As the market matures, investors are becoming more sophisticated, learning to evaluate managers based on risk-adjusted returns rather than headline performance alone. With private credit continuing to support private equity and transaction liquidity, the sector has seen sustained growth despite anticipated market adjustments.
Anna Ellis: So, Mike, let's switch to a different part of the market. Let's talk about private credit. A lot of talk about private credit. We spent a lot of time talking about uncertainty, sticky inflation, interest rates, how do you see all of this impacting private credit going forward?
Michael Lukin: Yeah, look, it's been an amazing run in private credit over the last probably five years. We've seen the real growth in the sector is base rates started to lift and so private credit returns look more and more attractive. Not completely unexpected given the US market has been there for a long time. And if you think about, adoption of new asset classes, new types of securities, US generally leads the market and the rest of the world follows. So, when we kicked off our private credit business, it was still relatively early days in private credit here locally. And what we've seen since is really a proliferation of managers hit the market. What I would say is what we've seen up until now is really, partially it's the media and the press around private credit, partially it's probably investors getting up the curve on what private credit really is. But really a treatment of all private credit managers is the same.
So, you know, in some cases I'll sit in a meeting with a potential investor in a private credit meeting and try to explain the nuances of what private credit is and the different sectors and different risk profiles. But they tend to still gravitate back to how you think about equity managers, which is if this managers delivering 20% and this manager is delivering 15%, the 20% manager must be doing a better job. And really private credit doesn't operate like that. It's very much a nuance of what is the risk you're taking. So, it's all about risk adjusted returns.
And I think what we're seeing is as the market here matures, it's very rare that a deal goes bad in the first three months, six months. But as you get more maturity in the private credit business in Australia, I think we will start to see differentiation amongst the managers. You'll see investors getting more sophisticated once they dig into why a manager is underperformed or a manager is outperformed. And so, I think on that basis, we will see probably a shift in allocation, potentially a slowdown in allocation to private credit over the course of 2025 as investors start to get their heads around what this all means. But as we see some underperformance in some parts of the market that will affect flows and how those flows operate in private credit.
But having said all that, private credit is definitely here to stay. The benefit of private credit to the local private equity community that brought up credit markets here in Australia, there is no doubt that it is adding to transaction capability and adding to liquidity in the market. And so, over the course of the next year and next five years continue to see really strong growth in private credit. And really, those managers that show the ability to ride out the cycle and generate good returns, we'll continue to see more and more flows coming to them. So very supportive of the private credit market here in Australia. I think if I think about, the private equity industry in Australia, it is turning to private credit more and more regularly now for capital. Even five years ago you may see a private credit player in a syndicate on a private equity deal. Now you're seeing deals done where it's completely private credit funded debt in a private equity deal.
Anna Ellis: And Mike, why is that? Like what has really been driving that? Is it an understanding of intimately of the needs of what a private equity wants? Is it that the big four banks here are just no longer as active in that space?
Michael Lukin: Yeah. So, I think it's a combination of all of the above. I think the certainty you get from private credit. Private credits the game of putting capital out into those types of transactions. The banks, they will move in and out of sectors depending on what's attractive to them from a risk perspective where they're over allocated, regulatory requirements, and capital adequacy requirements. And so you will see different banks, I always say of the big four, there's always two that are active, one that's floating around and one that said we're not doing much in syndicated loans or private equity backed loans at the moment. They're all always different. The two that are active are always different. One that's out is always different, but you see that they all tend to float in and out of the sector a little bit in terms of their appetite for the space.
Whereas if you think about the big private credit firms around the world, they are in the business of supporting private equity through transactions. So, they want to deploy capital. And I think what that means is you get certainty, you get speed of execution, particularly as the private credit market becomes more competitive and you see more options in the market. And so, I think all up, that actually means that, doing a deal, if you can do a deal with private credit, even if it's maybe a little bit more expensive, there are generally some benefits to that. I'd also add the other piece of that is what I would call, ‘special situations’ type lending. So, there's parts of the market that it would just take too long for the banks to get their head around lending to that part of the market…
Anna Ellis: processes along…
Michael Lukin: …processes along, they don't have a track record. So, things like NAV lines are a great example. So, this is where a lender will allocate capital or provide debt capital to a private equity fund to help either create liquidity for their investors or to help fund further growth in the portfolio. That is very much a private credit backed industry. Very difficult to say, the big four banks here say get their head around security being equity in a private equity portfolio. So, I think we're seeing these more special situations tending to gravitate... the great thing about those special situations types lens is they're actually very, very attractive if you can do the diligence, you understand the lend that you're undertaking, you can actually make outsides returns. So very supportive of that.
Anna Ellis: And you mentioned earlier, sometimes you sit in meetings with investors and you talk about the differences between different credit, well, different types of credit funds, for example. What are some of the points of difference typically you see around private credit?
Michael Lukin: Yeah. So look, I think there's obviously the more traditional structuring of credit. So, senior debt, subordinated loans, stretch senior, mezzanine loans. I think investors generally get the head around that, that if someone's senior in the capital structure, I compare them to someone that's senior. The example I give is there's businesses that were borrowing money at 15% when base rates were zero. You know, I'd argue if a business needs to borrow money at 15%, even if it is senior when base rates are zero, it's probably equity, right? And it probably should be equity. And so I think that's the nuance that we'll see as we play through the cycle that a business that's really strong cash flow in a good sector that's not heavily levered, you won't get the same yield on that as something that's a bit more spicy and potentially equity like in nature. And I think that's really where investors will start to unpick different kind of styles of approach to private credit as to as to what it is it that I actually owe.
Anna Ellis: Yeah. So that sort of may be education piece that not all private credit is the same.
Michael Lukin: Correct. Exactly.
