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Speaker 1: Welcome to Fear and Greed summer series brought to you

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Speaker 1: by Montgomery Investment Management. I'm Sean Aylmer. The boom in

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Speaker 1: private credit in recent years has caught the eyes of

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Speaker 1: investors and regulators alike. What's the outlook over the next

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Speaker 1: couple of years. Roger Montgomery is the founder and chief

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Speaker 1: investment officer of Montgomery Investment Management. Roger, welcome back to

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Speaker 1: Fear and Greed.

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Speaker 2: Great to be with you, Sean, Thanks for having me so.

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Speaker 1: Private credits growing. Why is it such an attractive opportunity

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Speaker 1: when you have private equity Potentially, you have different managed funds,

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Speaker 1: you have bonds.

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Speaker 2: So it comes back to it's better to own a

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Speaker 2: bank than to have your money in a bank. Before

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Speaker 2: the Global Financial crisis, banks did the bulk of business

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Speaker 2: lending in Australia and around the world. And so if

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Speaker 2: you'd said to me fifteen years ago, Sean, I'm going

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Speaker 2: to lend money to a small or medium sized corporate

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Speaker 2: in Australia, obviously you've got rocks in your head. Don't

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Speaker 2: do it. And why because the banks have stitched up

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Speaker 2: or they had stitched up that market, and so any

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Speaker 2: business that you were being invited to lend to obviously

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Speaker 2: didn't pass mustered with the banks and was too risky.

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Speaker 2: But what happened after the global financial crisis around the

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Speaker 2: world is that regulation was tightened up about who to

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Speaker 2: lend to and how much capital for each class of

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Speaker 2: loans the banks needed behind them in order to make

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Speaker 2: that loan, and so it becameless profitable, not unprofitable, but

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Speaker 2: it became less profitable and more capital intensive for banks

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Speaker 2: to provide certain types of loans.

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Speaker 1: Now.

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Speaker 2: Consequently, in Australia, what's happened is that the gap between

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Speaker 2: what small and medium sized corporates in Australia would like

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Speaker 2: to borrow and what the banks are willing to lend

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Speaker 2: has blown out to about three or four hundred billion dollars.

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Speaker 2: To fill that gap, we've got a whole bunch of

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Speaker 2: new very smart run by ex bankers, non bank lenders,

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Speaker 2: and they're called originated and so what they're doing is

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Speaker 2: they're providing the capital now to these businesses who are

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Speaker 2: looking to grow. So we're not talking about distress businesses.

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Speaker 2: We're not talking about unsecured loans. We're talking about secured loans.

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Speaker 2: So capital you've got directors, guarantees, you've got security over

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Speaker 2: the business, you've got security over the assets and so on.

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Speaker 2: So they're secured loans to businesses. They're the loans that

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Speaker 2: banks used to make, but the banks aren't doing that

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Speaker 2: anymore and they've left this gap. And so to fill

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Speaker 2: that gap, you've got these non bank lenders. And how

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Speaker 2: do they get the financing to lend? Where do they

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Speaker 2: get the money? They get it from investors like you

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Speaker 2: and me who are investing through private credit funds. That's

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Speaker 2: why it's grown. And not only that, we've also got

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Speaker 2: a unique period in history where the baby boomers are

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Speaker 2: retiring and looking for income solutions, and those two forces

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Speaker 2: together have combined to see private credit grow.

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Speaker 1: Okay, so we've had lots in the last couple of

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Speaker 1: months from the corporate regulator about private credit. Now, ASEK

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Speaker 1: said that it is part of the market. They didn't

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Speaker 1: say it's a bad thing by any stretch, but they

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Speaker 1: just talked about transparency and the need for sort of

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Speaker 1: parameters around it. If I want to invest in private credit,

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Speaker 1: what should I be looking at? How do I think

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Speaker 1: about it within my portfolio?

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Speaker 2: Yes, so, look, just as there are different risks in

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Speaker 2: different stocks on the stock market. There are different risk

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Speaker 2: profiles for different private credit funds. So for example, personally,

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Speaker 2: I wouldn't want to invest in a private credit fund

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Speaker 2: that lends to property developers. So one of the first

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Speaker 2: questions is do you lend to property developers? So you

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Speaker 2: can have property backed finance that's where a director puts

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Speaker 2: their house up for.

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Speaker 1: Example, which is different.

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Speaker 2: A loan, but that's different to lending to a property

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Speaker 2: developer who's building something on spec. You know they're hoping

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Speaker 2: to sell after they've developed, You've got all the risks

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Speaker 2: of cost blowing out and so on. So there's that.

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Speaker 2: Then you want to know, for example, you want to

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Speaker 2: know are there any lock up periods? Am I going

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Speaker 2: to be locked into this for any period of time?

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Speaker 2: Some funds have no lock up, others have a twelvemonth lockup.

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Speaker 2: Then you might want to know is the fund externally

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Speaker 2: rated or internally rated? So the funds that we distribute

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Speaker 2: in Australia are externally rated using the same tools and

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Speaker 2: software that the big banks use to rate the portfolios.

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Speaker 2: The wholesale funders rated triple B and the retail funds

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Speaker 2: rated double A, but a lot of other fund managers

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Speaker 2: they internally rate their funds, which is like marking your

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Speaker 2: own homework. And then you want to know what is

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Speaker 2: the average term of the loan what we call it

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Speaker 2: in the industry duration, what's the average duration of the portfolio. So,

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Speaker 2: for example, you look at a portfolio and you see

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Speaker 2: the average duration is two years. What does that mean. Well,

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Speaker 2: let's say we have a big recession in Australia and

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Speaker 2: everyone wants to pull their money out of the fund

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Speaker 2: at the same time. Worst case scenario, the fund would

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Speaker 2: gate the fund. That means they close it off, shut

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Speaker 2: the gate, and they'd say, right, we're going to pay

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Speaker 2: you back as the loans are paid off. Now, if

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Speaker 2: you've got a two year average term, it could take

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Speaker 2: two years for you to get your money back, and

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Speaker 2: anything can happen in that two years. The funds that

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Speaker 2: we distribute have durations average durations that are less than

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Speaker 2: four months, and so if that happened, most of the

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Speaker 2: money is coming back relatively quickly. So they're just some

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Speaker 2: of the things that I'd be looking for to compare

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Speaker 2: these funds. But of course, if you approach a financial planner,

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Speaker 2: they should know these differences and they'll be highlighting them

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Speaker 2: to you.

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Speaker 1: So how should it fit into your portfolio?

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Speaker 2: Then, well, I think at the moment, I think, you know,

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Speaker 2: with the stock market potentially entering a period of heightened volatility,

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Speaker 2: you maybe want to rebalance your portfolio and take some

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Speaker 2: of the profits out of the stock market that you've

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Speaker 2: made over the last three years. We've had three very

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Speaker 2: very good years, and normally, you know, the risky thing

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Speaker 2: that people says, get out of the I mean it's

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Speaker 2: a bit immature, Actually get out of the stock market.

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Speaker 1: And go to cash.

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Speaker 2: Well, it's an expensive exercise because you're going to be

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Speaker 2: getting nothing on your money, and the stock market could

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Speaker 2: keep going up. But if I said to you, look,

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Speaker 2: you could park some of your profits into a private

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Speaker 2: credit fund that's going to give you between seven and

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Speaker 2: a half and nine and a half percent per annum,

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Speaker 2: paying cash monthly, Well, your opportunity cost is a lot

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Speaker 2: lower because you're still getting an attractive return or the

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Speaker 2: potential for a very attractive return. While you're out. You've

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Speaker 2: reduced your exposure to the stock market. You should never

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Speaker 2: exit the stock market entirely, because you're always going to

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Speaker 2: need growth.

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Speaker 1: Roger, thank you for talking to Fear and Greed Summer

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Speaker 1: Series always a pleasure. Roger Montgomery from Montgomery Investment Management.

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Speaker 1: To learn more, visit mont invest m O, n TI,

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Speaker 1: n V, eest wont invest dot com and you can

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Speaker 1: sign up for Roger's insights that Roger Montgomery dot com.

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Speaker 1: Fearing Greed is not a financial advice podcast. If you

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Speaker 1: want to invest, we recommend you visit a financial advisor

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Speaker 1: here can tailor investments to your needs. Don't forget to

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Speaker 1: hit follow on the podcast. I'm sure I am. And

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Speaker 1: this is Fearing Greed brought to you by Montgomery Investment

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Speaker 1: Management