How private debt can help guard against rising inflation

A boom in M&A activity has filled the pipeline for private debt investors like Revolution Asset Management’s Bob Sahota. In this short wire, he explains how private debt can guard against inflation, provide diversification and deliver yield. 
Bob Sahota

Revolution Asset Management

With rising global inflationary pressures mounting, a range of factors are converging to create a new inflationary era. From the demand distortions and supply dislocations associated with the COVID-19 pandemic, geopolitical risks, as well as monetary and fiscal tightening, these factors are expected to increase volatility across financial markets in 2022.

The reality of higher inflation and interest rate hikes has prompted asset owners to review their current defensive fixed income allocations and assess the level of risk protection required in order to earn the investment returns needed to meet their targets. 

Income generated by traditional fixed income sources such as fixed rate bonds are now harder to find. Strategies across private markets, in particular private debt, may be well equipped to deal with the ongoing market volatility and changes to interest rates. In periods of higher inflation, private debt can offer investors a level of protection – being a floating rate asset class means the underlying yield increases as inflation and interest rates increase. Additionally, the long term, patient capital nature of private debt, and the ability to absorb and pass on rising costs mean these strategies can actually benefit from inflation.

But senior secured private debt can offer more than that. 
It’s a defensive allocation that can help to preserve capital and provide genuine diversification and yield, whether through the right sub-sectors of private debt or the underlying assets well-positioned to flourish during an inflationary environment.

The Australian investable private debt universe is large, and we believe the most attractive sub-sectors include leveraged buyout and private company debt – in businesses with brand and customer strength operating in non-cyclical industries; private and public Asset Backed Securities such as floating rate quality mortgages; and loans to stabilised commercial real estate assets with annual contracted rent.

Risk mitigation in senior secured private debt also relies heavily on strong credit discipline. A proactive approach to risk management can help build greater resilience in changing market conditions such as inflationary environments.

Revolution Asset Management believes the outlook for private debt remains positive. With a robust deal pipeline, deployment into 2022 is set to be strong. In private company and leverage buy-out loans, the M&A boom of 2021 drove three times the level of activity vs the prior year and 40% higher vs the five year average, and with international borders reopening, this is expected to fuel activity in 2022. In private Asset Backed Securities, warehouse funding is reaching A$10 billion and continues to offer very attractive relative value compared to public Asset Backed Securities. In the current market, we are witnessing significant growth particularly in non-bank lending activity in Australia and New Zealand, which continues to provide attractive opportunities for our portfolio and helps quality non-bank lenders realise their growth plans.

Allocating more to higher-yielding, floating rate assets such as private debt could be one strategy to minimise interest rate sensitivity of fixed income portfolios and guard against inflation risk, while at the same time increasing and diversifying sources of return.

This information has been prepared by Revolution Asset Management Pty Ltd ACN 623 140 607 AFSL 507353 (‘Revolution’). Performance numbers provided are as at the date of this article, and subject to change. Although every effort has been made to verify the accuracy of the information contained in this document, Revolution, its directors, officers, representatives, employees, associates and agents disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by any person directly or indirectly through relying on this information. The information in this document is not financial product advice and has been prepared without taking into account the objectives, financial situation or needs of any particular person. All investments involve risk. Past performance is not a reliable indicator of future performance.

Bob  Sahota
Chief Investment Officer
Revolution Asset Management

Successfully managing private debt portfolios for over 25 years - through a full market cycle (GFC included) across leveraged finance/private debt, real estate debt, ABS & investment grade corporate credit on behalf of institutions and super funds.

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