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Consider wider private credit universe to maximise diversification, returns
In private credit, “priority number one” is diversification, and investors who define the asset class very broadly will get the most diversification benefit. A recent lender-friendly market shift makes some of these opportunities even more attractive – even if they require stepping out of one’s comfort zone.
At The Inside Network’s Alternatives Symposium, Kyle McCarthy (pictured), alternative credit strategist at PIMCO, said he encourages investors seeking diversification and superior risk-adjusted returns to look beyond traditional alternative investments like real estate and consider the full universe of private credit opportunities.
“Some of these areas can seem a bit far afield when you just think about real estate or single-sector exposure to the corporate space,” he said. “But in reality, a lot of these asset types have direct connective tissue with public securities.
“This is how you can build in a broad range of exposures and underlying economic risk factors.”
McCarthy joined David Lewis, CEO and founder of Oceana Investments and flagship manager of the Oceana Australia Fixed Income Trust, in a session titled An income for all seasons. Lewis discussed trade and debtor finance as a particularly attractive private credit opportunity.
“There are a number of key attributes of these kinds of debt assets that make them appealing in a diversified credit portfolio,” Lewis said. “First and foremost is the potential to earn consistently strong risk-adjusted returns.”
He noted that supplier and debtor finance make up 80 per cent of Oceana’s fixed-income class, with a $75,000 average loan size and about 7,000 borrowers and obligors. Annual turnover in the Australian debtor finance market is about $75 billion. Loans typically have shorter tenors of up to 180 days.
Trade or supplier finance is the provision of a line of credit to a buyer of goods or services – the borrower – with a lender funding invoice payables owed by the borrower to the supplier. The framework is “mutually beneficial”, allowing “borrowers to pay their payables, and suppliers to receive their receivables, earlier than their working capital would typically allow”, Lewis said.
Debtor finance is the provision of funding against invoice payment obligations, i.e., funding against receivables. Invoice finance involves receivables or invoice discounting, through whole-of-book or selective-invoice discounting and, to a lesser extent, single-invoice factoring.
In supplier finance, returns range from 12-15 per cent per annum. On the debtor finance side, they average around 12-24 per cent.
“When we launched the fund in 2016, we wanted to offer high-net-worths access to these kinds of returns, which they couldn’t ordinarily access,” Lewis said. “That has slowly become an institutional offering as our track record has developed over time.”
Other benefits of these alternative investments include low default rates and the hedging characteristics of the underlying transactions. “By definition, it provides a natural hedge because only businesses that are still trading as strong going concerns will have significant payables and receivables,” Lewis said.
And while McCartney agreed about the attractive lending environment, he said investors should remain cautious because of the likelihood credit quality will deteriorate as macroeconomic headwinds remain in play.
“Look for opportunities outside of just corporate and commercial real estate locally. Going global really opens up the opportunity set and provides much more diversification for Australian investors.”
