(Bloomberg) -- Some of Australia’s large institutional investors are looking for growth in the nascent local private debt market to take advantage of elevated interest rates and as banks shy away from riskier lending.
IFM Investors Pty., owned by the nation’s top pension funds, has seen its A$12 billion ($8 billion) Australian debt portfolio, which includes private credit, grow by about 20% annually in the last two years. QIC Ltd., meanwhile, is aiming to double its A$1.5 billion private debt business in the next two to three years as both firms seek alternatives to the traditional bond and loan markets.
Private credit funds are benefiting from a reluctance by banks to lend to the sector due to possible pitfalls, with regulators stepping up supervision of the asset class. In Australia, the market has grown into a A$40 billion industry, according to data compiled by the Reserve Bank of Australia and offers potential for growth as it makes up for just 2.5% of total business debt.
Interest rates at a 12-year high are offering good returns for domestic pension funds, with recent strong employment data giving policymakers little cause to ease borrowing costs.
“We’ve seen quite a lot of flows come in over the last 12 to 18 months,” Hiran Wanigasekera, IFM’s co-head of Australian diversified credit, said in an interview. “It’s the relative value opportunity right now that base rates are up and credit offers a very good alternative and a more stable return.” IFM’s private credit funds are targeting returns of 10-11% per annum.
Global private credit has more than tripled to $1.5 trillion since 2014, excluding yuan-denominated funds, according to figures at the end of December 2023 from investment data firm Preqin Ltd.
As the industry grows, the Australian Securities and Investments Commission has said it will set up a specialized unit to engage with the private markets amid persistent concerns about valuations. ASIC, one of two regulators in the pensions industry, is engaging with market participants to examine where improvements should be made.
ASIC is monitoring superannuation funds’ financial reporting and disclosures, Commissioner Simone Constant told Bloomberg last month, adding that as banks retreat, pensions face more complex risk. “We might ask with commercial real estate private credit, what does it mean for members that it is outside the banks’ risk appetite, but inside the super funds’ appetite?”
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QIC, which manages money for the Queensland state government as well as institutional investors, said they were seeing better quality deals under a high interest rate environment. Companies hold more equity, meaning that they have less debt to service, leading to “better balance sheets with more conservative capital structures,” head of private debt Australia Phil Miall said in an interview. QIC aims for returns of 9-10% in Australia.
Australian private-credit investments, previously the mainstay of pension funds and institutions due to high barriers to entry, are now becoming more accessible to wealthy individuals. But they come with risks.
“Private credit is interesting but I think manager selection is incredibly important,” said Jacqueline Fernley, chief investment officer at wealth manager Mason Stevens at the CFA Society Australia conference in Melbourne on Thursday. “You have to be very, very careful.”
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