With the Reserve Bank of Australia (RBA) cash rate at historic lows and dividends being cut, it is becoming increasingly difficult for investors to find reliable sources of income for their portfolios.
So, what are the options for income-seeking investors, how can they obtain better returns than cash, with better liquidity than term deposits?
What are direct corporate loans?
One avenue for investors to consider is moving slightly up the yield curve to direct private lending to Australian companies. While it is often overlooked by retail investors and underrepresented in media headlines, this subset of fixed income can provide attractive risk-adjusted returns and is a large market in its own right, contributing around 77 per cent of all debt funding to Australian corporates (in addition to the equity shares of those companies).
Corporate lending is the means of providing loans to businesses of scale (i.e. not small to medium businesses) for a specific purpose and without them, most companies would not have enough funding for business activities such as acquiring other businesses, buying equipment or purchasing assets such as real estate.
This sector was traditionally dominated by banks, but in the years since the global financial crisis, increased regulation has driven up the cost of bank funding, leaving an opportunity for alternative asset managers like Metrics to seek to provide investors with access to this attractive market.
The way corporate loans are structured provides a range of protections for investors; floating rates provide protection against inflation and loans are often secured against the borrower’s assets. Lenders in the market typically undertake rigorous due diligence before lending and ongoing engagement with borrowers is often maintained throughout the loan term to assess and manage risks.
In addition, the size and diversity of the market mean there are opportunities to suit a wide range of investor needs – from lower risk investment-grade assets to investments that offer the potential for higher yields but with more associated risk although less risky than equivalent equity positions.
Offering both capital stability and regular income, corporate loans provide a compelling alternative to other fixed-income assets. And while the majority of investment opportunities are via unlisted institutional funds, there are now select opportunities available for retail investors in the Australian market.
For investors who are considering dipping a toe into the corporate loan market, we believe accessing a well-diversified fund is key. While the corporate loan loss rate in Australia is low, at just 0.32 per cent over the past 10 years, a well-diversified portfolio of loans helps further limit downside risks, while allowing investors to participate in a range of sectors.
The future for equity markets is looking increasingly uncertain, bond yields are depressed and cash and term deposits look set to deliver lacklustre returns for the foreseeable future. For investors seeking regular income in a low-interest rate environment, we believe the corporate loan market warrants a closer look.
Andrew Lockhart, managing partner, Metrics Credit Partners