Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 505

Private debt returns rise with inflation and less risk than equities

Rising inflation and official interest rates have helped to bring private debt into the mainstream of investment classes as investors seek to avoid the turbulence of public markets. The risk of a global slowdown is now also testing investment strategies.

Many investors are again looking beyond equities and fixed income to weather the economic uncertainty in a way that reduces capital volatility and maintains a reliable income.

For investors reliant on income from their portfolio, switching into bank deposits may be the first thing they think of. According to the latest SMSF quarterly statistics report (Dec 2022) from the Australian Tax Office, 16% of Australian SMSF capital is invested in cash and term deposits.

While this may be a well-worn path, it isn’t necessarily the best strategy for all trustees. Money in the bank does provide security but term deposits deliver lower returns that are locked in at a fixed rate and don’t keep pace with inflation.

Reduced capital volatility even during economic downturns

The global economy is in the midst of a broad-based slowdown, as the rise in central bank rates to fight inflation and Russia’s war in Ukraine continue to weigh on economic activity.

The International Monetary Fund (IMF) forecasts global economic growth to fall from 3.4% in 2022 to 2.8% in 2023, before settling at 3% in 2024. The slowdown is expected to be especially pronounced in advanced economies, where growth is expected to slip from 2.7% in 2022 to 1.3% this year.

The IMF’s latest World Economic Outlook notes the global economy might appear poised for recovery but turbulence is bubbling below the surface. The situation remains fragile, as shown by recent instability in the banking sector, and inflation is stickier than anticipated even a few months ago.

As uncertainty around the economic and policy outlook continues, a key attraction of private debt is that it aims to provide capital stability through the economic cycle.

Australian corporate debt is a lower risk investment than equity because Australian corporate insolvency laws give priority to the interests of creditors in claims over the assets of a business.

In a private market, lenders negotiate directly with borrowers, enhancing risk management. A skilled lender or private debt manager will negotiate with the borrower appropriate terms and conditions, controls, reporting obligations, covenants, and security to ensure the lender has greater influence on loan terms seeking to mitigate potential risk of loss.

Covenants and ongoing borrower reporting obligations are negotiated and provide protection and early warning of changing risks. Security held over the borrower ensures the rights and protection of capital ranks in priority to shareholder equity and any unsecured creditors.

Most loans in the Australian private debt market are senior secured loans. This means Australian laws protect the lender’s capital, giving them the ability to recover interest, principle, and fees from the assets of the borrower.

As a result of the protections in place, the corporate loan loss rates for Australian companies have been very low for many years.

Source: Major Bank APS 330 reporting. Past performance is not a reliable indicator of future performance.

Floating rate structure provides natural inflation hedge

While the economy is slowing, prices have accelerated. Global headline inflation rose to 8.7% in 2022 from 4.7% in 2021.

Central banks in major economies have tightened monetary policy rapidly to tackle this inflation but price pressures are proving quite stubborn. Global inflation is set to fall to 7% in 2023 due to lower commodity prices but is unlikely to return to target before 2025 in most cases, according to the IMF.

Inflation poses a threat to investors because it chips away at the purchasing power of savings and investment returns. It can be particularly damaging to returns on fixed income investments such as bonds.

Private debt offers protection against inflation because corporate loans earn their returns from fees charged to borrowers and interest that is generally charged at a floating rate. The interest on Australian corporate loans is usually structured as an additional margin over the benchmark Bank Bill Swap Rate (BBSW).

The BBSW is essentially the rate at which Australia’s major banks are willing to lend short-term money to other banks. It reflects not only the current level of the RBA cash rate but also the expectations the banks have of future cash rate settings.

So, if interest rates rise, income should also rise, which acts to protect capital.

Regular income even in turbulent times

Private debt can provide regular income, even during extraordinary times. Interest and fee payments are received from borrowers at specified intervals under the binding terms of their debt contract. A floating base rate, with additional credit margin, ensures total interest income rises in line with upward movements in market interest rates (which may occur as a means of combating inflationary pressure).

This contrasts with dividends that are paid to equity holders at a company’s discretion. Even when equity markets were at their most turbulent in early 2020 during the beginning of the pandemic, and many companies were suspending or reducing dividends, well managed private debt funds continued to deliver consistent monthly income for investors.

Attractive risk-adjusted returns

The private debt asset class can provide attractive risk-adjusted returns throughout the economic cycle. More conservative funds can deliver a return around 6-7%, an attractive alternative to low-yielding corporate bonds, hybrids, government bonds or even cash deposits. A higher yield fund can deliver a cash distribution around 10-12%.

Traditionally the asset class was only available to wholesale investors. However, in recent years, opportunities have become available to SMSFs and other self-directed investors to provide ways to access the opportunity in both listed and unlisted vehicles.

When accessing corporate loan investments through an ASX-listed structure (Listed Investment Trust or LIT), investors benefit from liquidity available via secondary market trading. Investors enjoy the premium income distributions associated with this asset class with the ability to buy or sell units on the ASX daily. When accessing private debt via an unlisted managed fund, investors are not subject to stock market volatility that may impact the LIT pricing and can buy and sell units in some funds monthly (subject to liquidity).

As one of the few asset classes that aims to provide capital stability as well as attractive, reliable returns, private debt can play a key role as investors seek to preserve and grow their portfolio at times of elevated uncertainty.

 

Andrew Lockhart is Managing Partner and Co-Founder of Metrics Credit Partners, an Australian debt-specialist fund manager, and sponsor of Firstlinks. This article is general information and does not consider the circumstances of any investor. Its listed vehicles operate under the tickers MXT and MOT.

For more articles and papers from Metrics Credit Partners, click here.

 

RELATED ARTICLES

Six guidelines on how to allocate SMSF cash

How the Reserve Bank scuppers retail depositors

CBA to be less competitive in retail deposits

banner

Most viewed in recent weeks

What to expect from the Australian property market in 2025

The housing market was subdued in 2024, and pessimism abounds as we start the new year. 2025 is likely to be a tale of two halves, with interest rate cuts fuelling a resurgence in buyer demand in the second half of the year.

Retirement is a risky business for most people

While encouraging people to draw down on their accumulated wealth in retirement might be good public policy, several million retirees disagree because they are purposefully conserving that capital. It’s time for a different approach.

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

Howard Marks warns of market froth

The renowned investor has penned his first investor letter for 2025 and it’s a ripper. He runs through what bubbles are, which ones he’s experienced, and whether today’s markets qualify as the third major bubble of this century.

The challenges with building a dividend portfolio

Getting regular, growing income from stocks is tougher with the dividend yield on the ASX nearing 25-year lows. Here are some conventional and not-so-conventional ideas for investors wanting to build a dividend portfolio.

How much do you need to retire?

Australians are used to hearing dire warnings that they don't have enough saved for a comfortable retirement. Yet most people need to save a lot less than you might think — as long as they meet an important condition.

Latest Updates

Superannuation

So, we are not spending our super balances. So what!

A Grattan Institute report suggests lifetime annuities as a solution to people not spending their super balances. The issue is whether underspending is the real problem or a sign of more fundamental failings in our retirement system.

Investment strategies

The two best ways to maximise dividend income

People often marvel at Warren Buffett now getting 60 cents in annual dividends on every dollar he invested in Coca-Cola 30 years ago. What’s often overlooked are the secrets to how he achieved this phenomenal result.

Taxation

The fetish for lower taxes has gone too far

Since the time of Reagan and Thatcher, most business leaders and investors have clung to a dogmatic belief that lower taxes bring higher profits and economic growth. The truth, as always, is far more complicated than that.

Superannuation

Meg on SMSFs: Winding up market linked pensions with care

Due to recently-introduced rules, many people with old style pensions, also known as legacy pensions, will look to wind them up this year. The temporary amnesty allowing these pensions to be stopped should be navigated with care.

Property

Why our Torrens title property system hasn't been adopted elsewhere

Far from an outdated relic, Torrens title appears to be the revolutionary, cheap, low-risk way to handle property dealings. Here's a look at why this Australian invention from the 1850s hasn't caught on more widely.

Property

DigiCo REIT and the data centre opportunity

Data centres offer compelling growth prospects. But their potential hasn't gone unnoticed, and DigiCo appears to be buying properties in a seller’s market, resulting in better opportunities being found elsewhere.

Retirement

The $1.2 trillion sea change facing Australian investors

Over the next decade, three million Australians will shift from accumulating wealth to living off it. Those taking part in the great migration need a sound strategy that delivers sustainable income and protection from market bumps.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.