Why is everyone talking about private credit?
Here is why private credit is creating such a buzz among investors
Earlier this year, US media reported that private credit, also known as private debt, has fast become one of Wall Street's most popular investment classes.
Data firm Preqin is forecasting that the value of the global private credit market will reach an all-time high of $US2.8 trillion ($4.3 trillion) by 2028, almost doubling the 2022 figure of $US1.5 trillion ($2.3 trillion).
Clearly, private credit is creating quite a stir. Yet it's not a new asset class.
La Trobe Financial, for example, has been providing investors with an opportunity to invest in private credit for over 70 years.
What has changed is the investment environment, and there are good reasons for investors to take notice.
What is 'private credit'?
Private credit means a lot of different things to a lot of different people. It is all about investing in a broad basket of loans usually provided by non-bank lenders. These loans can include residential mortgages secured by property, or they can be commercial loans made to reputable businesses.
Either way, private credit falls within the 'fixed interest' class of assets, which is renowned for playing two key roles within a portfolio.
Firstly, fixed interest provides a source of income. Secondly, it has little, if any, correlation to volatile asset markets such as sharemarkets. So, investors don't have to wear the highs and lows we see in equity markets.
Retail investors often appreciate the need to include fixed interest in a portfolio. But many can see it as an asset class beyond their reach, being dominated by government or corporate bonds that can require substantial sums of capital and are quite complex for investors to understand.
This is where private credit is meeting investor needs.
Private credit funds allow Australians to add fixed interest to their portfolio even when they have small sums to invest.
The pluses that private credit brings to portfolios
As I've noted, private credit has low levels of volatility. This is because the underlying loans are not traded on public markets in the same way that, say, shares are. In addition, the yields on private credit are much higher than returns on cash or deposit accounts.
And this combination of strong risk-adjusted returns plus low volatility is resonating with local investors. A report by accounting firm EY found that the private credit market in Australia is currently worth around $188 billion, up from $175 billion in late 2022.
But the appeal is not just about strong yields and low volatility.
Private credit, as an asset class, is relatively straightforward and - with the right investment structure - easy to understand. This matters to investors, who can readily weigh up the pros and cons of the investment strategy, and make an informed decision.
Why is private credit attracting the spotlight?
Over the past decade, we've had an extended run of low interest rates combined with high sharemarket volatility.
In this environment, investors have had to hunt for higher yields, in some cases going out on the risk curve - even pushing past their personal risk tolerance - to make their money work harder.
The challenge of finding quality assets that align with investors' risk appetites, and which are backed by experienced and trusted providers, has been a key driver of interest in private credit.
Opportunities in US private credit
For Australian investors it can be tempting to focus on homegrown investments.
But there are good reasons to think more broadly.
Private credit opportunities aren't limited to Australia, and adding international assets has the potential to further enhance portfolio diversity, and boost returns.
The US private credit market, for instance, is massive, and growing rapidly, as investors line up to get a slice of the action.
A recent report by the US Federal Reserve, the equivalent of our Reserve Bank, found the private credit market in the US has "grown exponentially in recent years", reaching nearly $US1.7 trillion ($2.6 trillion) by 2024.
A large part of this interest is being fuelled by very compelling yields.
The Federal Reserve says that over the past decade, private credit has "generated higher returns than most other comparable asset classes". In fact, since about 2005, US private credit has delivered returns to investors averaging 9.4% per annum.
This is an especially powerful result given that private credit has almost none of the volatility of equity markets.
It's worth stressing that private credit is not the same as a savings account or term deposit. Your money is not backed by a government guarantee, so there is a higher level of risk involved
However, for investors looking for the trifecta of regular income, healthy yields, and low levels of volatility, private credit - both homegrown and US-based - can provide a simple, capital-friendly solution that can bring much-needed diversity to a portfolio.
Get stories like this in our newsletters.
