Andrew Lockhart

In the current market, many income investments are no longer offering the safe haven and downside protection they once did.

Investors, of all sorts, need to revisit and better understand where investments sit in the capital structure and the role they can, and sometimes can’t, play in portfolios today.

Andrew Lockhart, Managing Partner at Australia’s leading corporate non-bank lender Metrics Credit Partners (Metrics), said investments that are senior in a company’s capital structure and rank ahead of equity, result in less volatility and lower correlation to equity markets.

“For example, regardless of conditions in equity markets, Australian corporates still have to borrow and refinance their loans, and continue to pay interest on debt owing,” Mr Lockhart said.

Corporate loans are lower down the risk spectrum than growth assets such as equities because they come with a range of embedded protections, are generally secured by the borrower’s assets and lenders are paid before equity holders in the event of business insolvency.

“As such, an investment in defensive asset classes such as corporate loans have historically provided an important source of downside protection and attractive alternative sources of income in previous downturns.”

Preserving capital does not mean losing income

While preserving capital is key for pre-retirees and retirees, corporate loans can also provide an important source of income, from the interest corporate borrowers pay. As they are slightly higher up the risk curve than government bonds, corporate loans offer attractive income returns.

“For those investors who require liquidity, an investment in an ASX-listed fund providing exposure to a diversified corporate loan portfolio can provide daily entry and exit – with income paid monthly,” Mr Lockhart said.

Strong local corporate loan assets

Corporate loans are loans made to businesses of scale (ie not SMEs) for a specific purpose, such as working capital, real estate, capital expenditure and acquisitions and returns are generated from the interest and fees they pay.

This subset of fixed income is classified as a defensive investment as it is structured with embedded protections such as covenants, controls and security over the underlying asset.

While corporate loss rates are low, averaging 0.32% over the past 10 years, Mr Lockhart said it is important for investors to tap into well-diversified portfolios that effectively spread risk.

“Corporate loan fixed income portfolios with around 150 such loans provide diversification across sectors and individual borrowers and can therefore be a valuable addition to an investor’s fixed income allocation,” he said.

A corporate loan fund can provide exposure across a range of industry segments including industrials, consumer staples, healthcare, IT, utilities, infrastructure and commercial real estate.

“With the fall and continued volatility in equities markets, we believe corporate loans warrant a closer look for investors seeking downside protection,” Mr Lockhart concluded.

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