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Australian institutional investors turn to private markets for risk management

By Jessica Penny
4 minute read

Australian institutional investors are reducing investment risks as a direct result of the current environment by increasing their allocations to private credit, according to State Street.

While the majority (58 per cent) of investors in the Asia-Pacific (APAC) are not convinced inflation has peaked, new data from State Street’s private markets allocations survey has shown that Australian investors are a little more optimistic with over one in two noting they believe inflation has stabilised.

However, despite the increased optimism, the survey did show that Australian institutional investors are diversifying away from crowded markets into fresh niches to sustain their portfolio performance.

Speaking to InvestorDaily, State Street’s Eric Chng said the firm has spotted an increasing shift among Australian investors from private equity to other private market asset classes – 57 per cent compared to 46 per cent in the APAC.

“This trend is underpinning exponential growth in the private credit space as one of the prime examples of strategy rotation. Infrastructure and real assets remain a favourite domain amongst Australian investors,” Chng said.

Despite the headwinds, investors generally see private markets as an attractive long-term asset class, he explained.

“Australian investors are also looking at enhancing risk management processes.

“Based on our survey, currently Australian institutional investors hold 31.7 per cent of private assets in their overall portfolios. They see the percentage goes up to 37.5 per cent of their portfolios within the next 3–5 years.”

This significant shift necessitates robust risk management processes and data harmonisation across asset classes, Chng highlighted.

Moreover, playing into this theme, Chng said as many as 33 per cent of local respondents are hiring specialists in alternatives, compared to just 23 per cent for APAC respondents.

“This is a key development arising from expectations that as the investment universe expands into newer strategies and more complex asset classes, the need for talent to augment the skill sets necessary to form front office investment allocation to middle and back office talents will increase dramatically,” Chng said.

“Operating models will need to be refreshed and transformed to meet future challenges.”

Ultimately, Chng highlighted that despite near-term challenges in fundraising timelines, APAC investors are drawn to private markets for their inflation-hedging attributes, longer-term nature, and performance generation potential.

“Many private companies are also staying private for longer due to the availability of capital to support their growth within the private markets,” he said.

According to State Street, APAC investors view private equity (70 per cent), real estate (64 per cent), and infrastructure (72 per cent) as the main asset classes they will increase allocations into over the next 3–5 years supporting the views above.

Last month, investment executives responsible for over $220 billion of Australians’ retirement savings said they have identified opportunities in private credit, a market tipped to grow to US$2.3 trillion over the next five years bolstered by banks ceding territory in corporate and institutional lending as they face increased funding costs, a renewed focus on shareholder returns, and ramped up regulatory pressures.

Also in April, the International Monetary Fund (IMF) noted the burgeoning popularity of private credit over the last few years, citing features like speed and flexibility as particularly appealing to borrowers. Heightened interest is also being shown by institutional investors, like superannuation funds, due to the asset’s offer of higher returns and less volatility, the global fund said.

“It’s the flavour of the month,” said John Pearce, chief investment officer at UniSuper, at the Asia Pacific Financial and Innovation Symposium in Melbourne in April.

“We’ve been allocating to private credit, particularly in Europe, that’s where there is some really attractive spreads at the moment, where the banks aren’t willing to play in that mid-corporate market … It’s really attractive.”

Similarly, speaking on an InvestorDaily webcast, Metrics Credit Partners managing partner Andrew Lockhart forecast that banks will progressively continue to cede market share, a trend that is creating opportunities for private credit providers to fill the gap and cater to borrowers seeking alternative finance options.

“We certainly are of the view that the market will continue to move towards private investors, private credit providers, and the regulated banks will probably continue to move more and more towards consumer home loan financing and lending for small and medium sized businesses,” Lockhart told InvestorDaily.