Private debt has rapidly gained prominence in investor portfolios over the past 10 years. Yet it is not a new or untested asset class in the global arena. In recent times, it has garnered significantly more attention within both institutional and private client investment circles. And it’s not hard to see why—the rapid increase in interest rates in 2022, combined with slower public market debt issuance through 2023, saw total yields increase to highly attractive levels, often double digits depending on the risk profile and use of leverage.
With such attention (and returns) comes heightened scrutiny on the asset class, alongside broader private markets as seen with ASIC’s recent discussion paper Australia’s Evolving Capital Markets: A Discussion Paper on the Dynamics Between Public and Private Markets. Such a discussion can be healthy of course but can also confuse what we believe is a sound, long-term investment thesis when used in an institutional manner—as a result, we continue to build private debt into investor portfolios. In this month’s Core Offerings, we explore the value of private debt, discussing its breadth and some of its associated risks.
Alternative asset specialist KKR recently stated that “private debt is, in the simplest of terms, the extension of credit by non-bank financial lenders. It is defined by who is performing the lending, rather than the kind of lending being done”. Private debt is a broad market, it reaches the same markets as public and commercial markets.
There is far more than just the evaluation of returns when assessing private credit managers and dispersion of returns is typically much higher in private relative to public markets, stressing the importance of manager selection. We apply a rigorous screening process when it comes to selecting private debt managers, and we are currently introducing more global focused strategies given their breadth and maturity relative to domestic players.
A key focus of ASIC’s discussion paper was on private debt and highlights several due diligence factors, including valuations, where in Australia, private debt is generally not marked-to-market in a comparable way to global peers. We view ASIC’s discussion as a positive evolution of Australia’s private debt market, as we see any movement towards greater transparency and more robust valuation practices as beneficial to both retail and institutional investors.
“Private debt is the extension of credit by non-bank financial lenders. It is defined by who is performing the lending, rather than the kind of lending being done.”
From a Strategic Asset Allocation (SAA) perspective, we assess private debt (like any other asset class) through our proprietary risk factor lens. This framework, detailed in our June 2024 Observation, Splitting the Investment Atom, gives us deep insight into the underlying risk and return drivers behind all investment markets and allows us to evaluate and compare the merits of any asset class relative to our entire investible universe. This lens illustrates that, at least from a top-down perspective, private debt’s role in a multi-asset portfolio is to provide efficient exposure to credit risk, an illiquidity premium (that compensates an investor for owning an illiquid asset), and other idiosyncratic risk drivers (unique risk to an individual asset, bespoke deals, and greater management alignment).
When assessing historical returns of closed-end funds, private credit has outperformed publicly traded syndicated loans in every vintage year from 2000 to 2023.
This provides us with context for why private debt warrants consideration in investor portfolios. It also sheds some light on why historically, private debt has demonstrated the potential for attractive risk-adjusted returns, often exceeding those of public debt markets.
When assessing historical returns of closed-end funds, private credit has outperformed publicly traded syndicated loans in every vintage year from 2000 to 2023; this has equated to 0–3% per annum (10 years to September 2024). This outperformance stems partly from an illiquidity premium—compensation for holding assets which aren’t easily traded, along with a complexity premium often associated with structuring bespoke deals.
Private debt’s role in a multi-asset portfolio is to provide efficient exposure to credit risk, an illiquidity premium, and other idiosyncratic risk drivers.
Given the level of attention and product proliferation afforded to ‘private debt’ in recent years, Australian investors could be forgiven for believing that private debt as an asset class is synonymous with domestic Commercial Real Estate (CRE) lending. The private debt universe however extends far beyond any single strategy or geography. The table below highlights the primary sub-sectors, the total market size of each, how banks and the public markets participate, and the numerous private strategies available to investors.
Private debts’ characteristics combined with its diversification benefits (from its breadth as an asset class) support our case for a dedicated allocation within portfolios.
In building out our private debt allocations, the primary focus areas have been across the two largest sectors, namely corporate lending and asset-based finance. We invest in CRE, in addition to distressed debt and special situations globally. However, these exposures are typically a component of broader offerings versus dedicated strategies. We consider these sub-sectors to be more ‘satellite’ in nature and as such would allocate a smaller allocation within our clients’ portfolios.
In building out our private debt allocations, the primary focus areas have been across the two largest sectors, namely corporate lending and asset-based finance.
The corporate sector is the largest and most mature sector on a global basis. The key strategy is direct lending, involving (typically, floating rate) loans made directly to companies to finance operations, growth, or acquisitions, either with a private equity sponsor (eg loans to companies owned by a private equity firm) or without (non-sponsor-backed). The sector has not only grown significantly in absolute terms, but also on a relative basis as a segment of the total addressable sub-investment grade credit market as depicted in the bar chart below. With the level of private equity ‘dry powder’ at near record highs, further growth is anticipated with industry research suggesting that private credit could reach USD 2.6 trillion alone by 2029 (Preqin as at 18 September 2024).
Despite the competition and growth in the sector, risk-adjusted returns in direct lending remain attractive and we expect it to remain the dominant allocation in private debt portfolios.
Corporate lending is the largest and most mature private credit sector gloablly. The key strategy is direct lending, involving loans made directly to companies to finance operations, growth, or acquisitions, either with a private equity sponsor or without.
The asset-based finance (ABF) sector extends credit against diversified pools of hard or financial assets as opposed to lending to operating businesses. It is a critical tool for financing the day-to-day activities for millions of businesses and consumers globally and crosses a broad range of credit types from residential mortgages, credit cards and student loans, to planes, trains, automobiles, sports and entertainment royalties.
Making the case for ABF is its:
Asset-based finance is a critical tool for financing the day-to-day activities for millions of businesses and consumers globally and crosses a broad range of credit types from residential mortgages, credit cards and student loans, to planes, trains, automobiles, sports and entertainment royalties.
Private debt currently, can provide equity-like returns and lower volatility (owing to the lack of a daily mark to market pricing). It sounds attractive, but investors also need to consider the underlying risks inherent in private debt markets.
Investors need to consider the underlying risks inherent in private debt markets.
It’s important to highlight that corporate direct lending globally translates largely to sub-investment grade credit (ie equivalent to public high yield bonds and syndicated loans of BB+ quality or below). While senior positioning in the capital structure gives lenders priority claims over assets, it does not mean that the underlying credit quality is investment-grade.
Defaults are a reality in all lending and is a normal part of the credit cycle. It is therefore a primary risk factor when investing in the asset class. In the last five years, corporates have experienced the impacts of both COVID-19 and the rapid rise in interest rates through 2022. Both these events have heightened the level of defaults across public and private credit portfolios. Defaults often grab the headlines, but the general rhetoric often misses the impact of recovery rates which impact ultimate loss rates on loans and portfolios.
Recovery rates dictate the amount a lender can recuperate after a borrower defaults and are determined by numerous factors including the seniority of and type of security attached to the debt, the extent of the deteriorating financial health of the business, and industry, macroeconomic, and other factors. Of critical importance is the lender’s credit underwriting and ability to work-out a challenging scenario with the company and the private equity sponsor—genuine experience and appropriate resourcing is imperative here.
The chart below shows average annualised loss rates catering for both default and recovery rates, across direct lending and public markets. Such losses appear fairly benign. However, it is important to highlight that default, recovery and loss rates will vary from the average through the cycle (eg in more ‘stressed’ years like 2020 where year-end loss rates were higher). Similarly, a more extreme recessionary scenario ahead could see default rates pick up materially and recovery rates decline resulting in larger losses.
New global private debt offerings are often employing fund-level leverage.
With the influx of global private debt offerings coming to the market, one also needs to consider that fund-level leverage is often employed with many such offerings adding 0.5-1.0x leverage (ie $150–200 exposure per $100 invested). Clearly this increases risk as potential losses can be magnified, but conversely, it also increases returns which is how many funds have been able to deliver double digit yields post high fee loads.
When looking at domestic strategies, a far shallower market typically results in lower loan-level diversification exposing investors to greater idiosyncratic risks associated with individual positions. Single sector strategies (eg CRE) also focus capital on specific return and risk attributes associated with a given sector. That does not imply that local or sector specific strategies should not be used; it just means that sizing needs to be adjusted to cater for the heightened concentration to specific loans or sectors.
The ‘Liberation Day’ tariffs announced in early April sparked extensive market volatility and a sizeable intra-month correction in risk assets. Amidst the market panic, we employed our constraints-based framework to develop a set of clear signposts to chart a course through the chaos. These disciplined signposts helped us identify a potential peak in US policy uncertainty as US President Trump ran into his key constraint—the bond market. We used this opportunity to further increase our overweight to equities via a special intra-month tactical tilt which has proved accretive amid ongoing moderation in the US’ trade stance. We remain constructively positioned overall and are primed and ready to respond to emerging risks and opportunities.
Navigating policy uncertainty: Trump 2.0 heralds potential tailwinds for the US economy but also more political and geo-political uncertainty. Investors will need sound frameworks and steady hands to navigate potential disruptions prudently.
Can central banks secure the soft landing? Benign inflation allowed central banks to cement a global rate cutting cycle in 2024. The challenge for 2025 will be balancing how much they ease to support growth without re-igniting inflation.
Discovering opportunities beneath the surface: Elevated valuations mean that the best opportunities may lie beneath the broad index level, rewarding more active ‘hunter’ versus passive ‘gatherer’ investors.
Fortune favours the bold: 2025 is likely to favour investors who can digest and exploit the opportunities that come with market volatility. Prudent portfolio diversification and active management will be important tools in the astute investor’s arsenal.
This document has been authorised for distribution to ‘wholesale clients’ and ‘professional investors’ (within the meaning of the Corporations Act 2001 (Cth)) in Australia only.
This document has been prepared by LGT Crestone Wealth Management Limited (ABN 50 005 311 937, AFS Licence No. 231127) (LGT Crestone Wealth Management). The information contained in this document is provided for information purposes only and is not intended to constitute, nor to be construed as, a solicitation or an offer to buy or sell any financial product. To the extent that advice is provided in this document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your ‘Personal Circumstances’). Before acting on any such general advice, LGT Crestone Wealth Management recommends that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of a financial product, you should obtain and consider a Product Disclosure Statement (PDS) or other disclosure document relating to the product before making any decision about whether to acquire the product.
Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, LGT Crestone Wealth Management and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances.
LGT Crestone Wealth Management, its associated entities, and any of its or their officers, employees and agents (LGT Crestone Group) may receive commissions and distribution fees relating to any financial products referred to in this document. The LGT Crestone Group may also hold, or have held, interests in any such financial products and may at any time make purchases or sales in them as principal or agent. The LGT Crestone Group may have, or may have had in the past, a relationship with the issuers of financial products referred to in this document. To the extent possible, the LGT Crestone Group accepts no liability for any loss or damage relating to any use or reliance on the information in this document.
Credit ratings contained in this report may be issued by credit rating agencies that are only authorised to provide credit ratings to persons classified as ‘wholesale clients’ under the Corporations Act 2001 (Cth) (Corporations Act). Accordingly, credit ratings in this report are not intended to be used or relied upon by persons who are classified as ‘retail clients’ under the Corporations Act. A credit rating expresses the opinion of the relevant credit rating agency on the relative ability of an entity to meet its financial commitments, in particular its debt obligations, and the likelihood of loss in the event of a default by that entity. There are various limitations associated with the use of credit ratings, for example, they do not directly address any risk other than credit risk, are based on information which may be unaudited, incomplete or misleading and are inherently forward-looking and include assumptions and predictions about future events. Credit ratings should not be considered statements of fact nor recommendations to buy, hold, or sell any financial product or make any other investment decisions.
The information provided in this document comprises a restatement, summary or extract of one or more research reports prepared by LGT Crestone Wealth Management’s third-party research providers or their related bodies corporate (Third-Party Research Reports). Where a restatement, summary or extract of a Third-Party Research Report has been included in this document that is attributable to a specific third-party research provider, the name of the relevant third-party research provider and details of their Third-Party Research Report have been referenced alongside the relevant restatement, summary or extract used by LGT Crestone Wealth Management in this document. Please contact your LGT Crestone Wealth Management investment adviser if you would like a copy of the relevant Third-Party Research Report.
A reference to Barrenjoey means Barrenjoey Markets Pty Limited or a related body corporate. A reference to Barclays means Barclays Bank PLC or a related body corporate.
This document has been authorised for distribution in Australia only. It is intended for the use of LGT Crestone Wealth Management clients and may not be distributed or reproduced without consent. © LGT Crestone Wealth Management Limited 2025.
