Private debt continues to offer attractive risk-adjusted returns

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Specialist alternative asset ratings firm Evergreen Ratings has nominated Australian private debt as an asset class offering one of the most attractive risk-adjusted return profiles.

In a new research report, Evergreen Ratings has given a ‘Commended’ rating to Global Credit Investments’ Commercial Finance Fund, which invests in this sector providing senior commercial debt facilities secured by physical and financial assets.

Evergreen Ratings Founder and CEO Angela Ashton says that in recent years, with APRA-regulated authorised deposit-taking institutions (ADIs) facing more onerous macro-prudential guidelines, the domestic market has seen more borrowers seeking funds outside traditional banking sources.

For non-ADIs, such as Global Credit Investments (GCI), there has been an increasing flow of potential lending opportunities, as well as the ability to be more selective about which loans to proceed with.

“The market dynamics are supportive of attractive risk-adjusted loan pricing which presents an opportunity for a capital provider to earn excess returns,” Ashton says.

At the same time, investors seeking yield are finding fewer attractive opportunities. “Interest rates are at historical lows and stock dividends fell last year due to the effects of COVID-19,” Ashton says.

“This leads to a situation where people are struggling to find good sources of consistent yield. Private credit is an asset class that can help to fill that portfolio need and we are seeing more and more of these types of funds approach us for consideration. However, these funds are not all the same. There are important nuances in lending practices and the types of borrowers each manager targets. It’s important to understand the risk each fund is taking and to ensure you are being properly rewarded for that.”

GCI was co-founded in 2015 by Steven Sher and Gavin Solsky. Steven spent 17 years in senior investment and executive roles at Goldman Sachs, and Gavin founded the professional services and outsourcing firm Portland Group.

Steven Sher says: “We’re proud to be awarded the ‘Commended’ rating for the GCI Commercial Finance Fund from Evergreen Ratings.

“Since its inception, our Commercial Finance Fund has outperformed investor expectations and provided them with exposure to private credit markets that are typically difficult to access. The preservation of our investor’s capital and managing downside risk is at the core of all GCI investments.

“We’re delighted to have simultaneously partnered with and funded our borrower clients’ growth,” says Sher.

The fund targets a return of around 8.5 per cent a year, net of fees. It invests in the smaller end of the private debt market, with loans ranging from $5 million to $30 million.

The fund was launched in July last year, when two established GCI funds were merged. It has returned 9.3 per cent on an annualised basis since then and it has not recorded any loan defaults.

Evergreen considers that the GCI Commercial Finance Fund is well positioned to capitalise on private debt premia.

Ashton says: “Private debt can be an attractive asset class due to private debt premia. It is also one of the few asset classes where the skillset of the manager can actually demonstrate the ability to preserve investor capital.”

She adds: “Evergreen looks for private debt premia from several sources, including:

  • illiquidity premium, which is the compensation required for not being able to trade the debt security on an exchange;
  • complexity premium, which is the compensation required for analysing deals in the private market and structuring appropriate risk mitigation; and
  • supply/demand premium, which comes from playing in the lower end of the market where there is less competition.

“We do not believe the fundamentals of this market in Australia will deteriorate over the foreseeable future,” Ashton says.

Ashton says the GCI fund incorporates a number of risk protections. These include taking senior security over all assets of the borrower, the establishment of a special purpose vehicle to house all collateral and a requirement that the borrower provide a first loss provision.

“The fund is underpinned by a very strong investment philosophy and the track record to date. Combined with GCI’s investment processes, this augurs well for future performance.”

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