Graham Lees

Private credit funds will offer investors an attractive opportunity to benefit from regular cash income and low volatility regardless of which economic conditions prevail during 2024, a year which brings much uncertainty, according to the managing director of Tanarra Credit Partners (TCP), Graham Lees.

According to a new Insights paper from Tanarra Credit Partners (TCP), “TCP Outlook for 2024: Risk of Inflation Lingers”, the private credit asset class finished 2023 with a strong performance. The JPM Credit Research: Leveraged Loan index gained 13.2 per cent in 2023, with BB loans returning 10.2 per cent and B loans gaining 14.6 per cent.

“These were the second strongest returns for loans on record. We expect another strong year in 2024 despite a possible increase in financial market volatility, given the rise in official interest rates, which has raised the cost of credit generally. This flowed through to returns with the JPM Leveraged Loan index above 8 per cent in January,” said Mr Lees.

“Private credit as an asset class is likely to benefit from higher floating interest rates on corporate loans, and it is a low volatility option for investors against a backdrop of a very uncertain economic outlook,” Mr Lees said.

Geopolitics risks are high with ongoing conflicts in Ukraine and the Middle East. In addition, with elections in 60 countries in 2024 including in major markets such as India and the US, and a possible Donald Trump victory, 2024 is likely to be a volatile year for financial markets.

“With so much uncertainty, it remains a challenging environment for investors. While cash rates at around 4 per cent offer investors a reasonable return in nominal terms, the return is much less attractive in real terms, or after inflation which in most developed nations sits at more than 4 per cent.

“We believe private credit offers investors a more attractive opportunity to benefit from higher interest rates and regular income, as well as strong investor protections which are built into corporate loans,” Mr Lees said.

Unlike bonds, private credit is not issued or traded in public markets. Loans are organised by the lending partner according to the individual borrower’s needs. Corporate loans deliver a regular income stream for lenders, and the floating rate structure helps hedge against inflation. Corporate loans typically have floating rate coupons, which are linked to the bank bill swap rate and are reset regularly by the lender.

“Importantly, private credit offers investors attractive risk-adjusted when compared to equities, and returns in-line with the long-run returns on shares.”

“Furthermore, we anticipate higher refinancing demand during 2024 from private equity sponsors facing challenges in exiting portfolio companies due to the low level of IPO activity.”
Private credit as an asset class has enjoyed strong growth in recent years with total global assets under management (AUM) rising over US$1.4 trillion in 2022. Within Australia, there is growing demand for private credit from Australian borrowers as it offers greater flexibility and access to credit compared to bank loans.

Borrowers frequently benefit from the greater speed of execution compared to traditional bank loans. In addition, there are several downside protections available for private credit investors.

“For instance, for those that largely invest in senior secured loans, the investment equity capital sits underneath the debt financing in the capital structure. This means significant value would need to be eroded before investors’ capital is at risk,” Mr Lees said.

“While borrowers typically do pay a higher interest rate for private credit financings versus regular bank loans, many borrowers are prepared to pay the higher cost in return for the benefits offered by private credit.”

According to Mr Lees, private credit has strong downside protection features that help fund managers mitigate the risks of underperforming borrowers during economic downturns. TCP investments typically feature the following protections. Senior ranking security provides first right to cashflows and assets of borrowers hence providing a buffer against any deterioration in corporate earnings.

“In addition, maintenance financial covenants are tested quarterly, which provides an early warning signal against any deterioration in the credit quality of a borrower, enabling us to take action if required to protect our investment,” he said.

“While private credit is clearly under the spotlight for investors as an asset class well-suited to navigate the complex economic environment ahead in 2024, we believe it is important to partner with an experienced fund manager to maximise the benefits offered by the asset class.”

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Graham Lees

It is a myth that only uncreditworthy borrowers who cannot access bank loans will seek private credit financing, and the asset class also attracts quality corporate businesses, says managing director of Tanarra Credit Partners (TCP), Graham Lees.

According to a recent whitepaper from Tanarra Credit Partners (TCP), Private Credit – higher returns vs. bank lending does not always equate to outsized risk., there are several tools that lenders can use to mitigate the risks of private credit financing. When combined with the returns available, this creates an appealing risk-return proposition for investors.

Private credit as an asset class has enjoyed strong growth in recent years with total global assets under management (AUM) rising to over US$1.4 trillion in 2022. Within Australia, there is growing demand for private credit from Australian corporate borrowers as it offers greater flexibility and access to credit.

Mr Lees says borrowers frequently benefit from greater speed of execution compared to traditional bank loans and more importantly the risks of investing in the asset class can be reduced through diligent lending practices.

“When it comes to private credit, investors should seek out those providers experienced in structuring deals that have experience investing through cycles, and that conduct detailed due diligence on prospective borrowers including review of third party financial, legal and commercial due diligence reports, and detailed financial modelling to assess a range of downside scenarios.

“These checks enable lenders to better understand the credit profile of the businesses they may finance, and it gives a high degree of comfort around the ability of the cashflows of the business to service their debt.”

He says there are several downside protections available for private credit investors, and that not all private credit funds are the same.

“For instance, for those that largely invest into senior secured loans as we do, there is meaningful equity capital sitting underneath the debt financing in the capital structure. This means significant value would need to be eroded before the senior debt is at risk,” he says.

“Our loan investments also typically have maintenance financial covenants that are tested quarterly and provide early warning signs if there is any deterioration in the credit quality of borrowers. This means the lender can take quick action to protect investor capital and increase pricing, if warranted.”

Mr Lees says it is important that loan documentation is structured to impose restrictions on the borrower that protect the lender’s position. “This includes provision for cashflow sweeps to repay debt should the business underperform, restrictions on the borrower’s ability to make acquisitions and sell assets without debt repayments, and not allowing distributions to be made to shareholders until debt has reduced.”

“While borrowers typically do pay a higher interest rate for private credit financings versus regular bank loans, the higher cost is compensation for the benefits offered by private credit.

“Bank loans typically require more restrictive terms and conditions, and borrowers may prefer to pay a higher interest rate in return for greater flexibility offered by private credit finance,” he says.

“Private credit financiers also typically offer faster and more transparent decision-making compared to a bank’s credit process.

“Borrowers are often prepared to pay more in return for the greater certainty and speed of execution. This is particularly important for borrowers who are under a strict deadline to conclude a corporate activity such as a borrower seeking financing to complete an acquisition.

“We believe that private credit as an asset class will continue to benefit in a world of high benchmark interest rates with its floating-rate yield profile, and is a low volatility option against a backdrop of an uncertain economic outlook,” Mr Lees said.

Unlike bonds, private credit is not issued or traded in public markets. Loans are negotiated and structured according to the individual borrower’s needs. These private corporate loans typically have floating rate coupons, which are linked to the bank bill swap rate and are reset regularly.  This helps provide investors with a hedge against inflation, and means that the capital value of the investment is not at risk from movements in interest rates, unlike traditional fixed rated corporate bonds which are exposed to that duration risk.

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Graham Lees

The continued growth of the Australian private debt market presents a compelling opportunity for investors, according to Tanarra Credit Partners managing director, Graham Lees.

Assets under management for the global private debt market are in excess of US$1 trillion, and this number is set to grow as banks continue to pull back from financing.

However, the Australian private credit market is relatively under-penetrated, which represents a significant growth runway, Mr Lees says.

“Investing in Australian private debt provides stable cash income with an attractive risk-return profile, strong investor protections and a low correlation to other asset classes.

“Private credit at floating rates offers the best opportunity for investors, as it provides a natural hedge against inflation and interest rate movements.”

He says despite the headwinds facing the global economy in 2023, Australia’s outlook remains relatively positive, with growth projected at 1.6 per cent, underpinned by population growth, and strong mining, tech and services sectors, compared to other developed economies – which are projected to grow at approximately 1.2 per cent on average.

He adds that alternative investments help diversify portfolio risk and generate returns at a time when traditional assets are underperforming.

“This year we have started to see many more investors revisiting their investment approach and moving away from traditional strategies which have performed poorly during the recent market volatility.

“One of the alternative asset classes which is benefiting from this shift is private credit – it is an effective and defensive investment strategy to have in place during an uncertain economic environment.”

Aside from attractive returns and diversification, Mr Lees explains that private debt also provides investors with access to institutional-quality investments which may not be available to them otherwise, as well as offering potential downside protection and lower volatility.

“Over the past month we have seen interest in private debt start to really pick up, with more investors interested in investing into our fund, and we believe the remainder of this and next year will see that trend continue,” says Mr Lees.

Tanarra Credit Partners formed a partnership late last year with GSFM to provide retail investors in Australia with access to Australian private debt assets.

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Stephen Miller

Local and global equity markets – in particular Chinese and Asian equities – are positioned well for 2023, but inflation is the joker in the pack for investors, according to GSFM and its fund manager partners Tribeca Investment Partners, Man GLG and Tanarra Credit Partners.

A more positive inflation picture in the United States (US) may provide a more positive environment for US financial assets, but recession looms as a key risk even if China re-opening helps mitigate that risk somewhat, according to GSFM investment strategist Stephen Miller.

“Locally, the inflation portents aren’t so encouraging, and that may result in some headwinds to local market performance for both bonds and equities.

“The RBA and local interest rate markets continue to underestimate inflation momentum and the attendant policy rate implications.

“High frequency data continue to indicate significant domestic inflation momentum as we go into 2023. The unemployment rate remains close to a 50 year low.

“Well-intentioned but potentially flawed changes to the regulatory environment, particularly in relation to the wage-setting framework, run the risk of entrenching higher inflation in Australia compared to elsewhere.

“Against that background, the Reserve Bank of Australia (RBA) should be possessed of an acute inflation anxiety in its approach to policy settings through 2023. The inflation impact will be the wildcard for investors in the year ahead,” he says.

Managing director of Tanarra Credit Partners, Graham Lees, agrees there is a high level of economic uncertainty for investors to contend with.

“The global outlook remains challenging with a multitude of economic and market indicators signalling that elevated levels of market volatility are likely to persist. Ongoing geo-political events in the Ukraine  add to the uncertainty with implications for energy and food prices, as well as global supply chains.

“Locally, we are yet to see the full impact of rising interest rates, and the flow-on effect this will have on household behaviours and consumer spending. It is also not clear how far interest rates will need to rise to curtail inflation, but we believe Australia is relatively well placed compared to other economies.

“In this environment, private credit investments – particularly those with a senior security ranking and that are floating rate – provide protection against both inflation and rising rates and represent a safe haven investment.

“There is a significant opportunity in Australian private credit and we expect the strong level of deal flow to continue in the current environment.

“Private credit across the Asia-Pacific region has a long growth runway that can be levered over the coming years, given its relative under-penetration against more mature, offshore markets,” Mr Lees says.

Man GLG Asia Opportunities Fund portfolio manager Andrew Swan says the next few months will be important in determining how China is going to emerge from its post COVID-19 era.

“I would say in the next month we’ll start to get a sense of whether this is a strong, broad recovery or a narrow, shallow recovery.

“A broad, strong recovery will have implications for the rest of the world, in particular commodity prices. But if it’s a narrow, shallow recovery, there probably won’t be any impact on the rest of the world, apart from more Chinese tourism into other places.

“There is definitely a surge in demand for travel coming, which makes a lot of sense, given people have been locked into local cities now for a few years. We’re seeing very, very strong forward indications on both domestic and international travel.

“We do believe the Chinese economy will recover but we are more in the narrow, shallow recovery camp than the broad, strong recovery camp. If you look at what has built up in terms of household savings, it’s all gone into long-term term deposits. Normally if you’re making that decision, you’re locking your money up, you’re not really thinking you’re about to spend it anytime soon,” he says.

Tribeca Investment Partners lead portfolio manager, Jun Bei Liu, says we can expect a period of weaker economic and earnings growth before a new upswing can begin.

“On a positive note, Australia is well positioned to ride out an economic slowdown, and while it will not be immune to rising rates and tighter liquidity conditions, it should avoid recession due to the benefit of a much weaker Australian dollar, ongoing strength in the labour market, supportive commodity prices (and volumes) as well as a temporary downturn in consumer spending.

“At a corporate level, we expect to see meaningful cuts to earnings expectations as the combination of rising costs and weaker demand begins to pressure margins.

“In the absence of a deep global or domestic economic slowdown, we think earnings downside should be modest with most corporates well positioned to navigate a short-term decline in demand,” she says.

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