themselves being diversified, an allocation to US private credit provides additional international diversification opportunities.

How secure is US private credit?

All investments come with risks. However, certain factors can reduce the risks associated with US private credit.

In particular, investors should check the product disclosure document to understand the nature of security pledged against the underlying loans. The thing to watch for is whether the loans are first or second lien.

First lien loans rank highest in the pecking order of borrowings. They get paid their income first, but take any losses last.  This makes first lien loans more secure.

If it's a lower capital volatility outcome you are focused on, it's also worth aiming for a private credit manager that steers clear of high loan-to-value ratios (LVRs), and that undertakes due diligence to ensure the companies it lends to are sound, and operating in low risk industries.

How liquid is US private credit?

Private credit is part of the fixed interest class of assets though it works very differently from something like a term deposit.

Unlike money in an Australian bank account, your capital is not protected by a government guarantee. Another point of difference is that private credit is less liquid than a savings account.

'Liquidity' refers to how easily you can cash in an investment. Private credit is not a place to park your cash short term.  It is less liquid than public credit, which is why investors get to enjoy an illiquidity premium.  Many US private credit funds offer ongoing liquidity windows, meaning you can get your money out at stated times, such as quarterly.  And there can be no guarantee you can get all your money out each quarter.

So be aware of this, and how quickly you may need any money you're considering investing.   For example, a private credit fund may make allowance for 5% of the fund's total capital to be redeemed each quarter.

The upshot is that withdrawing money is possible, but it may require forward planning.  A good rule of thumb is to only invest money you are unlikely to need in the short term. Don't look on private credit as your liquidity valve in the way that cash savings can be.

How volatile is US private credit?

The loans behind US private credit are not traded on open markets or public exchanges. This gives private credit low levels of volatility compared to other investments with a similar yield profile.

That's been a key driver of investor interest in US private credit.

The volatility seen on share markets in recent years has seen a growing number of individual investors as well as self-managed super funds look for investments combining high returns, regular income and low volatility.

It may sound like a tall order, but this is exactly what private credit offers along with the additional benefit of portfolio diversification.

Opportunities to invest in US private credit funds have been available to large institutional investors for many years. What's exciting is that they will soon become available to retail investors in Australia, allowing each of us to tap into a market that can tick plenty of boxes for investors.

The answers given to the questions noted above are the author's personal views and do not constitute financial advice and should not be relied on instead of professional advice. The author has not considered your personal financial circumstances. We recommend you seek the assistance of a finance professional. Past performance is not a reliable indicator of future performance Consider the Product Disclosure Statement (PDS) before investing. PDS available on or around June 3, 2024. Target market description available on La Trobe Financial's website www.latrobefinancial.com.au.

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Chris Paton is chief investment officer at La Trobe Financial. He has more than 14 years' experience in banking, asset management and financial services and has held a number of senior roles since joining the business in 2017. Prior to joining La Trobe Financial, Chris worked in law specialising in the banking and finance sector. He holds Bachelors in Commerce (Distinction) and Law (Hons).