CPA Australia has weighed into the debate about the cost to oversee the industry, adding its voice to those who argue the fee structure favours the larger funds.
US President Donald Trump’s tariff announcement has driven spreads wider. In this volatile market environment, investors need to exercise caution and keep a careful eye on the fundamentals.
Private credit funds experiencing explosive growth: Zenith
Australia’s private credit funds are more than 30 times larger than regulatory estimates, triggering concerns about the experience and expertise of some providers cashing in on booming private and institutional demand, according to analysis by Zenith Investment Partners.
The research found about $60 billion in private credit broadly split between retail and wholesale investors compared with a recent estimate of about $2.8 billion by the Australian Securities and Investments Commission (ASIC).
That estimate excludes another estimated $30 billion that might be held in large industry funds.
Dugald Higgins (pictured), head of responsible investment and real assets at Zenith, says he is supportive of private credit “in principle”, but fears there is a risk the proliferation in providers is outpacing “robust design and delivery”.
“A lot of products seem to lack evidence of appropriate skill sets, risk and governance, or track records through asset, credit and leverage cycles,” he warns.
Private credit, also known as private debt, is finance for business that is not traded on public markets and is typically arranged by non-banks as an alternative to bank lending and public debt market finance.
The recent ASIC report says private credit funds had increased by about 240 per cent in the past decade from about $600 million to $2.8 billion. It conceded that “better-quality data” about the size of the sector was needed, adding that other estimates of the total ranged from $1.8 billion to $188 billion. The Reserve Bank estimates the market to be about $40 billion.
ASIC concluded that the private credit market did “not appear to be systemically important” in Australia, but warned “failures are on the horizon, and at current volumes it is untested by prior crises”.
Higgins agrees there is no evidence of systemic issues, but warns there could be “material issues for (individual) funds”.
Potential risks range from governance problems, inaccurate valuations, poor processes for management of conflicts and liquidity through to issues about financial reporting and audits.
Demand for private credit has increased as traditional banks became more selective in their commercial lending, particularly following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry that reported in 2019.
In addition, private credit’s ability to be flexible and quick in providing funding has increased their attractiveness as demand increases for major projects, such as infrastructure and energy transition.
Providers include global heavyweights such as KKR and Goldman Sachs but most providers are local.
Higgins says: “We must remember these are risk assets, not risk-free assets. The trick is discerning between the high-quality propositions and the junk.”
A sharp increase in fund launches increases the risk that any spike in failures among poorly run funds will undermine market sentiment and affect all funds, irrespective of quality, he adds.
“This can be especially damaging when dealing with low liquid assets,” he says. “A widespread loss of sentiment can cause a system-wide surge of redemption requests that will inevitably be unable to be met, because these funds are not designed to be highly liquid.”
Rodney Sebire, Zenith’s head of alternatives and global fixed income, says different lending strategies and levels of risk makes navigating private debt a “minefield”.
“Managers employ a range of strategies, however the ability to compare performance across managers is difficult given the nature of private lending and the differences between individual loans, covenants and security packages.”
For example, a manager with an “impeccable track record” with no technical defaults could pass a first review without revealing the number of loan restructures, payment deferrals or covenant reliefs.
“In challenging environments, the type of lending, quality of underwriting, level of covenant protections and security packages quickly separates good managers from those with relaxed standards,” he says.
Financial problems linked to private credit arrangements have created operational issues for Healthscope, the nation’s second-largest private hospital operator.
Sebire adds: “Current challenges in the healthcare sector illustrate how excessive debt, rising borrowing costs and declining revenues can lead to debt restructures to protect equity investments.”
Higgins says the different estimates of the market size could be caused by failure to keep up with rapid market growth, using different assumptions and the “challenges of data collection”.
ASIC declined to comment.
