The world’s wealthiest families are flocking to private credit this year. Is this an opportunity for all investors? CrowdProperty’s COO Tony Zulli considers four questions to help understand why private debt could be an option for other investment portfolios, not just the wealthy.
What family offices are doing
KKR’s Family Capital Survey, conducted annually, reveals findings from interviews with the chief investment officers of family offices worldwide. It gauges these CIOs’ views about asset allocation, returns, and opportunities in financial markets in the forthcoming year.
This year’s survey — the collective thought of CIOs representing US$3 billion in assets — showed that private credit was the asset class to which most family offices planned to increase allocations in 2024.
A notable 45% of respondents planned to increase allocations to private credit, followed by 31% for infrastructure and 28% for private equity. Notably, for stock investors, 31% planned to decrease allocations to listed equities.
How do we use the decisions of the ultra-wealthy to inform investment decisions for smaller portfolios?
This is not as simple as replicating portfolio asset class allocation — a portfolio’s size, investment policy and objectives will always play a role in its construction. We can, however, ask why the wealthiest investors are making certain decisions and — if those reasons apply to us, too — think about whether we can be guided by them.
Question one: What’s changed?
Financial markets remain in a state of uncertainty and flux. It is unclear whether the current exuberance in share markets will be sustained or whether we are in a bubble.
What is clear, however, is that sophisticated investors recognise the possibility that public markets have become saturated and highly volatile. The S&P 500 has reached record valuations on the backs of stocks like Nvidia, even while the inflation and interest rate environment remain uncertain; many are undecided whether this demonstrates “irrational exuberance”.
This doesn’t mean that investors are pulling out of public markets entirely, of course, but it has drawn the importance of risk diversification into sharp focus. A diversified portfolio, comprising various asset classes and sectors and including an allocation to uncorrelated alternative investments, can navigate financial market uncertainty more effectively than a concentrated portfolio.
Question two: Why private credit?
Private credit typically offers higher yields than traditional fixed-income investments, especially when interest rates are high. Generating income higher than inflation — especially if that income rate is relatively stable — is always attractive.
Another important reason is that sources of capital have become scarcer, with traditional banks declining to lend in many sectors. The IPO market is still in a drought, and private equity firms are offering unrealistically low valuations for businesses as high inflation drives down the present discounted value of cash flows. The result is that there are many high-quality borrowers in the market choosing debt (on attractive terms to borrowers) over other sources of capital.
High-quality borrowers in Australia are particularly likely to seek debt from non-bank lenders, as traditional banks face regulatory and capital hurdles. Borrowers in certain sectors — especially real estate — have been unable to access loans, even after months of trying. This presents a clear opportunity for private investors.
Question three: What kind of private credit?
Many of the respondents to KKR’s Family Capital Survey would be attracted to the higher-risk, high-income opportunities offered by mezzanine financing to businesses. This makes sense in the context of a large pool of capital, where risk can be spread amongst other private credit investments.
However, other forms of private credit are likely more appropriate for smaller, risk-averse individual investors, including first-mortgage-secured debt opportunities.
As a result, real estate debt has become an attractive proposition for Australian investors.
Small-to-medium (SME) property developers — building medium-density homes in the places where people want to live — have often found themselves unable to finance their projects through bank loans. This is despite the dire housing shortage, which the National Housing Finance and Investment Corporation has estimated will reach 175,000 by 2027.
Because the housing crisis is a crisis of demand, the dearth of solutions currently on the table means demand will remain high for the foreseeable future. Immigration trends and the surprisingly low number of development applications (DAs) suggest that whatever crisis we’re in now will be even more significant in the future.
This observation supports the value of residential real estate and, therefore, of SME developers’ projects, especially if they are in locations where we know people want to live, and the homes are of a desirable standard of quality. And, while they’re on the lookout for capital, lending to these developers is a great opportunity.
All Australian investors — including retail investors and SMSFs — can now take advantage of this opportunity through specialist private debt funds, including CrowdProperty’s.
Question four: Why not invest in real estate directly?
This question brings us back to the beginning of this article. The point of a private credit investment is to diversify a portfolio through assets that are uncorrelated with traditional financial markets and to target income that exceeds inflation. While the relative risk of the investment will relate to the performance of the underlying sector, most of this risk is borne by the borrower, especially where the loan is first mortgage secured.
An investment property is always risky and requires a sizeable investment from most investors’ portfolios. This is especially true if it involves financing at a time when interest rates are remaining higher for longer.
Investing like the wealthy in 2024 means looking for diversification opportunities outside traditional financial markets. However, choosing an investment that makes sense within your portfolio’s risk-return parameters is always essential. An excellent financial adviser familiar with the full range of alternative investments available, including private credit funds, is a more necessary investment than ever.
Tony Zulli is Chief Operating Officer and Director, CrowdProperty Australia
