The investment executives responsible for over $220 billion of Australians’ retirement savings have identified pockets of opportunity in alternatives but noted that getting “appropriately rewarded” remains crucial when taking on illiquid assets.
Particularly, the super fund CIOs highlighted the current appeal of private credit, a market that is tipped to grow to US$2.3 trillion over the next five years bolstered by banks ceding territory in corporate and institutional lending as they face increased funding costs, a renewed focus on shareholder returns, and ramped up regulatory pressures.
This month, the International Monetary Fund (IMF) also noted the burgeoning popularity of private credit over the last few years, citing features like speed and flexibility as particularly appealing to borrowers. Heightened interest is also being shown by institutional investors, like superannuation funds, due to the asset’s offer of higher returns and less volatility, the global fund said.
“It’s the flavour of the month,” said John Pearce, CIO at UniSuper, at the Asia Pacific Financial and Innovation Symposium in Melbourne this week.
“We’ve been allocating to private credit, particularly in Europe, that’s where there [are] some really attractive spreads at the moment, where the banks aren’t willing to play in that mid-corporate market … It’s really attractive.”
However, he cautioned, “these relativities aren’t going to last forever.”
“At the moment, clearly, it’s private credit versus private equity. It’s in favour of private credit, but the market adjusts over time. It might take a while [to] adjust, but today, that’s where the value is for sure,” Pearce explained.
He explained that despite private credit’s ‘alternatives’ designation and illiquid nature, super funds aren’t “at all” restrained from entering into it.
“Super funds in Australia, we’ve got a lot of licence actually. We could own bitcoin if we wanted to. There’s a lot of flexibility,” Pearce said.
But, given super funds are not endowment funds or sovereign wealth funds, Pearce highlighted super funds’ limited capacity to take on illiquid assets.
“This notion of super funds having this permanent source of capital is just not true. We have the capacity to take on illiquid assets, but that capacity is not unlimited,” he said.
Joining Pearce on the panel, HESTA CIO Sonya Sawtell-Rickson said: “[Private credit] is a very diverse asset class”.
Although appealing, she believes understanding the risk spectrum is key.
“Investing in investment-grade credit is great. Throw in a bit of leverage in there, it changes the dynamic. You change the sector; you change the dynamics. So, I think it’s about being very clear about what you’re targeting, that you’re getting appropriately rewarded for the risk you’re taking, and making sure you’re with partners that you trust to underwrite that risk appropriately,” she said.
Sawtell-Rickson explained the $74 billion fund has an illiquidity budget set in reference to potential changes in policy, financial competitive pressures, as well as financial market risk.
She further elaborated that HESTA often sees “strong competition” between private credit and private equity, infrastructure, and property for allocation within its portfolios.
“In the current environment, that’s a little bit different, where the pricing [of private credit] is more attractive,” Sawtell-Rickson said.
“We are seeing a dislocation here in that we’ve seen some balance sheet damage that needs repair and often, when there’s balance sheet restructuring, it’s a great time for credit.
“But we also want duration on those cash flows … So when we think about allocations, it’s not just the pricing today, it’s how long we can lock in that return and what does the three, five, or 10-year outlook for this investment look like.”
Joining his peers, TelstraSuper’s Graeme Miller said he believes illiquid assets, often feared, could play a greater role in superannuation in the future.
“I think superannuation is increasingly going to be thought of as the efficient payout of wealth over a period of time to people, to help give them financial security, comfort, and happiness in retirement. And in that context, in fact, many assets that are labelled illiquid that you might initially think are quite scary for an older cohort of members, suddenly become a lot more attractive,” he said.
“If you think about what retirees are after, they’re after sustainable income to help them live the sorts of lives they want to live. Well what does private credit give them? Private credit gives them sustainable, reliable, transparent, predictable income.”
Conceding that illiquidity can’t be ignored “altogether”, he said “it’s a lot more nuanced than saying that it’s not suitable”.
“The most important point is [that] we need to get appropriately rewarded for taking illiquidity risk, in the same way as we need to be appropriately rewarded for taking all the other risks that we choose to take or choose not to take in our portfolios,” he said.
IMF points to potential problems
This growth in popularity that private credit is currently enjoying hasn’t come without scrutiny, with the IMF also alerting earlier this month that its fast growth, coupled with limited oversight, could exacerbate existing vulnerabilities into more systemic risk.
“In a severe downturn, credit quality could deteriorate sharply, spurring defaults and significant losses. Opacity could make these losses hard to assess. Banks could curb lending to private credit funds, retail funds could face large redemptions, and private credit funds and their institutional investors could experience liquidity strains,” the fund said.
“Significant interconnectedness could affect public markets, as insurance companies and pension funds may be forced to sell more liquid assets.”
Its words of warning extended to the growing retail presence in the asset class, with the IMF noting that while liquidity risks appear limited today, this expanding retail presence may alter the assessment.
In Australia, private credit is considered a fast-growing alternative asset class that mostly targets capital-seeking companies and income-seeking investors.
In a statement published on the ASX, Metrics Credit Partners’ Andrew Lockhart said last month he expects private credit worldwide to continue its growth.
He predicted that as regulators seek to reduce systemic risks in financial markets by ensuring banks are appropriately regulated, more organisations will have to turn to non-bank lenders for funding.
“In Australia, we don’t have a bond market of any size or scale, so private credit has an important role in supporting the growth of quality companies and projects. But for all the potential, private credit is only as good as the managers behind it, in terms of how they assess and monitor loans, manage risk and allocate capital,” Lockhart said.
