Private debt continues to offer attractive returns

The Australian private debt continues to offer attractive risk-adjusted returns and remains an asset class offering one of the most attractive risk-adjusted return profiles, according to Evergreen Ratings. 

Evergreen’s chief executive, Angela Ashton, said with Australia Prudential Regulation Authority (APRA)-regulated authorised deposit-taking institutions (ADIs) facing more onerous macro-prudential guidelines, the domestic market saw more borrowers seeking funds outside traditional banking sources. 

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

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“Interest rates are at historical lows and stock dividends fell last year due to the effects of COVID-19. 

“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.” 

According to Ashton, private debt could be an attractive asset class due to private debt premia, but it was also one of the few asset classes where the skillset of the manager could actually demonstrate the ability to preserve investor capital. 

Evergreen looked 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. 

Following this, the alternative asset ratings firm gave 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. 

Ashton said the GCI fund incorporated a number of risk protections, which included 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,” she added. 

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