How The ‘Four Ds’ Are Shaping Private Credit Investment

It’s not just demographics that are our destiny.  A range of generational tailwinds are set to benefit the alternative investment universe, with investors being the clear winner.  In a world of volatility and soft growth, one alternative investment – Private Credit – is beginning to roar.

With major generational trends providing the wind in its sails, alternative investments, including the burgeoning private credit sector is emerging as a foundational piece for investment portfolios.  This has not always been the case for retail investors.  And for anyone who has been in the investing game for a while, you would know that things have changed dramatically over the past 20 years.

As Chris Paton, CIO at La Trobe Financial, puts it, “Once upon a time, the world of investing was quite simple. It used to be simply cash, bonds, and equities – and the equities were probably a carefully selected portfolio of a few quality stocks.

Times change, and so too are investment strategies.  For the first time recently, the amount of passively managed assets on US stock exchanges now equals the number of actively managed assets. And it’s continuing to grow.  Investors are picking trends, themes and sectors.  At the same time data shows that private capital markets are increasing significantly in size, a global trend that creates significant opportunities in alternative investment classes.

“With this critical mass, comes opportunity for retail investors to now participate in private markets, which until now, have largely been the domain of the institutional, and to a lesser degree wholesale investors. And it is providing a formidable wall of opportunity for investors to consider”.

Paton remarked, “With alternative investments representing everything outside of traditional bastions of stocks, bonds and cash, globally, this represents an enormous pool of assets.  Investors can build, diversify and improve portfolio performance with very conservative, prudent allocations to alternative investments.  These can simultaneously improve return and performance, while reducing correlation to other portfolio assets.”

Of course, not all investors are so quick to embrace opportunity.  With the global rise of alternatives clear throughout the last decade, a recent study showed that 76% of Asian investors remain under-invested in private market strategies.[1]  As Paton puts it, “This is a compelling opportunity for Asian investors to embrace  by considering a globally relevant, growing investment sector”.

[1] Fund Selector Asia

The growth of Alternatives and Private Credit

Tailwinds driving alternative investment opportunities are significant, and are here to stay.  According to Paton, a range of big generational investment trends are at play that will continue to deliver an ever-growing pipeline of quality assets that meet the needs of today’s investors.

He sees these trends as the four D’s.

• DIGITALISATION will see over $1 trillion in investment over the next 10 years to enhance data storage, processing and transmission infrastructure.
• DECARBONISATION will necessitate $150 trillion in investment over the next 30 years to support decarbonisation of global energy systems.
• DEGLOBALISATION as countries and companies onshore critical industries, will drive $1 trillion of investment over the next 10 years; and
• DE-BANKING arising from the de-risking of our interconnected, global financial plumbing since the GFC, providing a wonderful opportunity for investors to participate in these great themes.

Paton believes that the fundamentals of these growth areas, and the assets they will generate, align very closely with the needs of investors. “They are long-term trends. They will not, likely, produce assets with wild price fluctuations. And they support generation of low volatility income”. He adds that the growth in quality private capital on offer won’t slow down any time soon, “which positions alternative investments such as private credit with a generational tailwind.”

These are all big numbers, and the direction is clear.  Vast sums of capital are already being unlocked which align with these themes.  Across infrastructure, real assets, and private credit, just to name a few, investors can expect to see a whole range of strategies coming to market.

Paton again, ‘Importantly for investors, these trends very much align with an impending gap in traditional investment portfolio outcomes.  We are looking into a medium-term period of soft economic growth coupled with elevated volatility.  The types of assets these trends create include income generating, low-volatility assets which don’t need high-growth environments to thrive.  Previously, these assets have been snapped up by institutional investors, and maybe some larger wholesale groups.  Today, these opportunities are increasingly being delivered to investors in retail-friendly vehicles.  And that’s a winning mix for investors.’

The fundamentals of investing in private credit

The elephant in the room remains the growth of new managers entering the market.  Paton explains that success in any sector starts with getting the fundamentals right, and over La Trobe Financial’s seven decade history (which includes managing Australian real estate private credit) confirms three non-negotiables:

1. the right assets
2. the right structure, and
3. the right manager

These three principles are at the forefront of its approach to managing assets, which it implements across its strategies in Australian Real Estate Private Credit, and US middle market corporate private credit.

The outlook ahead

According to Paton, there is little doubt that the growth of private market investment is set to continue this year, next year, and well into the future. “Quality companies are tapping private markets for capital.  The financial and regulatory environment will support this trend, driving more and more capital towards private credit and other alternative assets.  Investors, too, are increasingly looking to private investments to secure low volatility income for their portfolios”.

Beyond Asia, investors globally are shifting their focus to alternatives.  According to Macquarie, individual investors globally are currently allocating 5% of their wealth to alternatives as at 2023, but AUM is forecast to grow at 9.3% per year through this decade.[1]

“Alternative investments like private credit are well placed to be a big part of this growth story”.

[1] Macquarie, Prequin