“A flight to safety”: IAM cautions on private credit as fixed income becomes preferred defensive option

Jenna Hayes

As private credit funds fill the lending gaps left by banks, the asset class’s rapid expansion is not without risks, with concerns growing that fund managers may be taking on riskier loans to maintain momentum, says Jenna Hayes, head of sales capital markets at Income Asset Management (IAM).

“The accelerated growth in private credit, largely due to increased regulatory constraints on banks post-GFC facing more stringent lending criteria, could have unintended consequences as some funds take on riskier business lending,” Ms Hayes says.

“Private credit has filled that gap. But like anything, when you experience rapid growth, the risks aren’t always going to be understood, especially as the asset class is far more complex than investors think.

“Some private credit funds are growing so quickly that in order to deploy their cash, they must say yes to deals they may have said no to in the past. There’s more risk than meets the eye here.”

While private credit has been an attractive option for investors looking for diversification, Ms Hayes cautions that many Australian investors may not be achieving the balance or returns they had expected.

“One of the reasons investors are drawn to private credit is diversification. However, in our experience, Australian investors are overweight in equities and property as it is. So, if your private credit fund is investing in real estate, then you might not be getting those benefits of diversification that you may think you are,” she says.

In response to these evolving market dynamics, investor sentiment is shifting towards publicly traded fixed income assets such as bonds, as stability becomes a key priority.

“We are seeing a flight to safety into government and corporate bonds. Investors are not necessarily moving into cash, but away from equities, and we are seeing greater flows into bonds,” Ms Hayes says.

“The returns on investment-grade bonds are yielding between 5.5 – 6.5 per cent, which is higher in some cases than the dividend yields of ASX 200 stocks.”

According to Ms Hayes, credit investments are set to play an increasingly important role in investors’ portfolios, especially given renewed equity market volatility. The Australian share market has dropped around 2.7 per cent over the year to 24 March. In the US, equity markets have also dropped led by technology shares, with the Nasdaq Composite Index down around 5.8 per cent over the year to date, and the S&P 500 down 2.0 per cent.

As investors reassess their portfolios in search of stability, IAM stresses the importance of fully understanding the complexities of private credit and ensuring that diversification strategies align with actual market exposures.