Alex Ramsay (Infradebt), Theo Calligeris (Realm Investment House), and Tom Schubert (Drummond Capital Partners) share their insights into how they’re thinking about portfolio construction when picking a good private credit option.

The team at Drummond Capital Partners is just as passionate about managed accounts as it is about private markets and bringing these assets to the private wealth sector. This year, Drummond launched a quarterly liquid managed account, which focuses on allocations to private equity and private credit. 

In allocating to private markets, Tom Schubert — Managing Partner/Portfolio Manager at Drummond Capital Partners — says the business has reviewed 70 private credit managers and screened out almost half of these over the last 12 months. Currently, Drummond only uses four of these managers, with a few others short-listed for possible future inclusion.

In making the case for private credit, Tom believes it’s an attractive asset class to be invested in. The market has grown 16.1 per cent since 2015 and has a value of US$1.7 trillion (as at 2023). This growth has largely been attributed to the banks stepping back from riskier and more complex lending (post-GFC), as a result of tighter regulation and higher capital requirements, with private credit stepping in to fill the void.

“Demand for yield has seen a lot of investor interest in private credit,” says Tom. “Credit spreads in this asset class are quite attractive relative to their public market equivalents, so there is a good liquidity premium available for investors.”

Speaking on private credit at the 2024 IMAP Independent Thought Conference, Tom says as a result of some significant super fund failings locally in private markets, ASIC is looking to review this sector from a governance and regulatory perspective, which will impact manager selection.

“Having reviewed many global private credit managers, particularly in the U.S. where this asset class is well established, we’ve found the governance standards in the U.S. are far higher compared to Australia. Better regulation of this sector will be good from an investor outcome perspective, as well as for the sustainability of the sector,” says Tom.

“As allocators, we need to be more aware of the risks in allocating to private credit managers. This means extra due diligence is required when investing in this space.”

When selecting a good private credit manager, Tom says there are a number of key factors to consider, as part of any due diligence process. Some of these include: the importance of manager scale (given the additional work required, and the higher cost of successful origination and execution of deal flow); risk management systems; governance structures; and a proven track record by the manager in private credit.

“Unlike public markets, manager performance in private markets tends not to ‘mean revert’ (top quartile stays top quartile). So, you could say, past performance is a good indicator of future performance in private markets,” he says.

As an active Australian fund manager with an absolute return focus investing in Australian credit and fixed income markets, Realm Investment House likes private credit. It is actively involved in the residential mortgage-backed security space, where it partners with major banks to lend money to non-bank lenders (like Athena and Pepper Money), which in turn lend this money onto consumers. Realm aims to help non-bank lenders build up (originate) large enough pools of mortgages to sell into the public market.

According to Theo Calligeris — Portfolio Manager at Realm Investment House — the residential mortgage-backed security space in Australia is a $120 billion market that is actively traded in this part of private credit. The reason why Realm is attracted to this sector is the relatively stable income it provides.

In contrast, as a specialist infrastructure fund manager, Infradebt has a focus on debt-lending to Australian infrastructure projects. Infrastructure debt is primarily asset-backed lending, and Infradebt’s clients range from large institutional investors, through to smaller wholesale investors.

Alex Ramsay — Co-founder and Investment Director at Infradebt — says the business lends to sole-purpose entities that own and operate large physical assets (or have a fixed long-term right to an income stream over a period of time) that have a defined single purpose, like renewables and social infrastructure.  

“What we’re looking for is stable revenue through the cycle, and that’s what a good infrastructure asset should deliver to you. And most importantly, the asset should have very high operating margins and low operating costs. That enables the entity to service the debt on a long-term basis,” says Alex.