The Rise of Private Credit: Are You Investing in the Real Deal?

Eight years ago, when iPartners launched, alternative assets and private credit were relatively unknown. Today, private credit is a hot topic, dominating financial news. This increased awareness is positive, but it also raises an important question: Are all "private credit funds" created equal?

As the market matures, we expect smaller, less scalable funds to fade, while stronger players like iPartners continue to grow. This article aims to help you understand the different types of private credit funds and make informed investment decisions.

The Pre-"Private Credit" Era: Banks and Beyond

Before the recent boom, who funded companies? While banks were a major source, particularly before the Global Financial Crisis (GFC), the answer is more complex. Fixed Income Funds and Family Offices have been active in private credit for years, often under the radar. Many fund managers were simply categorised as "fixed income."  An obvious player that still retains the Fixed Income branding is someone like Challenger.

Australia's Private Credit Landscape: A Diverse Mix

In Australia, we see three main types of funds marketed as "private credit":

1. Mortgage Schemes branded as Private Credit: These are the most common and very concentrated risk category. They invest primarily in first mortgages (and often 2nd mortgages) over residential, commercial, and industrial properties, often including development funding.

   • Considerations: If you're seeking exposure to real estate debt, these funds can be suitable. However, prioritise funds with:

     • Strong track records (at least 3 years).

     • Experienced management teams.

     • Conservative loan-to-value ratios (LVRs).

     • Clearly defined investment strategies.

     • Low/No exposure to 2nd mortgages

       
       

2. Fixed Income Funds like Private Credit: These funds primarily invest across public market asset-backed securities (ABS) warehouses, term outs, leveraged loans, and syndicated loans. Essentially, they tend to focus more on the bank/sponsor originated and packaged asset pools.  The asset pool can overlap with traditional branded Fixed Income funds.

   • Considerations: Consider these funds if you want:

     • Exposure to a diversified pool of loans.

     • Lower risk compared to direct lending.

     • Potential for liquidity, as some of these assets can be traded.

     • However, expect lower returns compared to other private credit strategies.

     • Don’t be surprised by the smaller teams as the banks/sponsors/advisers do a lot of the heavy lifting to deliver pre-packaged trades.

       
       

3. Diversified Private Credit Funds: These are multi-asset, industry-agnostic funds that offer a blend of:

   • Direct lending to mid-market companies: Providing loans directly to businesses, often those overlooked by traditional banks.

   • Specialised financing solutions: Offering customised financing options like mezzanine debt or preferred equity, catering to specific company needs.

   • Focus on bespoke deals and tailored structures: Negotiating unique deal terms and structures to optimise risk and return.

   • Considerations: These funds might be suitable for investors seeking:

     • Higher potential returns.

     • Direct exposure to private companies.

     • Diversification beyond traditional asset classes.

     • However, be prepared for higher risk and less liquidity.

     • Look for managers with a strong track record in credit analysis and deal structuring.

     • Size of team, small teams will unlikely have the depth of resourcing to originate/structure/execute/manage a diversified private credit exposure

       
       

Why Does This Matter? Asset Allocation is Key

While all these fund types have a place in the market, understanding their differences is crucial for effective asset allocation. Don't mistake a concentrated mortgage scheme or a fixed income like private credit fund for a genuine diversified private credit fund.

Key Takeaways:

• The private credit market is evolving rapidly.

• Not all "private credit" funds are the same.

• Due diligence is essential, especially when considering new fund managers, as above <3 years live track record, buyer beware!

• Understand the underlying assets of a fund before investing.

• Choose the type of private credit fund that aligns with your risk tolerance and investment goals.

• Don’t be overly concentrated. i.e investing in 3 different property private credit funds is not a diversified private credit exposure.