In the face of concerns over companies’ borrowing spree during the pandemic, many investors have been bracing themselves for a potential financial reckoning. However, Aware Super, one of Australia’s largest pension funds, remains optimistic, stating that they do not anticipate a significant wave of corporate defaults in the near future. While interest rates are expected to remain elevated for a prolonged period, Aware Super continues to place their bets on the private credit market—a sector where private funds offer tailored corporate loans to borrowers. With a substantial portfolio of 160 billion Australian dollars (US$107.18 billion), the fund believes there will be ongoing opportunities to achieve reasonable returns.
Private Credit Market – A Lucrative Opportunity
Despite uncertainty surrounding the economic outlook, the private credit market has flourished as traditional lenders, including banks, have become more cautious about extending new loans. Damian Graham, the Chief Investment Officer at Aware Super, emphasizes the potential longevity of this opportunity. He suggests that even if inflation remains high and interest rates stay elevated, as long as the default cycle remains manageable, investors can expect reasonable returns. Aware Super’s confidence in the private credit market is based on their observation that corporate borrowers, in general, are in good financial shape with reasonably low leverage. However, Graham notes that there may be added pressure on businesses in the early stages that carry higher levels of debt.
Aware Super’s outlook on corporate defaults diverges from the fears held by many investors who worry about the consequences of companies’ borrowing during the pandemic. They believe that the private credit market will continue to provide attractive returns as long as the default cycle remains under control. With their substantial asset management portfolio, Aware Super sees ongoing opportunities for growth and remains bullish on the overall health of corporate borrowers.
The Rise of Interest Rates: Impact on Corporate Borrowers
The possibility of interest rates remaining higher for a longer duration has sparked concerns among investors. The fear is that highly indebted corporate borrowers may struggle to repay their loans. However, recent investor surveys indicate that many plan to increase their exposure to private credit, signaling a different perspective on the issue.
Uncertainty Surrounding Rate Cuts
One of the risks in this scenario is the timing and speed of rate cuts. Although markets have responded positively to expectations of looser monetary policy, it remains unclear when and how quickly these cuts will occur. The U.S. Federal Reserve attempted to dispel speculation of a rate cut in March, while the Reserve Bank of Australia sent hawkish signals in the minutes of its December meeting, suggesting the possibility of an increase in the official cash rate.
Default Rate Forecasts
In a recent report, Fitch Ratings predicted that default rates for leveraged loans in 2024 would range from 3.5% to 4.0%. For high-yield bonds, the forecasted default rates for the same period are between 5.0% and 5.5%. These figures represent an increase from the 2023 default rate forecasts of 3.0% to 3.5%. Despite this projected uptick in defaults, experts like Graham believe that it is a reasonable expectation.
Opportunities in the Market
Among investors, the structured credit market has gained significant interest. Its appeal lies partly in its size, which presents ample opportunities for potential returns. Additionally, Aware sees potential in commercial property investments throughout this cycle. Specifically, they believe that offices may become more attractive as an investment option.