Andrew Lockhart, Managing Partner, Metrics Credit Partners, presents an outlook for business credit in the next 12 months and the role it plays in a portfolio.
Like other areas of the economy, business credit will feel the weight of monetary policy tightening in 2023 as official interest rates rise to around 4 per cent and slow economic growth. A marginal increase in loan default and potential credit loss may occur in a scenario in which growth falls to around 1-1.5 per cent by year end.
The good news is any decline in economic activity is unlikely to be large by historical standards and private debt is likely to maintain its track record of producing higher real returns with less risk than other assets across most conditions. Proxy data shows the sector generated a positive real return for 93 per cent of the time from June 1969 through 2022 – a period which included four recessions in Australia.
Private debt consistently has the highest ratio of real return to risk than other asset classes because it delivers a higher yield, per unit of risk. Its characteristics – including floating rates, strong governance, and low correlation with public markets – enable consistent risk-adjusted returns and income.
PODCAST Listen: Private Debt Keeps Delivering in Turbulent Times with Andrew Lockhart
Its place in a portfolio depends on individual circumstances. Private debt funds which hold relatively low risk positions, and hence generate lower-yielding returns, can be a suitable alternative for defensive investors seeking an alternative to traditional fixed income investment options such as bonds which incur losses in a rising interest rate environment.
At the other end of the spectrum, funds which hold higher-risk mezzanine debt or subordinated debt, for example, can replace part of an allocation to equities. These holdings produce equity-like income but carry less risk due to their position in the capital structure (i.e., debt ranks in priority to equity in the capital structure of a company), so have appeal to investors who are uncomfortable with stock market volatility.
In the event of a slowdown, a competent private debt manager will limit losses by maintaining a sharp focus on credit risk, loan monitoring and diversification. The security provided by borrowers also provides an additional cushion to limit potential losses.
Metrics Credit Partners Pty Ltd ABN 27 159 646 996 AFSL 416 146 (Metrics) makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, Metrics excludes all liability for any loss or damage arising in any way due to or in connection with the publication of this article, including by way of negligence.
