Private debt: what does it all mean?

Is this your first time reading about “private debt” and you can’t make head nor tail of it? You’re not alone.

The world of private debt investments was once a closed door to the average investor and for good reason. Investing in shares for the first time can be daunting as it is, let alone investing in something that is potentially more complex many times over.

What might surprise many, however, is that they already have money in private debt and don’t know it because it’s done on their behalf by their super fund.

Many super funds have ramped up their investment in the sector. AustralianSuper, one of the top-performing super funds in the country, said that it plans to have $15 billion of investments in private debt by 2024, up from over $5 billion a year ago. DIY investors in the US are ahead of the curve with more than $US1 trillion of their retirement savings going to private debt.

Why the sudden interest in this asset class? Put simply, traditional sources of fixed income haven’t been delivering the same rates of return as they have done in the past.

Covid-19 made banks more risk-averse and companies needing to borrow money turned to non-bank lenders, bolstering the private debt market. Rising inflation cemented the trend.

Private debt is money lent to individuals and businesses in exchange for an agreed interest rate. These debts are bundled inside a private fund that can then share the interest earned to its investors.

The returns vary because there are at least 600 fund managers in the country that can offer private debt products.

How do you buy them? Therein lies the rub. Many private debt products are geared for so-called “wholesale” investors. In Australia, these are investors who have net assets worth more than $2.5 million or at least $250,000 a year in gross household income, or both.

Investors outside this category are called “retail”, which for all intents and purposes, are those of us who are just starting to build our personal wealth.

Metrics is one of the few private debt specialist funds that cater for retail investors. For example, for a minimum investment of $1000, you can have access to private debt

through its Metrics Direct Income Fund. The fund aims to return 5.10% a year net of fees, which appeals to those who are searching for returns above the cash rate.

As with any other investment, it’s best to speak with a professional financial adviser to gauge if investing in a private debt fund is right for your personal circumstances.

For investors who want the transparency of ASX-listed funds, Metrics also offers the Metrics Income Opportunities Trust (MOT) and the Metrics Master Income Trust (MXT).

Private debt, by its nature, is not meant to be publicly listed so the trade-off here of investing in trust vehicles is that they are vulnerable to market sentiment, which has more to do with how investors feel about the stockmarket than about the real prospects of the underlying private debts.

A couple of interchangeable terms you’ll come across in our article are “marked to market” and “mark to market”. People who work in the finance business, such as accountants, stockbrokers and fund managers, use this term to refer to how a certain investment is priced at the end of a trading day.

For example, you may have bought a certain unit trust at $5 per unit on a Monday, but the next day the government announces bad news about the economy and that unit price could be marked to market as worth $4.80. The circumstance of that investment didn’t change in 24 hours, but markets did.

Conversely, the government might release good news about employment numbers three days later and the unit trust is priced at $5.10. Again, the situation of the underlying investments in the unit trust hasn’t changed, but the price reflects market confidence.

“Investors turn to private debt funds for mainly higher returns, but it is important to remember there is no such thing as a free lunch,” says Max Riaz, investment director at Banyantree Investment Group.

“Private debt could be a small exposure in your otherwise diversified investment portfolio. Manager selection is everything and their experience in managing loan defaults in slower economic times should be the number one selection criteria.”