Below trend growth to continue
It’s hard to invest for income right now. Maybe it’s time to try something different.
With Australia’s official cash rate at a record low, term deposits and even government bonds are failing to produce the income so many investors rely on. Maybe it’s time to explore something new?
While many high net worth investors are revelling in a resurgent share market, those investors relying on fixed income assets for the bulk of their investment portfolio face a quandary. The return on cash is sitting below inflation while government bonds are set to stay low for the foreseeable future. So where to invest?
It’s of particular concern for those investors who are income focused, such as those close to, or in, retirement. Their stage of life dictates an overwhelmingly defensive investment strategy, but also one that offers income opportunities. That’s not going to happen with cash or government bonds right now.
This, together with the continued uncertainty, is driving investors to consider all options, says NAB Private Client Executive Natalie Irvine. “We’re in unprecedented times. So, it’s hard to predict what’s going to happen over the next 12 months. People are spreading their risk a lot more for that reason – looking for products that they may not have necessarily invested in previously to actually get that yield.”
There are other options out there. Take the private debt market. Historically, it’s delivered higher yields than public debt securities, often with lower volatility. What’s more, there are a growing number of private debt opportunities available, according to JBWere Head of Alternative Assets Gillian Gordon.
“The global private debt market has almost tripled over the past 10 years,” Gordon says.
The reasons for its growth? The Global Financial Crisis introduced more stringent requirements for capital raising, which meant banks in the US and Europe in particular had to increase their capital bases, tighten their underwriting standards and adhere to more stringent reporting requirements. As a result, non-bank lending (variously referred to as private debt or private credit) now dominates US and, to a lesser extent, European lending markets.
This is in stark contrast to Australia, where private debt is a relatively new, sometimes unknown asset class, Gordon says. “Australia is very different, largely because our lending market is dominated by the Big Four plus a number of other similar domestic banks.”
Behind this is the fact that while Australia was affected by the likes of the Basel III banking regulatory framework, our capital adequacy requirements were already highly conservative, with banks well placed to weather any crisis that came their way. As a result, they weren’t scrambling to tighten their conditions in the same way as the US.
Nonetheless, private debt is becoming more popular here too, boosted in large part by the changing borrowing practices of private equity firms. As Gordon explains, private equity as an asset class has enjoyed substantial growth in recent years, yet the banks are not always in the best position to lend to these firms – particularly in the mid-market – due to heightened regulations. As a result, these firms have looked to diversify their lending sources to include both banks and private lenders such as fund managers and insurance companies.
Private debt comes in all shapes and sizes. “It’s a very broad spectrum, just like the public debt markets,” Gordon says. The big focus for JBWere here, however, is around performing senior secured debt – that is, direct lending between a lender and borrower that sits high in the capital structure. “Senior secured direct lending and real estate-linked private debt are the two main areas that are growing in the Australian market,” Gordon says.
Investing in private debt offers its own challenges. In the public markets you can buy a bond or hybrid thanks to banks like NAB breaking these into smaller pieces. Private debt doesn’t offer that luxury. “You can’t, as a private wealth investor, buy a single private debt asset or a single private debt loan,” Gordon says. “Instead, you have to access private debt in fund format via a fund manager, in either a listed or unlisted format.”
In Australia, there are a sizeable number of listed options available, including on NAB and JBWere’s platforms. “But where private debt is growing is most certainly in that unlisted space,” Gordon says. And with good reason. “If you buy private debt in a listed format, you can experience higher volatility because it is more frequently traded; whereas if you access private debt through an unlisted fund, you are likely to experience lower volatility.”
Then again, you also get less liquidity. “It’s a trade-off,” Gordon says.
Nevertheless, lower volatility remains one of the asset classes big upsides. “Private credit has historically delivered lower volatility than its equivalent for the same risk within public debt markets,” Gordon says. “That’s really driven by the fact that this is a private asset that is more illiquid.”
Historically, the asset class has also delivered lower defaults and lower loss rates, which means, if a loan defaults, you are likely to lose less money. “You tend to get back more if you’ve got a private debt loan that’s defaulted, versus public,” Gordon says.
Then there are the higher yields, plus the opportunity to diversify. “You can invest in a much broader universe beyond those companies that can, or want to, access the banks or can issue debt within the public market,” Gordon says.
Of course, you also need to consider any potential risks or downsides. These include a lack of transparency as well as the general illiquidity, Gordon says. There’s also the credit risk to consider – these assets span a wide variety of strategies with varying degrees of risk as well as return.
As Irvine says, it’s another good reason for your private wealth manager to do the detailed due diligence on private credit exposure and necessary background checks before you invest.
So, what else is out there? Gordon points to real assets such as infrastructure and property. “If you invest in core infrastructure, its main focus is to deliver income often through contracted cash flows.”
It also provides an inflation hedge. “That’s quite important,” Gordon says. “We are in a low-yield environment, but there is a lot of talk about if and when inflation will return as an issue. That’s likely to play out at some stage, so having an inflation hedge within your portfolio makes sense. A great asset class for that is real assets.”
Real estate offers similar benefits to infrastructure in the form of rental income, with valuations in specific sectors, such as residential, healthcare and industrial, in particular moving higher in recent times.
Natural resources may be another asset class to consider This involves investing in the earth’s naturally occurring resources such as water, timber or agriculture. While it hasn’t always delivered high returns historically and is relatively difficult to access, it does tend to deliver performance that has low correlation to other asset classes, given its performance link to non-market factors such as weather patterns.
Gordon considers the current low yields as sufficient reason to take a second look. “In this macroeconomic environment, with people looking for yield and trying to diversify their portfolios, I do think there is a role to play for natural resources.”
In fact, NAB has offered several private equity opportunities in this space on the agriculture side. “We’ve been involved in half a dozen or so raisings for different standalone assets, or more recently for units in the Diversified Agriculture Fund,” Irvine says.
Certainly, now is the time to look further afield, Irvine says, and NAB Private and JBWere can help you do so – whether it’s a discussion about your longer-term plans, offering opportunities to invest in little-known trades, or providing the support to review your entire investment strategy.
More than ever in the current environment, the important thing is to not set and forget your portfolio.
© National Australia Bank Limited. ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.