Tim Keith: Why private credit is emerging as an option for those shunning term deposits and property market

While rising interest rates might seem like good news for term deposit investors, savers may not realise there are other fixed-income investments that pay higher rates of interest than term deposits while offering greater liquidity. While the big banks have raised interest rates on term deposits and savings accounts, interest rates on many of these products remain below 3 per cent after being adjusted for inflation. Still, for savers who rely on cash and term deposits for income, another interest rate rise this week or in September is on the cards given sticky inflation. And that could be good news. The average advertised interest rate on three-year term deposits, for example, was 3.95 per cent in May, unchanged from a year ago, according to the most recent data from the Reserve Bank of Australia. The one-year rate was a little better at 4.55 per cent and not much more than the current inflation rate of 3.8 per cent. In addition to relatively low returns, term deposits often involve locking up your money for long periods of time — savers won’t be able to access their money during the fixed period. Interest rates, too, are fixed for a term deposit and remain unchanged for the entire term, even if there is a rise in official interest rates. Yet some investments benefit from higher interest rates and offer more flexibility when compared with term deposits. This includes fixed-income investments which have “floating rate” coupons or returns. Floating rate investments, including corporate loans made by private credit funds, offer an interest rate that is linked to variable interest rates, so returns on private credit funds will generally increase in a rising rate environment. With the potential for another official rate rise this week, that means the yield earned on private credit could increase over the next 12 months, unlike the interest rates on one-year or three-year term deposits. For income-seeking investors who are willing to take on more risk than that involved with cash or term deposit, private credit investments can deliver investors annual yields close to 10 per cent, which is almost double typical yields on cash and up to four times the yields on rental properties which often fall below 5 per cent. That’s one of the main reasons our largest institutional investors such as AustralianSuper and UniSuper have been allocating more to private credit assets in recent times. In the case of UniSuper, over the past 18 months the biggest new investment allocations it has made have been in the debt markets, not equity, chief investment officer John Pearce, told The Wall Street Journal in April. While the pension fund was holding back on allocating any more to corporate bonds, it said it was still taking bets on private credit. Over time, we expect individual investors to follow the lead. Private credit investments do not attract the large stamp duty impost or require a large initial deposit such as is required for residential property purchases. Instead, it is accessible and offers reliable income for all investors, including retirees, which is why super funds are piling into this asset class. Another benefit of floating rate loans is that they typically display low correlation to equities, so this asset class may help to insulate against share market declines. Need to diversify asset base out of property One thing is likely — one asset class that probably won’t do well if interest rates rise again is residential property. Australians have stockpiled their wealth in property. Around two-thirds of household wealth is now held in residential property, a proportion that has increased over time with rising property values, according to data from the Australian Bureau of Statistics. So that makes many Australians vulnerable to a correction in the property market, especially if rates rise and the economy slows. As such, Australians arguably need to diversify into other defensive asset classes such as fixed income to reduce the risk of their wealth being hit by higher interest rates. With interest rates potentially rising again, which will potentially hurt property prices, private credit offers investors the potential for downside protection in this environment. Additionally, it offers opportunities to younger investors as they can invest much smaller amounts of money, unlike property investments which, due to their expense, are beyond the reach of many Australians. Tim Keith is managing director of Capspace