The global private credit market has experienced rapid growth, surpassing $2.1 trillion according to estimates from the International Monetary Fund (IMF). This market emerged about three decades ago as a financing source for companies too large or risky for commercial banks and too small to raise debt in public markets. In more recent times with the increasing banking regulations that followed the Global Financial Crises, commercial banks have refocused their lending services towards the very few that strictly qualify, presenting opportunity for private capital to meet the needs of growing economies.

We continue to have a constructive view on private credit and direct lending as an investment asset class for the following reasons:

Strong and reliable cashflow generation
Private debt can provide regular income even during periods of extreme volatility. Interest and fee payments are received from borrowers at specified intervals under the binding terms of their debt contract. The asset class can provide attractive risk-adjusted returns in various market conditions. In the current environment, more conservative funds can deliver a return around 7% – 8% while higher yield funds can deliver a cash distribution around 10% – 12%.

Capital stability
In a private market, lenders negotiate directly with borrowers. A skilled lender/private debt manager will seek to negotiate appropriate terms and conditions, controls, reporting obligations, covenants, and security to mitigate potential risk of loss. As a result of the protections in place, the corporate loan loss rates for Australian companies have been very low for many years.

Diversification
Private debt has a low correlation with other major asset classes, including growth assets such as equities and property, as well as other fixed income products such as bonds, providing excellent diversification opportunities.

Inflation protection
Private debt offers protection against inflation because corporate loans earn their returns from fees charged to borrowers and interest that is generally charged at a floating rate. The interest on Australian corporate loans is usually structured as an additional margin over the benchmark Bank Bill Swap Rate (BBSW). So if interest rates rise, your income should also rise, which can protect the capital of your investment.