In this week’s video insight, I discuss how private credit funds can be an effective strategy for Australians, especially during the current cost–of–living crisis. I delve into why these funds might be a helpful addition to your investment portfolio, particularly in these challenging economic times. I provide a general overview of private credit as an asset class and explore its potential benefits, including the potential for regular income generation and risk management.  

Transcript: 

Hi everyone, I’m Roger Montgomery from Montgomery Investment Management, and welcome to our video insight. This week we’re diving into a topic that’s top of mind for many of us here in Australia – the cost-of-living crisis. It’s tough out there, and today, I want to explore a financial strategy that might not be on everyone’s radar but could be incredibly beneficial during these times: investing in private credit funds. So, let’s break it down in a simple, straightforward way. 

All the comments I make here refer to private credit funds generally or as an asset class, rather than any of the funds we distribute in Australia. 

First up, what exactly is private credit? Put simply, private credit is lending money, either directly or through warehousing, to companies or individuals, outside of traditional banking by non-bank lenders. It’s a way for investors to potentially earn returns, that are reliable, relatively stable, and regular. It’s especially appealing when compared to public markets which are volatile and unstable. 

Now, you might wonder, ‘Why consider private credit during a cost-of-living crisis?’ Well, it’s all about diversification and potentially higher returns. Private credit funds often target higher interest rate returns compared to what you might get from say, savings accounts or government bonds. That’s particularly useful when every penny counts, and it’s also useful when many alternatives only pay out their income at the maturity of the investment or semi-annually. Some private credit funds have reliably paid out their returns monthly, which is very handy amid current economic circumstances. 

So, if we’re talking about benefits, the biggest one is regular income generation at attractive rates of return. Private credit funds can provide a steady flow of income through interest payments – something incredibly valuable when the price of everything seems to be going up much more than the official inflation rate suggests! 

Another key point is risk management. Investing in private credit can also provide important diversification benefits, such as reducing volatility by holding some of your portfolio away from more volatile public markets. Many investors might also think of private credit as risky. And if we were having this conversation before the global financial crisis (GFC) when the banks completely monopolised lending to small and medium corporates, I would agree with them. Back then, one would only be able to lend to the businesses the big banks rejected. But since then, regulation and various banking inquiries have resulted in the major banks reducing their exposure to some business lending. Today, there is a $200 billion gap between what small and medium corporates want and need for growth and what the major banks are willing to lend. That gap is now being filled by private credit lending, and many businesses that are borrowing, are very high-quality businesses. Oh, and that reminds me of something else; there’s a big difference between private credit funds that lend to higher-quality borrowers and those that may solely focus on lending to distressed businesses. 

Private credit is a well-established asset class overseas and has long been the preserve of high-net-worth and ultra-high-net-worth investors. More recently, private credit funds have proliferated in Australia, which reminds me to warn you to carefully consider the track records of the private credit funds you are considering. Be sure the manager can point to a longer-term track record. While that track record isn’t a reliable indicator of future returns, it may go some way to helping understand another risk. 

Of course, no investment is without risk. Another one to consider is liquidity – meaning how easily or often you can withdraw your investment. Some funds offer monthly liquidity, others are quarterly or annually, and others might lock you in for the first year or so. It’s important to know how much notice you have to give before redeeming your investment and how often that much-needed income is paid. 

So, how do you get started? Well, it’s not a step to be taken lightly. You’ll want to do your homework and talk to a financial advisor if anything requires explaining. Look at the manager; how long is their track record? Have they invested through tough economic times? Have they missed or deferred payments, or have they paid out monthly income without a blip? What types of loans does the fund make? Do they concentrate on a particular industry, like property development, which is arguably riskier than other industries? Do they have a small pool of large loans that you’ll be investing in, or are you lending to a large pool of small loans? What is the average term of the loan portfolio? A pool or book of loans with an average term of two years has a different risk profile to a book with an average term of a few months. And are the interest payments variable or fixed? If interest rates rise, it may be preferable to receive a variable return that potentially rises alongside rising official rates. And of course, be sure to understand the fee structure. Cheapest, by the way, is not always better. 

To wrap up, investing in private credit could be a sound strategic move for you during economic uncertainties like our current cost of living crisis. For some investors, missing out on higher monthly cash income just doesn’t make sense. So, private credit has the potential to relieve some of the pressure. The offer of potentially higher returns and income generation is definitely appealing, but like all investments, it requires careful consideration and advice. 

Thanks for watching, everyone. If you found this information helpful, let us know in the comments or give us a thumbs up and subscribe for more insights. If you have any questions about, or experiences with private credit, leave a comment below, send an email to investor@montinvest.com or call (02) 8046 5000 – We’d love to hear from you.