With rising global inflationary pressures mounting, a range of factors are converging to create a new inflationary era. From the demand distortions and supply dislocations associated with the COVID-19 pandemic, geopolitical risks, as well as monetary and fiscal tightening, these factors are expected to increase volatility across financial markets in 2022.
The reality of higher inflation and interest rate hikes has prompted asset owners to review their current defensive fixed income allocations and assess the level of risk protection required in order to earn the investment returns needed to meet their targets. Income generated by traditional fixed income sources such as fixed rate bonds are now harder to find. Strategies across private markets, in particular private debt, may be well equipped to deal with the ongoing market volatility and changes to interest rates. In periods of higher inflation, private debt can offer investors a level of protection – being a floating rate asset class means the underlying yield increases as inflation and interest rates increase. Additionally, the long term, patient capital nature of private debt, and the ability to absorb and pass on rising costs mean these strategies can actually benefit from inflation.
But senior secured private debt can offer more than that. It’s a defensive allocation that can help to preserve capital and provide genuine diversification and yield, whether through the right sub-sectors of private debt or the underlying assets well-positioned to flourish during an inflationary environment.
The Australian investable private debt universe is large, and we believe the most attractive sub-sectors include leveraged buyout and private company debt – in businesses with brand and customer strength operating in non-cyclical industries; private and public Asset-Backed Securities such as floating rate quality mortgages; and loans to stabilised commercial real estate assets with annual contracted rent.
Risk mitigation in senior secured private debt also relies heavily on strong credit discipline. A proactive approach to risk management can help build greater resilience in changing market conditions such as inflationary environments.
Download our latest thoughts on the impacts of inflation on private debt.