Why Hall of Famer Chris Cuffe is bullish on private credit

Five years ago, barely anyone was talking about private credit. Now, private credit managers are struggling to keep up with the inflows going towards that asset class. One of those managers, Keyview Financial Group, is approaching $1 billion in assets under management and says deal flow and credit quality both continue to be strong. 

There also seems to be a plethora of interesting investment thematics right now. One of those is commercial real estate. For some, it's a no-go area given the slow return to office following the pandemic, the vulnerability of some tenants, and the sharp drop in values that were seen in 2022. But Keyview's Alex Hone sees things very differently:

"We're now operating in an environment where interest rate hedges might be rolling off, or sales might be running a bit slower," Hone said. 

"There's a variety of good quality assets where we've been able to provide bridge financing or working capital facility for companies to restructure their balance sheets. That's been a good theme for six-plus months now and we feel that will continue to be a good theme for us to exploit," he added.

In this wire, we'll summarise a conversation Hone held with Keyview director and veteran funds management executive Chris Cuffe about the key talking points surrounding this asset class right now. 

Cuffe is best known for his years building Colonial First State and as CEO of what is now known as Challenger Limited. He is also a member of the Australian Fund Managers' Hall of Fame. The two will answer some of the key concerns investors are raising about private credit as an asset class and answer some of the misconceptions that exist in the market.

Private credit is here to stay

One of the key claims private credit sceptics have about the asset class is its outsized returns for what they argue is an unregulated and unquantifiable risk. But as Cuffe explains, the outsized returns don't come without a lot of manager skill.

"I think it's a legitimate sector that's here to stay, and I think it continues to surprise people with the returns being earned from it. But as we know, not all the glitters is gold, so you have to know what you're doing," Cuffe said. 

For some high-net-worth and sophisticated investors, private credit is receiving a lot of old money that was in equities and fixed income. Cuffe and Hone don't think of private credit as a "growth" or "defensive" play exclusively. Rather, they think of it as a legitimate portion of a fixed income allocation.

"I know plenty of portfolios where this is a double-digit allocation, maybe even up to 20% or more, depending on the investor's profile and their time frame," Cuffe said.

"The funding [for this asset class] has come out of a range of different asset classes, and that probably shows the unique characteristics of private credit," Hone added.

3 questions every prospective investor should ask about private credit

So, how can an investor do their due diligence and find out if a private credit firm cuts the mustard? Firstly, it's about diversification.

"In my view, your friend in private credit is a reasonable-sized fund with plenty of securities underneath. The reality is that things do go wrong in lending from time to time. The question is, how do you trade out of that, how do you work with the company, and what controls and security you had to start with," Cuffe said.

The second thing to look out for is the area of the asset class they operate in. That is, how niche is the area that the manager is operating in and are you prepared to take on that risk?

Finally, and most importantly, find out the team's experience.

"This is an asset class where, far more than the public markets, you can create really good value, but you need highly skilled people doing it. That's part of the reason the banks can't do it," Cuffe noted.

Is transparency around fees and returns improving?

One of the other big sticking points for private credit sceptics is transparency, specifically around fees and returns. 

Private markets have always been a difficult area to get industry-wide reporting on, especially before the arrival of organisations such as Preqin, who have worked to democratise access and data in this particular investment sphere. 

In private credit specifically, there is still no one industry-wide report which is why regulators remain so concerned about what will happen if and when something major happens. But that doesn't mean the asset class is not transparent already.

"I think there was some of that in the past, but the reporting of private credit players (certainly the ones I've dealt with) is good. It's regular, and often [it's] monthly. Most private credit players will also tell you if they've got a loan that's coming under some stress," Cuffe said.

The more important thing to Cuffe isn't fees but rather after-fee returns. Do the returns match up with the difficulty of the project, and are these returns highly volatile year-to-year?

"If it's a very complex transaction, the manager earns a good fee, and the investor receives a great return, that's a win-win to me," he said.

Even distribution payouts have changed in the last few years. Once upon a time, distributions in this asset class were very irregular. That has changed dramatically with many funds offering quarterly or even monthly distribution payouts. Having said this, don't start thinking private credit is about to become some sort of magic cash machine.

"I don't think any investors should think of private credit as an ATM. It's not a cash account. They offer high returns but it is an illiquid investment," Cuffe said.

Finally, is your money really locked up for years?

In short, not anymore. A few years ago, it was common for private credit investors to be locked up in funds for years at a time. Of course, this worked in a zero-interest rates era where there was essentially no inflation and no reason to panic. But all that seems to have changed.

"Now, those lock-up periods are much lower and the redemption periods are much shorter," Cuffe said.

"Of course, they're always subject to a manager being able to redeem and having the money there to do it. This is normally not a tough ask in the short-term because managers have loans that are running off all the time and because portfolios tend to be short - a couple of years in length only." 

You can catch Hone and Cuffe's full conversation here.