Perpetual urges investors to question private credit funds

As private credit funds face further scrutiny, Perpetual has highlighted key questions for investors to ask when considering these investments.

The rise of private credit funds is giving research houses cause for concern about their viability for retail and wholesale investors, Money Management recently wrote.

It was reported by the Australian Financial Review last week that advice licensee Count had sent a letter to its advisers recommending they exit their holdings in four private credit funds run by Metrics Credit Partners and MA Financial, noting an increase in the instability in the asset class.

Meanwhile, research houses are increasingly reconsidering their research processes regarding these funds. For example, SQM Research said it will be taking action in the form of a sector watch.

According to Perpetual portfolio manager Michael Murphy, who sits in its credit and fixed income team, the boom in private credit demand is raising concerns about how asset managers are handling valuations, fees and transparency.

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It comes amid ASIC’s scrutiny on the asset class, after it enacted a private markets review that flagged concerns about the rise of private credit funds. Product failures are likely, the corporate regulator said, and it is increasing its focus on the assets and their risk for retail investors.

As these concerns intensify, Murphy encouraged investors to do their own due diligence on private credit investments to prevent any unintended risk.

“It is important for investors to be asking questions. It’s only when there is real market distress that that will really become an issue – but it’s something many investors haven’t been thinking about and probably should ahead of that time,” he said.

It is critical to look closely at a client’s private credit exposure to gain understanding of how the manager is handling valuation, fee structures, credit ratings and potential risks, the portfolio manager explained.

Murphy said he has observed examples of managers leaving asset valuations untouched despite broader market downturns or even during periods of extreme dislocation.

“The question to ask is: are your assets marked to market? When assets become impaired, are you marking them down to reflect that? This is the kind of thing that’s fine until it’s not.”

Moreover, some asset managers use self-estimated credit ratings for their funds, rather than leveraging the expertise of an independent ratings house.

Murphy added: “That’s a bit like marking your own homework – saying ‘we like this deal, so of course it’s investment grade’. They generally get auditor to sign off, but I don’t think they really push back on those in the way you would if it was done by a proper rating house.”

Conflict of interest is another consideration to be aware of, which has the potential to drive investment decisions away from the clients’ best interests.

The portfolio manager said some private credit managers retain a proportion of the upfront fee typically paid by borrowers to secure financing, as opposed to leaving it within the fund.

This can lead to conflicted incentives, potentially encouraging the manager to prioritise deals with higher upfront fees over those with the best long-term risk-return for investors, he continued.

“You don’t want investors going for deals just because they have the highest upfront fees. We think it’s best practice to have a flat management fee, so you’re aligned to investor outcomes,” Murphy concluded.