- Income potential in sub-investment-grade credit
- Disciplined diversification essential
- Find out about Perpetual Credit Income Trust’s (ASX:PCI) limited-time capital raising
As investment-grade yields compress and equities hover at all-time highs, investors looking for stronger fixed-income returns may want to consider higher-yielding private credit.
That’s the message from Perpetual senior portfolio manager and head of credit research, Greg Stock.
Bond yields have trended lower and share markets have surged this year as markets adjusted to interest-rate cuts and inflation moderated.
But that means investors focused on investment-grade, publicly traded markets may be overlooking a growing pool of private and sub-investment-grade debt offering higher income.
“Private credit has expanded rapidly in part because it offers an in-built yield advantage over public markets,” says Stock.
“Because private securities are not traded on an exchange – and nor are they usually traded over the counter (OTC), investors require – and receive – a liquidity premium to compensate them for the fact they are usually held to maturity.
“Private credit is also often unrated or sub-investment-grade – that means it carries increased risk, but the extra risk is reflected in the higher income investors can earn.”
Stock manages Perpetual Credit Income Trust (ASX:PCI), which has just announced a new capital raising.
Understanding the growth in private credit
The expansion of private credit has been one of the defining investment shifts of the past decade.
As banks pulled back from lending, specialist funds stepped in to fill the gap – particularly in property development, infrastructure and corporate lending.
However, concentration in some of the riskier segments such as construction and real-estate development has drawn scrutiny from regulators.
Several funds have faced questions over valuation processes and fund liquidity structures.
The scrutiny is prompting investors to look more closely at how their exposure is managed – and whether the returns on offer adequately reflect the underlying risk.
“There are risks – but if they are well managed and investors understand what they are taking on, there’s definitely a place for these assets in portfolios,” says Stock.
“At Perpetual we have always prioritised transparency and risk management since we began investing in private credit markets over a decade ago.”
How to access private credit safely
Perpetual’s flexible credit strategies target higher income by investing across both public and private credit, rather than being tied to a single sector.
“These are higher-yielding strategies with a combination of public credit securities and private credit securities.”
That flexibility matters.
A well-designed, flexible strategy can mitigate concentration risk by spreading exposures across both private and public credit, different industries and varying credit grades.
In contrast, a fund heavily weighted to one sector – like property development lending – is effectively a single-sector bet.
“You can diversify via different issuers, but if all they are from one segment, you’re really heavily exposed to sector risk,” says Stock.
“You should expect higher returns, but you should also expect higher risk.”
The Perpetual team has been investing in the space for 21 years, through multiple cycles and the evolution of Australia’s private debt markets.
Balancing risk and return
Public credit markets skew toward investment-grade securities, while the vast majority of private credit is either unrated or rated sub-investment-grade – which means lower credit ratings and higher yields.
But higher risk does not automatically mean higher default rates, Stock says.
Sub-investment-grade borrowers may simply be more highly geared, operating in sectors where banks lend less, or too small for public bond markets.
“You don’t get any return unless you take some risk,” he says.
“The questions are the same: what’s the risk, what’s the appropriate return for that risk, and what’s the right position size?
“Analysis is crucial. We want solid business profiles with sound management, balance sheets and cashflow. Then we assess whether the spread adequately compensates for the financial risk.”
Stock says credit should act as ballast in a portfolio, delivering steady, reliable income with low volatility.
“This is the defensive part of your portfolio – it should be solid and reliable and without huge volatility,” he says.
PCI has a track record of delivering that outcome, with underlying net tangible assets staying remarkably steady despite changes in the traded price amid market volatility.
“Unless you have a large number of defaults, which we haven’t had, you shouldn’t get huge down-valuations,” says Stock.
Australian outlook remains sound
Stock says investors can take comfort from Australia’s economic backdrop.
“In a time of global economic volatility, Australia remains a good place to invest,” he says.
“Despite a muted economic backdrop, it’s still sound – the underlying economy keeps moving, even amid global uncertainty.
“And we continue to deliver our investors a sound income stream, even in volatile times.”
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 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 our credit and fixed income funds, including Perpetual Credit Income Trust (ASX:PCI), which has just announced limited-time capital raising offer.
Find out about PCI’s limited-time capital raising offer
Want to know more? Contact a Perpetual account manager