Investors are flocking to this asset class. Can the good times continue?

Ally Selby: Hello and welcome to The Pitch brought to you by Livewire Markets. I'm Ally Selby. If there's one area of the market that's seen explosive growth in recent years, it's got to be private credit, with assets under management expected to more than double over the next four years. But can the good times really continue? To find out, we're joined by Keyview managing director, Justin Lal. Thanks so much for joining us today, Justin. Really excited to feature you on The Pitch.

Justin Lal: Thanks for having me, Ally.

Ally Selby: Why private markets? Why have we seen such growth in this area?

Justin Lal: I'd come at that two ways. It's probably an investor side of things that's driving the growth, and then there's really a demand or borrower side of things as well.

So if I start with the investor side, what are private markets? What do private markets entail? And it's really being driven by investors increasing their allocation to what's being called alternative investments. Alternatives examples include real estate, infrastructure, private equity, and private credit. And it's really investors who are looking for a more balanced portfolio, diversification across the traditional asset classes. And I think more importantly and relevant to today, finding a natural hedge against inflation and higher interest rate environment as well. So private credit has been one of those asset classes that ticks the boxes for investors to give them that diversification and that hedge. And so that's a big reason why we're seeing investors drive more money towards private credit. I think the final thing I'd say on that is as we're seeing more of the population reach a retirement age as well, investors are looking for an asset class that can give them a lower risk profile but also a regular and recurring yield that private credit can give as well.

On the demand side of things, it's fair to say that there is an abundance of capital that's consistently required globally. In Australia, it's been widely publicised how the major banks have controlled a lot of the market here in Australia for a number of years, and that is declining over time, largely driven by the Australian regulators. And so the Australian banks have controlled historically up to 90% of the market share, and the regulators want that to be closer to 50% - where it is in other established economies. So we see that as a $1 trillion opportunity for private credit at its minimum. And so ultimately is demand for capital to fill that gap.

Ally Selby: That sounds very exciting, but what are the drawbacks of investing in private credit and what are the benefits?

Justin Lal: I'll start with the benefits first. I'd say the first thing is the level of due diligence and the access that you can typically get in a private market setting. What does that really mean? It means you can have very detailed discussions with management teams around intricate data that they can't ordinarily release to the public, forecast financial information. And that really culminates in well-informed investment decisions, and frankly, what I think are better investment decisions that you can make in a private setting versus a public market setting.

The second is we typically focus on mid-market companies or small to medium-sized businesses. Those businesses don't typically have access to public forms of capital, so can't access equity capital markets or traditional forms of credit as well. And so what it means is for us as a mid-market capital provider, there is a broader array of companies that we can choose from that we can align ourselves to where they demonstrate the same values that we have internally as well.

The drawbacks of private investing, generally speaking, I'd say the biggest one is liquidity or the illiquidity that exists in private markets. Very simple example, a private market investment, it may involve an investment horizon of three years. So someone has bought an asset, they're improving that, and in three years’ time it's saleable to the market. As an investor coming into that, you need to be prepared to be in that investment for three years. You may not be able to freely exit or liquidate your investment into that and recover what you've put in.

For us at Keyview, one of the things that we think about, and I've done this my entire career in private markets investing, is how do we solve for that illiquidity risk? And so there are two ways that I can say that we deal with that. The first is really addressing that illiquidity day one. So if we have a problem, how do we deal with this so we don't have to wait three years in that example to get our money back? And so a lot of the work that we do upfront, which comes back to the due diligence side of things, is how can we find a buyer of this asset or a company's group of assets if something doesn't go to plan? And we can do that in a fire sales scenario where we can realise liquidity quickly. And if that's not going to get our money back, we're not going to go and do that deal.

The second is probably the way that we think about portfolio construction. At Keyview, we manage funds which are made up of 20 to 30 underlying investments, all of which are illiquid in nature. But when you average that out of doing a transaction or two a month, you naturally have liquidity that builds through the portfolio as well. And what that does is it allows for our investors to benefit from the natural liquidity cycles of our portfolio where principal and interest is coming off loans that are coming back to us, as well as the investments that we're making as well. So I think the combination of those two things is the way that we try and address the illiquidity issue in private credit.

Ally Selby: Speaking of that, are there any non-negotiables so you can avoid, I guess, situations where you would have to do a fire sale of an asset?

Justin Lal: I'd say for us, the non-negotiable, and I'd say that this would be a market comment as well, is in private credit, you don't want to lose money. And while you don't want to lose money in any setting, private credit by definition is a credit investment. It does not have upside sharing potential. You have a contracted rate of return. And so ultimately, it is all about preserving your capital. Again, if I think about how we take things at Keyview, capital preservation is absolutely the most important thing for us and our investors. But then we will take an opportunistic lens around how can we maximise the relative return that sits around any given investment.

I'll use an example of a loan that we made to a large industrials company. That business, they were having trouble raising capital given some offshore parent company issues that they had. However, the fundamental business itself had 100-year track record in Australia, a number one or number two player in their product scape as well. And ultimately, when we went through the due diligence and whatnot as well, there was an opportunity for us to provide a loan where we were over three times covered from the assets of that company as well.

Now, solving the complexity around what was happening in that business but then providing that loan, we felt very comfortable with the capital preservation around that asset level coverage. But the opportunistic nature of how we approach things is the return that we're expected to realise from that is probably 500 basis points wider than where traditional banks would price that type of risk.

Ally Selby: In the intro, I talked about these amazing expectations for growth in private credit. Now that we're seeing interest rate expectations peak or peaking, how long can the good times last?

Justin Lal: Private credit right now is very topical. It's a hot asset class, but the one thing I'd say is it's not a new asset class. Private credit has been around for decades. It's often been some of the largest banks and investment banks' best kept secrets, and it's the first time it's really been offered now to a broader array of investors.

So I think the first way to answer that is while private credit is having its moment in the sun, it's an asset class that's been around for a long period of time and we expect will continue to be the case as well. Ultimately, private markets and private credit, generally speaking, are going to be correlated to users of capital and their ability to raise capital and need capital to grow their businesses. And fundamentally, if you have a view that businesses and asset owners are going to need capital to grow their existing companies, acquire assets, refinance debt or reduce debt, there is going to always be a need for private capital. As I said up front, the market opportunity in Australia is the largest that I think it's ever been, and that's not really going away, but in a low interest rate environment, while that may put some pressure on yields, the fundamentals of the asset class still remain the same.

Ally Selby: Well, thank you so much for your time today, Justin. It was awesome to feature you on The Pitch.

Justin Lal: Thanks for having me, Ally.

Ally Selby: If you enjoyed that too, don't forget to subscribe to Livewire's YouTube channel. We're adding so much great content just like this every single week.