While the global financial crisis (GFC) reshaped financial markets, one key fallout was bank lending. One of the casualties of banks having to carry much more capital for certain types of lending is small borrowers.
Due to regulatory adjustments heralded by Basel III the big four banks have refocused on residential mortgages or very large corporate loans. Simply put, many loans at the lower end of the scale are too unprofitable and labour-intensive for banks to dabble in this sandpit.
While that was bad news for SMEs looking to borrow, it created a golden lending opportunity that the Reserve Bank of Australia (RBA) says is worth around $400 billion in Australia alone.
This figure – worth around 2.5% of total business lending - represents the gap between what small and medium-sized companies in Australia want to borrow and what’s available to them from the big banks.
This explains why a slew of new market entrants have entered the private credit arena. It also explains why ASIC is ramping up its work to improve compliance and transparency. In response to poor behaviour, ASIC is expected to publish a report on private markets and the private lending landscape later this month.
The rebirth of private credit
Meanwhile, the funding gap identified by the RBA has created some sort of renaissance for the private credit sector which also knows all too well that there’s a growing cohort of baby boomers seeking regular monthly income.
The more volatile equity markets become, the more private credit will continue to grow with attractive yields.
One fund that’s capitalising on the perfect storm for private credit is the Aura Private Credit Income Fund which has about thirteen thousand small loans spread across roughly forty different industries.
What differentiates the fund from many other private credit funds is the length of its loan terms, especially when there’s economic uncertainty and investors want to know their funds are more readily accessible.
In response to this dilemma, Aura has ensured that 75% of the loans in its Private Credit Income Fund have a term of less than three months. However, given that private credit has little correlation to public markets, investor exposure to volatility is also reduced.
This fund has a seven-year track record, returning 9.64% per annum after all fees.
The Aura Private Credit Income Fund targets a net return of the RBA Cash Rate plus 5%. By selecting quality lenders and credit, there has been no volatility or loss of investors’ capital since inception.
Private credit insulates investors from the volatile US market
Contrary to a popular misconception, Brett Craig, Director at Aura Credit Holdings has reminded investors that private lending can’t be relegated to the fund-of-last-resort (for distressed businesses) basket.
With a lower correlation to equity markets than publicly traded fixed income, Roger Montgomery of Montgomery Investment Management expects private credit to continue to become an asset class in its own right that’s found in nearly all portfolios.
‘For more mature investors who cannot stomach stock market volatility, Private Credit has, to date, provided attractive returns on par with share markets but without any of the volatility associated with public markets,” said Montgomery whose fund is the authorised distributor of the Aura Core Income Fund.
“Additionally, as interest rates have risen in recent years, so have the yields on floating-rate loans, making private credit an attractive investment proposition offering “a degree of insulation from the volatility experienced in larger markets like the U.S."
Other players
New entrants have entered the private credit market in recent years including investment bank MA Financial which plans to raise a $300 million private credit trust.
Sydney-based Pengana has also poured cash into private lending and is launching numerous retail and wholesale funds.
Pengana Credit CEO Nehemiah Richardson expects the sector to continue growing despite major flaws in global private credit markets, especially with banks exiting this space.
Included within Pengana’s investment options is its ASX-listed Pengana Private Credit Trust (ASX: PCX) which offers access to over 2000 individual loans across 19 underlying funds.
This article does not constitute financial product advice. You should consider independent advice before making financial decisions. As with any investment opportunity, please weigh the associated risks.