Craig Brooke from KeyInvest speaks to James Dunn from The Inside Network on finding the cream of private credit crop. The Inside Adviser
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Investment paradigm shifts as portfolio positioning overtakes performance
Investment markets are once again in unchartered territory. Whether it is the S&P500 in the US posting record highs, our S&P/ASX200 breaking its valuation record for the seventh time this month on Monday, the burgeoning price of gold, the Magnificent Seven tech giants or the irrepressible ascent of the Commonwealth Bank, it seems there are more assets trading at incredible valuations than any time since 2007.
Many of the long-held or traditional beliefs and expectations about investment markets are being broken, or at the very least challenged on a near daily basis. Almost every asset class was expected to be impacted by 13 consecutive increases in interest rates, yet investments continue charging on valiantly in the face of a further weakening in the economy, and in the US, at least, finally some relent in the form of an interest rate cut.
As we work through the latest quarter of performance, and another strong 12-months that rewarded patient and considered investors, the biggest question is… where to from here?
First, let’s step back and consider a few of the more interesting and topical events or trends of the last quarter. Driving the performance of the ASX has been the Commonwealth Bank, and the banking sector more broadly, which represents 21 per cent of the ASX 200’s value and an even larger portion of its returns.
Data suggests the banking sector has increased in value by as much as $100 billion in 10 years, despite only having grown total profits by $100 million. How this can happen is an issue on everyone’s mind, but there are several undercurrents at play.
Chief among them is an almost unconscious need to continue buying shares in Australia’s largest companies. Other contributing factors include the powerful Your Future, Your Super legislation which now drives decisions for Australia’s largest industry super funds, which has led to a growing reliance on index-tracking ETFs. Industry super funds are now punished for underperformance to the point of being unable to accept members, which has forced many to revert back to being average by investing into the index.
This dynamic is not just prevalent on an institutional level. On the retail side, too, the pursuit of lower cost portfolios means that many self-directed investors are blinding reinvesting into the same concentrated indices every quarter.
This isn’t to suggest that index funds aren’t valid or appropriate, but rather that every investment decision should be considered on its merits, give consideration to the current environment, and be based on a sound framework for decisions, rather than being founded on the fear of missing out.
A similar case can be made with both gold bullion and private credit. Wattle Partners has long been a proponent of holding gold within portfolios for its history of performing differently to share and bond markets. Yet even gold has been hitting all-time highs regularly in 2024, despite many ‘traditional’ investors avoiding the asset due to its lack of income. It is clear that gold is benefitting from a concern that other markets may be overvalued.
The trend continues with the booming private credit market, which in our view stands out as a potential risk to the economy more broadly. Private credit is essentially comprised of loans made directly to individuals and businesses by someone other than a bank. The sector has grown exponentially in recent years as the major banks reduced their lending to so-called ‘riskier’ borrowers, which has ultimately shifted the risk to this sector. While we aren’t saying private credit is all bad by any means – indeed, the return profile is attractive and it can have solid non-correlation properties – it is clear the sector is benefitting from concerns about valuations elsewhere, with investors not always cognisant of the varying risk levels that exist.
This brings us to the Australian share market, which has long been known for its high dividend yield but has actually been overtaken by term deposits in this regard. Yes, you read that right. The S&P/ASX200 currently offers an income of 3.8 per cent, while you can now get a 5 per cent income from a government guaranteed term deposit.
Does this mean we should be investing everything into term deposits?
Not at all. Rather, it means we need to be considering more than even the golden rule of investing; I + G = TR, or ‘income plus growth equals total return’. Ask this question: If we are looking to invest into something other than a term deposit, how confident are we that it will be able to produce both a reasonable level of income, and also have the potential to grow in the coming years?
At this juncture it is important that we aren’t focusing on ‘relative’ returns, or the prospect of getting 14 per cent rather than the 12 per cent delivered by the index. What matters is that we are positioning for consistent, absolute returns, and that we don’t hold overweight exposures to certain assets that will fare poorly should the environment turn quickly, as it has a habit of doing.
