Why investors should consider an allocation to US private credit
Australian investors may not be familiar with US private credit, but here's why it could warrant a place in your portfolio.
Private credit has until more recently been one of the better-kept secrets of the investing world.
While asset classes such as shares and property attract the lion's share of headlines, private credit remains a growing opportunity for investors to achieve high yields and low levels of volatility.
But what is private credit?
In our previous piece we unpicked the world of private credit.
Essentially US private credit refers to loans made to corporations by non-bank lenders.
As with most investments, in the US private credit market we see high-quality assets and low-quality assets. There are simple strategies, and there are complex strategies.
Like any asset class, it's important to know exactly what you are investing in.
At La Trobe Financial, in all of our investment strategies, our starting point is to prioritise selection of high-quality assets delivered within a simple structure.
We maintain a narrow range of the types of assets we will consider, to deliver a quality portfolio in a clear and deliberate way.
That, in our view, is the best starting point for success in any asset class.
Demand for US private credit is skyrocketing
Private credit is not a new phenomenon, nor is it a flash in the pan.
In the US for example, the volume of middle market private credit being written by non-banks began exceeding the volume of credit being written by banks way back in 1999.
What's more, the market share between bank and non-bank lending has been fairly settled for a decade at roughly 80:20, heavily weighted towards non-banks.
The US Federal Reserve explains the demand for private credit as compared to public credit, saying borrowers have been willing to pay a premium for the speed and certainty of execution, agility, and customisation that private lenders offer.
However, building critical mass from a low base takes time, and the quantum of funds now in the market make private credit a globally recognised, significant asset class in its own right.
Three key things to watch
There are three key items to watch out for when considering an investment in private credit.
Let's start with the assets - the underlying loans and borrowers.
While assets are plentiful for managers to select from, are they high quality, or low quality? Look at what types of assets the manager will be investing into and ask, is it focussed and deliberate, or scattered and unclear?
Once you have comfort on the assets, do you understand the structure? Be clear about when and how you get paid your income and how you can access your capital. If it's unclear and doesn't make sense, that's a big red flag.
Finally, to the manager themselves. Nobody knows when the next bad time will be, but we all know that it's coming.
After all, economies move in cycles. Get confident that you are investing into a group with strong partnerships that knows how to manage the asset class in good times, as well as bad.
Why US private credit is so attractive
As with many asset classes, Australia's private credit market is a small fraction of the global market.
While the Australian private credit market is worth about $188 billion, by comparison, the international market is valued at $US1.5 trillion ($2.3 trillion). And it's expected to be worth $US2.8 trillion ($4.3 trillion) by 2028, a very large proportion of which is in the United States.
It's an enormous asset class with opportunities for managers to select high quality assets to suit a range of strategies.
Within the name itself is another benefit: Private credit is not traded on public markets. So, there is none of the rollercoaster ride of highs and lows that we see in equity markets. In this sense, private credit acts as ballast for a portfolio, helping to smooth out overall returns.
For Aussie investors, there are compelling reasons to consider an asset allocation to US private credit - and it's not just a matter of attractive yields, which have averaged 9.4%pa since 2005.
In the US, many private credit funds are backed by loans to corporations and secured by the assets of the business.
These loans, when bundled together in a fund in large numbers, cover a broad spectrum of companies and underlying industries, which is a plus for diversification.
US private credit can also be a hedge against inflation. As the underlying loans typically have a floating, or variable rate, the lender can adjust the return to protect the purchasing power of investors' capital over time.
Where opportunity really lies for investors at the moment is the opportunity to participate in the rebuild of the US middle market.
Already by itself the third largest economy in the world (Australia sits 15th by comparison), it stands to benefit from generational tailwinds: reshoring of jobs and manufacturing back to the United States, and their ongoing investment into renewables, decarbonisation, etc through the Inflation Reduction Act.
And you can limit foreign exchange risk. For Australian investors, the thought of foreign currency exposures can be off-putting.
There is a simple solution - invest in an Australian-domiciled strategy providing access to these global assets, and which provides a currency hedge. This offers an Aussie dollar experience with limited foreign exchange risk.
The bottom line is that when it's done right, US private credit brings diversification, attractive yields and low volatility to a portfolio.
It's a combination that can make US private credit a sweet spot for investors.
Financial product advice in this article is general only and does not consider your personal circumstances. Past performance is not a reliable indicator of future performance.
Get stories like this in our newsletters.
