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Is private credit a misunderstood giant in alternative investments?

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4 minute read

Private credit has surged to the forefront of alternative investments in recent years, but it remains one of the most misunderstood asset classes, according to a fund manager.

The size of the private credit market at the start of 2023 was approximately US$1.4 trillion, compared to just US$875 billion in 2020. According to some projections, it could grow to US$2.3 trillion by 2027.

But, notwithstanding its degree of growth, Frank Danieli, managing director and head of credit investments and lending at MA Financial, believes that private credit remains one of the most misunderstood asset classes.

“People don’t really yet understand what’s actually happening,” Danieli said on a recent episode of the Relative Return podcast.

Danieli explained that the popularity of private credit has actually been driven by tightening credit measures imposed by central banks.

“The theme here is not people out there taking more risk to get higher returns, but rather these huge, cavernous opportunities open up when banks, these massively scaled businesses, reduce the type of things they do,” he said.

“But those same borrowers, they need a solution and that you can step into that void, provide them that solution, and be paid a premium return for doing it.”

For players in the private credit market, Danieli explained the space is not without risk.

“Just because you can do a loan a bank used to do, doesn’t mean you won’t lose money,” he cautioned.

“You actually need to, in credit, have the right type of credit philosophy, the right type of process, the right internal discipline and skill sets to make sure that you are safeguarding capital first and foremost, and then making sure that you’re going to get a very resilient return.

“It’s quite a different way of thinking, the credit business, because we’re not necessarily trying to pick winners. It’s not like equities where you’re out there trying to find the best compound, multi-return bagger. Your primary job is to avoid losers and to make sure that capital is safe and that you can get your income very consistently, and that’s what your clients are paying you for.”

Danieli noted that fund managers are now trying to piggyback on the asset’s growth.

“Everyone is trying to become a private credit manager at the moment.”

Moreover, looking at the broader space of alternative investments, Danieli pointed to the increasing global integration of markets, with international players said to be showing increased interest in Australia.

“Here in Australia, we are now seeing more global managers come to Australia.

“We ourselves have gone global. We now have a team in New York and a platform there, a platform that we bought, which had operated there for a decade, but is now part of us and we’re growing.”

But with such rapid growth, mistakes become more commonplace.

Namely, Danieli explained that rapid market growth may lead to increased risk-taking, especially among newer participants unfamiliar with past lessons, while the migration of investors from traditional assets to alternative ones may erode discipline within traditional institutions, potentially impacting the market cycle.

“When you do see markets grow very quickly, you do have to recognise and be honest. I think that there will be parts of the market where some people are probably taking more risk than they should. And especially if you have newer and newer participants popping up, that some of those newer participants won’t know the lessons of the past and could make missteps.

“I think one of the other things that’s happened, as well as more interest from investors has existed in alternative assets, is that a lot of people from the traditional fixed interest or traditional asset classes have moved into alternatives.

“They might have moved out of banks into private credit funds, or they might have moved from one fund to another or whatnot. And that has also, I think, led to, in some instances, some of the discipline that you need in those traditional institutions actually having left. And that will be interesting to see how that plays out in the cycle.”

To hear more from Danieli, click here.