Private credit done well remains an important part of a well-constructed portfolio – despite the offshore noise. GREG STOCK explains.
- Offshore private credit concerns
- Australia remains well managed
- Find out about Perpetual Pure Credit Alpha Fund and Perpetual Credit Income Trust (ASX:PCI)
FIXED income is supposed to be the part of a portfolio that lets you sleep at night.
Right now, all the headlines are making that difficult.
From problems at one US manager to the collapse of a UK lender, the news is making private credit sound like a sector in crisis.
But if credit is one part of a broader portfolio – as it should be for diversified investors – Australians should largely tune out the global noise, says Perpetual’s head of credit research and portfolio manager, Greg Stock.
“Many people in recent years have been a bit more focused on the returns from credit instead of the risks,” says Stock.
“But we need to remember that this is designed to be the capital stable part of your portfolio.
“The original reasons for being in credit are still valid. And in fact, the outlook from here is better than it has been for a while.”
Trouble in private credit
Private credit is normally one part of a portfolio’s fixed income allocation, sitting alongside government and corporate bonds and other debt securities.
Typically, it is at the higher-returning but higher-risk end and is used to generate more income.
“Some of these higher returning strategies are on the riskier part,” Stock says.
“That means you can get impairments, and you can have various degrees of that.”
Difficulties at overseas private credit funds are real – but they involve a small number of offshore funds, each with identifiable problems.
Despite the offshore concerns, Australia’s credit market remains well managed and well structured, with strong creditor protections and a responsible lending framework, says Stock.
“There are more risky parts of your portfolio to worry about,” he says.
Managers matter
Stock says the key to successful fixed income investing is ensuring you pick a manager with a long track record of successful stewardship and on-the-ground knowledge of where it is investing.
“There’s nothing like being on the ground and knowing these markets, knowing these borrowers, knowing what drives the underlying funding,” he says.
“At Perpetual, our unconstrained credit strategies have some investment grade, and some non-investment grade, in corporate loans, securitisation and the like. And we actively manage it – we vary allocations over time and have limits on different sectors.”
He says there was a period around the GFC where some funds achieved very high relative returns to industry peers through highly concentrated sub-sector and issuer positions – but then failed to properly manage risk as the cycle turned.
“A year or two later, they’re no longer there,” he says.
Perpetual has invested in Australian credit for more than 21 years. The Pure Credit Alpha strategy is in its 14th year.
Stock says this active management makes a real difference to asset quality.
“We’ve grown as the markets evolve. We’ve managed through different cycles. We’re very conscious about risk management in our portfolios and measuring liquidity risks.”
“These underlying assets have low capital volatility,” Stock says.
“But you need an active manager to do it, an experienced active manager. We’ve been around for a long time now.”
Barbell strategy
Stock says one part of protecting investors is to design a fund so that its liquidity terms match the assets it holds. That means not promising investors quarterly redemptions if the underlying assets are multi-year loans that cannot be recouped quickly.
Stock’s Perpetual Pure Credit Alpha (PCA) and Credit Income Trust (ASX:PCI) strategies use a barbell approach – balancing exposure to less liquid private credit by also holding investment grade bonds that can be sold quickly if needed.
“Our products are built to last through cycles,” he says.
Positive outlook
Despite ongoing concerns, the outlook for fixed income is now as strong as ever, says Stock.
“There are challenges – GDP growth is going to be more muted; inflation is elevated for longer.
“But by and large the underlying investment opportunities are strong – and the investment thesis remains.
“There’s a lot of focus on headline risk – but interest rates are staying elevated, as is evidenced by the second consecutive rise at the March 17 RBA meeting, and possibly going higher (the RBA Rate Indicator suggests a 67 per cent expectation for another increase in May), and volatility means what was a marginally expensive market is now possibly turning into a cheap market.
“That outlook will give investors with a medium-term horizon great risk adjusted returns – real returns over inflation.
“In a world dominated by labour and commodity inflation, this is what investors would like.
“I think it’s time for patience and calm.”
About Greg Stock and Perpetual Credit Income Trust (ASX:PCI)
Greg Stock is a Senior Portfolio Manager and Head of Credit Research with Perpetual’s Credit and Fixed Income team.
Greg has more than 30 years of investing experience, including over 20 at Perpetual. He has researched and analysed credit markets on the buy side and sell side for more than a decade, through multiple cycles.
Greg is portfolio manager for several of Perpetual's credit and fixed income funds, including Perpetual Credit Income Trust (ASX:PCI).
Want to know more? Contact a Perpetual account manager