Investors favouring defensive alternatives

We remain cautiously optimistic about the Australian economic outlook for 2024, with GDP growth expected to remain positive as inflation comes off its peak and the economy continues to adjust to higher interest rates and cost of credit.

It appears central banks have navigated the challenge of utilising interest rate levers to manage inflation.

A soft economic landing is now the base case for most investors, and the Reserve Bank of Australia is indicating the same, although higher interest rates will be a feature of the investment landscape as inflation pressures remain elevated.

Consumer and corporate performance have been supported by the level of excess savings in the economy, although this has begun to deplete from its highs of the last few years.

Consumer and business confidence figures into Q1 2024 are keenly anticipated, as well as employment growth, as markers for the likelihood of an economic soft-landing eventuating.

Discretionary exposed segments of the economy and businesses with wage-driven margin pressure in competitive sectors (where higher costs cannot be easily passed on through higher prices or revenue) could face some genuine squeeze points by mid-2024. We do not anticipate any systemic issues.

Interest rates at or near their peak

The rate tightening cycle is probably not over everywhere, and history tells us market cycles often last longer than anticipated.

More favourable inflation data suggests we are much closer to the end of the inflationary cycle than the beginning and further rate rises are unlikely in Australia.

In the US, where rates increased earlier and by far more than in Australia, the US Federal Reserve is also predicting a soft landing for the US economy in 2024. If there are signs of emerging stress, the central bank could certainly use its interest rate levers to support the economy.

With more leeway to cut rates (compared to the RBA) there are reasonable prospects of a handful of rate cuts in the US by late 2024.

Bond yields in Australia and the US rose sharply throughout 2023, peaking at the end of October at just under 5% then declining (suddenly) over the final few months of the year to 3.9% (1).

The Australian stock market moved around, finishing the year strongly with the ASX200 up 12.4% (2).

Investors are seeking pockets of opportunity and defensive alternatives as they become increasingly comfortable with the diversification benefits of private market assets and the different risk/return and duration characteristics they can deliver. We favour resilient and defensive sectors including private credit and alternative real estate.

Private credit: Avoiding losers in 2024

Private credit in 2024 will be about avoiding the losers, not picking the winners. This will require a sharp focus on strong fundamentals with robust security, asset coverage and downside protection and the rights and controls lenders need to safeguard capital if required.

The best opportunities in private credit over 2024 will likely be in areas where banks have exited for structural or regulatory reasons, or where market forces more generally mean there isn’t a flood of money chasing the same transaction.

In larger, more highly contested deals, and large syndicated loans, debt terms are likely to continue to progressively weaken further over time.

Smaller, mid-market transactions (lending on a direct or club-basis with real influence over terms and pricing) are likely to be negotiated on attractive terms, earning outsized returns for the level of risk.

In asset-backed and specialty credit, highly diversified portfolios of loans with substantial asset over-collateralisation gives a high degree of downside protection if stress starts to emerge at the underlying borrower level.

When lending to companies, the best opportunities in 2024 will be borrowers with a strong market position in non-cyclical industries, and which are ‘price makers’ and not ‘price takers’ ensuring they can deal with the impact of higher input or wage costs or a period of sustained inflation and supply-chain disruption. There are also opportunities to partner with banks as they continue to pursue capital optimisation initiatives or partner, rather than compete with private credit funds.

Strong growth for real estate credit, but a careful approach is needed

Australia’s vast and highly diverse residential market continues to grapple with acute undersupply in the face of soaring demand. Despite the market imbalance, the forecast for residential prices over 2024 remains relatively benign as several key variables are in play.

Record levels of immigration, demographic changes, increasing average household size and acute affordability pressures are all impacting both the rental and owner-occupier market. A wide range of outcomes over 2024 is possible, depending on location and depth of the market.

We believe values will remain strongest in markets with the most acute demand/supply imbalance, for example, metropolitan Sydney.

The key questions for real estate credit investors will be:

1. The impact of the increasing affordability crisis on sales and prices, and
2. Which pockets of the market will continue to perform and offer opportunity.

Undoubtedly, the opportunities for private lenders to finance the growing demand for real estate credit will continue over 2024 as they work to complement the major lenders in addressing the critical housing shortage. Sound market fundamentals, security through first lien mortgages and an experienced manager to assess underlying value and exit strategies will remain critical to success

Defensive buying opportunities in alternative real estate

Buying opportunities not seen since the period following the 2008 global financial crisis are emerging in Australia’s accommodation hotel market.

Underpinned by positive supply/demand fundamentals, yields remain favourable relative to core real estate and the strength and recurring nature of revenue offers investors stable and durable income through a range of economic cycles.

Market dislocation caused by substantial increases in construction costs and the disruption to the travel industry due to the global pandemic has resulted in the opportunity to acquire assets at a meaningful discount to replacement costs. Under the right operator, with the right expertise and active management strategies offering scalable growth potential, accommodation hotels are a compelling investment case.

We see significant buying opportunities in 2024. This is as some existing owners will struggle to rebalance their capital structures with higher interest rates and lower valuations (and without access to new equity) along with the convergence of surging population growth, strengthening tourism figures, broad-based demand drivers from corporate and leisure sectors and positive demand/supply market fundamentals.

Unique investment opportunities are also arising for specialised alternative real estate assets like marinas and pubs.

Managed Fund

MA Secured Real Estate Income Fund

Australian Property

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Footnotes

1. Bloomberg, (VIEW LINK)
2. Australian Securities Exchange, (VIEW LINK)