Australia: The hard sell

With 10-year Australian government bond yields recently falling below 2 percent for the first time on fears of a Brexit, the country’s investors are starting to pay more attention to alternative asset classes. But it hasn’t been easy generating interest in the private debt market.

“It’s been hard getting Australian superannuation funds interested in private debt strategies that are actually oriented towards Australia,” says Steve Hall, chief executive at Brookvine, a debt funds management firm based in Sydney.

Brookvine, which was established in 2001 and has raised over A$10 billion ($7.5 billion; €6.6 billion) from institutional and private wealth investors for private debt strategies, believes the super funds, with their increasing appetite for regular long-term income driven by the country’s ageing population, will need to diversify their portfolios in the current low interest rate environment to meet their future commitments.

However, few funds yet have made an allocation to private debt because of concerns about increased leverage, illiquidity and a perception of weak deal structures in the private debt market.

“The super funds often have return hurdles that are higher than the rate of interest you’re likely to capture from a plain vanilla private debt strategy,” says Hall. “And you can expect an illiquidity premium that’s a touch higher than the strategies can afford. But it is getting easier. There’s a growing knowledge of and interest in private debt strategies.”

Among those strategies, it is the real estate sector that has shown the most promise with requests for commercial property debt on the rise.

An example is alternative lender MaxCap Group’s recent expansion. The Australian commercial real estate debt investment manager, has raised A$310 million in 17 deals since the beginning of the year – triple the amount raised in the same period last year.

Among the funds raised so far in 2016 are significant institutional mandates which have moved to fill the gap left by the retail banks restricted by regulation to lend to that market. MaxCap also plans to launch its first debt fund in the second half of the year, targeting around A$300 million and returns of 10 percent.

However, outside of real estate debt opportunities, fundraising for other private debt strategies can still be difficult, says Andrew Lockhart, part of the investment committee for Sydney-based investor Metrics Credit Partners.

“It’s hard to raise money in Australia. The super funds are still heavily growth-focused on equities. Most have exposure to the bond market but not to private debt,” says Lockhart.

Metrics Credit Partners’ A$1.6 billion Diversified Australian Senior Loan Fund has deployed 41 loans to Australian public and private companies, with borrower demand outstripping their mandates.

“There is still a shortage of capital,” says Lockhart. “We have far more opportunities to lend than we have capital. One of the things that restrains the sector is investors’ preparedness to invest in the debt market.”

Another restraint is government regulation of the super funds which restricts them from deploying their capital towards higher-risk asset classes.

“The super funds have a requirement to maintain liquidity and the insurance companies have regulatory pressure that prevents them from investing in non-public markets. That’s why it’s not easy to raise debt financing to invest in loans,” says Lockhart. “Over time, we hope to deliver good returns to investors so that they and others can see that private debt is a very sensible and viable investment option for them.”

However, banking regulations have helped drive growth in the sector, says Sebastian Paphitis, from professional services firm Ernst & Young’s capital and debt advisory team in Australia.

The private debt market, which EY estimates has grown to more than A$35 billion in invested funds, will continue to expand as new providers of capital emerge.

In Australia, the banks have always taken the lion’s share of the institutional market, providing around 90 percent of corporate debt, compared with 54 percent in Europe and 16 percent in the US, says Paphitis.

But changing regulatory and economic conditions are paving the way for a number of alternative funding options such as private debt placements, wholesale notes and high yield debt raisings, he adds.

“The Australian government’s efforts to support innovation in the market is providing a further boost for these new funding sources. This will see the disintermediation of the traditional funding sources gain greater momentum in coming years, following the trend in offshore markets.”

The example of those more mature markets in North America and Europe mean the prospects for future growth in Australia are good, says Hall.

“The bias back here has been towards more liquid strategies, so if you compare our super funds and insurers with their overseas counterparts, which have a greater appetite for private debt, you can see there is room for more of an allocation towards private debt.”

Among the super funds, real estate financing is starting to gain traction with some taking a more progressive stance on commercial real estate debt as a defensive income investment. But most are still a little uncomfortable with the asset class, according to Hall.

“It’s hard to get a handle on the actual size of the market but the one thing we know is that the supply of capital for lending in the small to mid-market segment, and anything that’s a little bit opportunistic, has diminished,” says Hall.

The mid-market mortgage trust industry that was once A$30 billion-A$40 billion in size and once comprised a number of foreign banks has fallen fallow since the financial crisis. The number of large lenders in the Australian market rapidly diminished in the years following the crisis.

Alternative lenders like MaxCap were beginning to appear in various forms, but not at a scale that could fill the gap left by the withdrawal of the banking sector from large parts of the debt market.

“From the position of the borrower, there is a real demand for other alternative sources of lending other than from the top-four banks,” says Hall.

With the banks moving out of some of the higher-return lending, how the country’s super funds see the country’s private debt market will determine its evolution in the years ahead. They are more active in the private debt space than they were five or six years ago, but it is really only at the margins.

“You’ll find the odd private debt investment, but it’ll be a very small allocation out of the aggregate exposure. I think you’ll find very little exposure overall,” says Hall. Moreover, the little that is there tends to be infrastructure debt rather than commercial real estate debt, he adds.

“You and I could stand on top of the tallest building in Sydney and say, well, that’s the market, the majority of these buildings have debt attached to them. But if you turn another way and look at the weight of money typically invested by an Australian superannuation fund, well, there’s actually very little of that there.”