Increased equity market volatility and inflationary pressures are seeing investors look for an investment option that can generate meaningful income and capital stability.

Private credit as asset class has seen substantial growth as it satisfies those key investor needs. We consider some of the key traits that justify the increasing popularity of this investment product.

1. Floating interest rates

Private credit funds write loans that are priced as a margin over a floating benchmark rate. The most common benchmark used is the 30-day Bank Bill Swap Rate (BBSW), which is closely corelated to the RBA Cash Rate.

In simple terms, the interest rate on a loan will be structured as “10.0% margin + 30-day BBSW”.

Rises in the RBA Cash Rate will see the BBSW rise, translating into higher inflation adjusted returns for investors.

2. Capital protection

The right private credit strategy can offer investors a meaningful degree of capital protection. A fund that focuses on asset-backed lending can deliver investors a regular income stream, underpinned by collateral that can be liquidated should the borrower default. An experienced private credit fund will be able to identify collateral assets that will retain their value in a downside scenario, and be able to be realised in a timely manner to return investor capital.

This class of private credit is particularly ideal for SMSF investors as it will minimise the chances of the investor or retiree losing their investment.

3. Attractive risk-reward proposition

A large, deep, and mature investment class – the property market for instance – has many financiers. This translates into pricing generally reflecting the underlying risk with few opportunities to generate outsize returns.

In contrast, the Australian corporate private credit market benefits from a few useful characteristics.

• It is a relatively new sector
• There is a relatively small pool of investment professionals with the requisite experience
• It is a fragmented sector with fund manager terms focusing on their respective niches – acquisition finance, cashflow lending, asset-backed lending

This translates into there being more demand for private credit than there is supply, permitting a competent fund manager to extract an interest rate premium for a lower level of risk.

At the Rixon Income Fund, we refer to this as the scarcity premium.

4. Accessibility for investors

There are a number of advantages to investing in private credit via a fund:

• The underlying loans are researched and structured by an investment team with deep experience in finance
• Quality funds will have an independent Investment Committee that will act as gatekeepers on behalf of investors
• The fund will appoint specialist banking & finance lawyers to document the loan and ensure it is property secured over assets offered as collateral
• While the underlying loans can range from 6-months to 5-years in timeframe, investors are able to enter and exit the fund allowing them some degree of liquidity

These characteristics make private credit an ideal allocation for most investment portfolios.