SMSFs remain heavily overweight equities and rely mostly on cash to cushion any fall in the value of those shares. This under-diversification is partly a result of the fact that other defensive investments are often accessible only to the biggest investors, with SMSFs and others not able to widely access the best opportunities.
The phased abolition of the local $47 billion bank hybrid security market may compound this issue by leaving a sizeable gap in portfolios of SMSF investors who have previously bought these assets for the attractive yield and steady income.
In this environment, SMSF investors would be prudent to consider investing outside traditional public markets to protect and grow their wealth.
Enter private credit
Private credit is emerging as a missing piece in the puzzle for income-hungry investors – providing diversification, yield, and resilience in a way equities or bonds alone cannot.
Globally, the private credit sector is marching towards a US$2.8 trillion global asset class by 2027, up from US$40 billion at the turn of the century, according to Preqin data. Changes to bank regulatory capital standards, market structural shifts such as the rise of the broker channel and technology changes have enabled non-bank lenders to grow market share. There are many parts of the corporate, real estate and asset-backed lending market where banks have scaled back. Private credit managers can step in to fill the gap.
Private credit managers raise money from investors to provide those loans. Returns to investors are generated from interest payments the loans earn.
As the sector has grown, its focus has changed. Twenty years ago, private credit funds used to concentrate on opportunistic credit with private-equity style returns. The growth in the sector has occurred as funds have focused on more traditional lending. The loans they provide are often those the banks previously made, or fill a gap where banks cannot lend efficiently.
In simple terms, private credit has largely moved from the ‘unbanked’ borrower to the ‘banked’ borrower. As a result, it provides investors with a genuine alternative to traditional fixed income such as bonds.
LITs: Opening the door for SMSFs
New listed investment trusts (LITs) make private credit increasingly accessible to SMSFs and retail investors. These vehicles, which are priced and traded daily on the ASX, provide exposure to diversified portfolios of private credit assets.
This has opened the door to a sector once seen as largely reserved for larger funds and forged new pathways for SMSF investors to strengthen diversification in their portfolios.
At the same time, regulatory shifts such as the proposed Division 296 tax on superannuation balances over $3 million have the potential to reshape investment strategies. Rather than leaning into growth assets that generate capital gains, SMSF trustees may gravitate towards income-generating assets like private credit that can deliver consistent cash yields with relative capital stability because the loans are secured, asset-backed or have defensive characteristics.
So how does private credit weather market uncertainty – and what role does it play beyond providing an alternative to equities and cash?
Three reasons private credit works
Genuine diversification: Private credit can grant investors access to a much broader range of assets and lending opportunities than the public bond market. Good private credit funds hold very large and diversified portfolios of loans across a range of borrowers.
Reliable income in volatile markets: Private credit offers investors the potential to preserve capital and generate resilient and regular income. It provides an opportunity to lend against high-quality assets with equity-like return characteristics, has low correlation to other asset classes and is a compelling and defensive floating-rate investment option.
Built for long-term investing: SMSFs can access the same underlying private credit portfolio through either listed or unlisted structures, choosing the option that best suits their liquidity needs without sacrificing exposure.
Getting private credit right
For SMSFs looking to invest in private credit, the choice of manager is key. A good manager recognises that success in private credit investing is driven by avoiding losers rather than picking winners. This means they need the credit skills to assess the ability of every borrower in a fund to meet its repayments over time.
Manager practices such as co-investing alongside clients demonstrate genuine commitment to shared returns (and shared risks). Equally critical attributes are scale, experience, transparency, and rigorous discipline – cornerstones of long-term performance that cannot be overstated.
Private credit has a demonstrated capacity to meet the needs of superannuation investors building long-term retirement portfolios. As the sector grows, SMSF trustees need to build an understanding of not just the asset class – but also the key criteria to apply when choosing a fund manager.
