The asset class that doesn't care about inflation and rate hikes

David Thornton

Livewire Markets

In a world saddled with inflation and the rate hikes that follow, equities and assets with long durations invariably suffer. 

Luckily, the investment universe is much broader than this. 

"Private debt has floating rate, it has security in terms of being secured against operating businesses or loans, and on top of that it gives you genuine diversification that you wouldn't ordinarily get in listed markets, be they equity or debt," says Bob Sahota, Chief Investment Officer at Revolution Asset Management. 

Private debt covers a broad spectrum of assets, but Revolution play in three key areas: (1) non-construction, non-development, real-estate debt; (2) private company debt, and (3) leveraged buyout debt. 

In this wire, Sahota explains the reasoning behind this focus, and why these investments provide such great consistency of returns in today's more than inconsistent environment. 

Edited Transcript

What does the private debt market offer to investors?”

The private debt market in Australia has really been something that I've been watching for a long time. I've been involved in the markets for 30 years in private debt. However, in the last six months we've seen more written and spoken about in private debt than I've seen in my whole career. Why is that? People are looking for, what do they do in an environment coming into 2022 of higher inflation, higher rates with geopolitical concerns in Europe? There's other concerns around the world in terms of volatility with interest rate duration really affecting many asset classes. 

Private debt has wonderful characteristics of being floating rate. It has security in terms of being secured against operating businesses or loans. And then on top of that, it gives you diversification, genuine diversification of sectors and industries that you ordinarily wouldn't get in listed markets, be they equity or in debt.

So in that way, it's a wonderful asset class coming into the back end of 2022 and beyond because it acts as really capital preservation with stable income, with less volatility and less correlation to the listed markets. And I think that's where private markets now are starting to become much more important in people's asset allocation. 

What types of private debt does Revolution Asset Management target?

Private debt really is a broad umbrella of different strategies. 

So when we talk about different managers, they have different definitions of private debt. They really range from low risk, low return, like providing loans to top 200 Australian corporates, which are wonderful from a credit standpoint, but don't really give you the return that we are seeking. But then you've got at the end of the spectrum distressed debt and special situations or even lending to bilateral SMEs, small to medium enterprises. This is a long continuum of different strategies and different sectors that private debt can be targeted. 

At Revolution Asset Management, we really target three key areas. Firstly, non-construction, non-development real estate debt. 

So where we're looking for tenant cash flow to be what services our loans, be that in commercial office, retail shopping centres with non-discretionary retail groceries chain, anchor tenants, or industrial properties with good quality corporate tenants. This is an area that's been very competitive so the banks have been extremely active. 

We've only done two deals in four years, but we remain very disciplined on that because back end of this year, we expect that that sector might actually yield some excellent deals. But the other two areas that we really focus on is private company and leveraged buy out debt. 

Last year in 2021, we had the largest year of M&A activity on record in Australia. And think about every one of those acquisitions, be they public companies being taken private, they require something in the order of 50% debt funding for those acquisitions.

We've found a very strong pipeline of deals to be able to choose the ones that we really are comfortable with in providing the funding for those acquisitions for top end of town companies with very strong international and domestic PE sponsors. The third area is asset backed securities. So we are involved in the private side of providing non-bank lenders access to financing in a whole bunch of different securitisation streams, be they mortgages, auto loans, credit cards, personal loans. This is an area that's also in significant growth because banks are retreating from many of those different areas because of capital regulation. And so some of the names that we've partnered with in that space are Latitude who is the old GE money business across Australia, New Zealand. Bluestone Mortgages, Mortgage House, more recently auto loans through MoneyMe who just acquired SocietyOne and Wisr. These are kinds of names that we've partnered with in helping them fund their business and their financing at extremely attractive rates for our investors.

What do your investors want from their private debt investments?

A lot of our clients these days are more interested in private debt, be they high net worths, all the way through to CIOs in large super funds for really similar reasons. They're looking for taking some risk off the table and going into more defensive asset classes. Traditionally, the bond asset class provided you with a lot of stability, liquidity, as well as a non-correlated risk to the more risky equity markets and other strategies. Really the bond sort of piece has really gone out of favour because of what we expect rates are going to do.

With long duration bonds, many of our clients are worried about losing money in that asset class and that not being a genuine diversification. Should equities turn down, bonds could actually go with them. 

So in order for us to be relevant to those sort of clients, we are telling them, well, you have to give up some liquidity in our strategy because it's a less liquid strategy.

However, you are picking up a very good credit risk return and then an illiquidity premium because in Australia, there's not too many private debt managers versus the opportunity set with banks moving out of many of these areas.

Looking to learn more about the role of private debt in a portfolio?

Unlike many assets, private debt generates income through market cycles and can provide diversification away from the publicly listed, big-four Australian banks and broader market movements. To learn more, visit the Revolution Asset Management website or send an enquiry using the 'contact' button below.

This content is designed for Institutional and Professional Investors only.

This article is for institutional and professional investors only and has been prepared by Revolution Asset Management Pty Ltd ACN 623 140 607 AFSL 507353 (‘Revolution’). Past performance is not a reliable indicator of future performance. Revolution is not licensed in Australia to provide financial product advice or other financial services to retail investors. This information should not be considered advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling units and does not take into account your particular investment objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information having regard to these matters, any relevant offer document and in particular, you should seek independent financial advice.

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David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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