This asset class' growth journey is just beginning

Over the past few weeks, my colleague Hans Lee and I have been speaking with Keyview Financial Group, a specialist in opportunistic private credit, to better understand the burgeoning private credit market.

We’ve been asking the questions that investors want answered and the previous two instalments of the conversation can be found below. 

Private Assets

What investors should know about private credit (but probably don't)

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Investment Theme

Peeling back the curtain on the fastest-growing asset class in the market

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We’re finishing the series today with some Rapid Fire questions directed at Keyview’s Alex Hone and Kevin Hua.

Investors worry that an asset class growing quickly can mean it’s risky. Is that true?

We understand why investors can feel cautious about asset classes experiencing rapid growth. While private credit is growing strongly, the recent focus seems to be catching up with what has been taking place quietly for many years.

However, any form of expansion can raise concerns about potential bubbles, mispricing, or overly aggressive capital deployment.

That said, the relationship between growth and risk is not always direct.

At an asset class level, the growth is a reflection of evolving market opportunities (such as the banks retreating from corporate lending), investor demand for portfolio diversification into differentiated strategies, and the emergence of more sophisticated strategies to manage risk.

Within the asset class of private credit, we see risk as being based on three pillars:

• the skill and experience of the private credit manager through the cycle; and
• the quality of the underlying security; and
• the manager’s ability to maximise its protection through the loan structuring.

It’s common to hear a manager state that they prioritise capital preservation, and rightly so, given we should all be in the business of protecting investors’ capital. However, the team’s ability to undertake work out experience is important in order to assess their ability to perform through the cycle, i.e. how skilled the manager is at preserving capital.

The security quality is paramount. Understanding residual value in a recessionary market environment is the appropriate approach in assessing the actual margin of safety and the ability to realise value.

Finally, the benefits of undertaking bilateral loans rather than being a small participant in a large syndicate should not be underestimated. It allows for bespoke terms around loan covenants as well as control should a loan breach occur and enforcement be necessary.

Overarching this, we would argue the mindset of the private credit manager is important.

At Keyview, we loan more like we are investors in the borrower’s business.

This mindset leads to thinking like business partners where we understand and actively manage the relationship with our borrowers. We believe this results in better outcomes for our investors and for us to take proactive measures early.

What about regulation and lending standards... does more need to be done?

Australia has one of the most sophisticated regulatory frameworks globally. As regulations stand today, private credit managers must operate according to obligations set by ASIC, APRA, Australian Financial Services Licences (AFSL), anti-money laundering and counter-terrorism financing regulations, consumer protection laws and Australia’s Foreign Investment Review Board. With fiduciary responsibility for people’s investments, it’s important and right that the appropriate protections for investors are in place.

Keyview is also a member of the industry’s peak body, the Alternative Investment Management Association, which engages with governments to put in place appropriate checks and balances. It views regulation as important to keep the industry accountable but also views regulation as an operational base level as all managers should have higher standards for investor protection and lending practices.

After all, if the industry isn’t doing the right thing, then investors will lose confidence and allocate their investments elsewhere.

Putting regulation aside, we think more needs to be done in investor education. Private credit is a more mature asset class in the U.S. and Europe, but it is still nascent in Australia. This means some investors are still coming up the curve in terms of understanding the different investment types in the sector as well as how a particular fund manager is investing their money, how they charge fees, and what they can expect in terms of transparency from their manager. The greater the sophistication of investors, the more pressure will be applied to managers to ensure they are operating in investors’ best interests.

As many have said before us, not all private credit managers are the same. As investors better understand the sector, we believe they will be in a stronger position to judge the private credit manager’s experience – both in structuring loans to maximise protections for investors and working out distressed loans to minimise or completely avoid capital losses. Our team has decades of experience across all market cycles. We have had loans deteriorate, triggering us to take action. Investors are well served to understand if their private credit manager has such work out experience.

Are there too many players? Does private credit need consolidation?

While private credit is receiving a lot of attention, the sector remains in its infancy in Australia relative to offshore markets. It is actually quite small on an absolute and relative basis to the overall Australian lending market, which remains dominated by the major banks.

For example, the largest non-bank lender is less than 1% of the Australian lending market and there are only a handful of domestic players who have in excess of $1bn funds under management.

That being said, there are a very large number of start-up or sub $500m participants, which may well consolidate over time as certain segments become more commoditised and the cost of participation increases.

We may also see more non-credit managers or offshore managers looking to move into private credit. If they’ve decided not to build their own private credit business organically, they may acquire existing players to establish themselves in the market. We have started to see this dynamic play out and it is likely to contribute to consolidation of managers.

Who will be the winners and losers – is it simply a matter of scale?

Like any market opportunity, to survive you are either the lowest cost producer or you differentiate. In terms of private credit, capital is a commodity and so the lowest cost producer is simply going to be a matter of size and having the lowest cost of capital.

Beyond that, there are many segments of the market where differentiation is possible and will allow a variety of players (of all sizes) to continue to service borrowers for an extended period of time.

Ultimately, private credit fund managers will be judged like public markets fund managers, i.e. on track record and performance.

While private credit currently has strong structural tailwinds, it is also an asset class that has a long history offshore and a long-term future in global capital markets.

Private credit is as embedded in capital markets as private equity. It is, and will always remain, an important segment of capital markets as asset owners and companies raise capital for growth or balance sheet efficiency. As the asset class continues to mature in Australia, it will grow as a function of both general credit growth in the economy and taking market share from large incumbent commercial banks.

What happens to growth from here?

Bringing this back to the broader addressable market and structural tailwinds, we believe we are only at the start of private credit’s growth journey in Australia.

What this ultimately means is strong levels of deal flow, the emergence of more credit funds, consolidation in the industry and the potential for moderation in returns over the medium to long term (in step with base rates) as non-differentiated participants increase.

While we believe the industry will continue to accelerate, credit managers' long-term success will depend on a moderate but sustained level of growth that doesn’t chase growth at the expense of credit quality.

Where does Keyview fit into this space? What does winning look like for you?

Delivering target returns through market cycles, coupled with protecting investor capital, is ultimately our key objective. We have always been certain that if we continue to deliver outcomes for our clients, then our corporate objectives are achieved. It is also why we believe so strongly in alignment and ensuring our own capital is invested alongside our clients’.

We are excited about continuing to help companies and asset owners with bespoke funding requirements that deliver them valuable economic outcomes while providing very strong risk adjusted returns for our clients.

To learn more about how Keyview uses the three levers of risk, return, and complexity to drive returns, you can read a previous article by Keyview's Miki Cvijetic - "High returns without high risk - Is it possible?" - here. 

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Keyview Flagship Fund

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Keyview Credit Opportunities Fund

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