There is much debate about whether rates will rise or fall or stay about here for some time – the latter being my personal stance and prediction. Irrespective of our own beliefs, I think we can all agree interest rates aren’t going back to the lows we saw when the U.S. Federal Reserve cut rates to zero, and our own Australian banks benefitted from the Reserve Bank of Australia’s (RBA) term funding facility, which provided three-year funding at 0.1 per cent.

It is also highly unlikely we will witness a repeat of the almost four decades of declining interest rates that so helpfully boosted the wealth of generations viz-a-vis the appreciation of all conventional asset classes, and a few unconventional ones too.

In the financial tapestry of recent decades, we’ve done nothing but revel in a climate marked by a period of generously declining interest rates followed by a prolonged period of ultra-low interest rates. Yet, today, the winds of change are upon us, hinting at a departure from this comfortable tailwind. It’s no longer far-fetched to anticipate longer periods of more modest economic growth, and narrower corporate profit margins amid a persistently higher rate of inflation. And where once a corporation might have been able to borrow ‘X’ at an interest rate of ‘i’, they can now only borrow something less than X at an interest rate higher than ‘i’. In such an environment, refinancing will be challenging for many more companies than it has been before. And in such an environment, debt will not rescue private equity ‘misadventurers’. It is, therefore, reasonable to assume an uptick in defaults, particularly amongst those ‘profitless prosperity’ companies I have written about frequently.

And while all of the above is reasonable, it is important not to become too bearish. Commentators and high-profile investors thrive off scaring the wider public. It serves them that there is always another big scary dark cloud on the horizon that everyone should be worried about. If it’s not refinancing the U.S. budget deficit, a war in Ukraine, Israel, or a possible conflict involving China and Taiwan, it’s a recession, rising interest rates and now zombie companies…again. Our industry thrives on imploring investors to look at all the dangers. As Charlie Munger once observed, “What witchdoctor ever gained fame and notoriety by prescribing two aspirin?”

Nevertheless, I don’t think it’s unreasonable to assert that we might see assets appreciating at less predictable rates and businesses wrestling a bit more for financing. Furthermore, the borrowing landscape is shifting – from the once-stable descent (over nearly forty years, I might add) to a terrain of subtle oscillations.

It’s worth emphasising that you should ignore predictions of a dramatic leap back to the sky-high interest rates of the 1980s. I think slight nudges upwards are possible as are slight nudges down. But over time, rates will, I expect, look relatively stable, settling at a generally higher plateau. 

Evolving strategies in a dynamic landscape

The sunset of the golden age of investment strategies that were buoyed by the falling interest rates of the past four decades, is upon us. The 1981-2021 period was an elixir for asset owners, from corporations and private equity investors to property developers and cryptocurrency speculators. The allure of bond returns paled as discount rates took a dip, making riskier assets the darling of the financial world.  And of course, the period was doubly rewarding for those who borrowed to dabble. The popularity of that latter strategy became the fuel for a boom in leveraged buyouts, debt financing of VC-backed companies, margin investing and derivatives trading.

And while investors willing to take bolder bets were reaping the rewards of a rising tide in asset prices, this same environment posed challenges for debt investors. The scramble and competition for attention-grabbing returns meant many had to decide between braving the storm with dwindling returns, dialling back the risk, or amplifying it in the hopes of higher returns. It was a time when true bargains were elusive, tucked away in the shadows of an overly competitive market.

Many a ‘risk-on’ investor might reminisce about the bounties of this era, but it’s prudent to remember the instrumental role played by the rising tide of falling interest rates, the tailwinds of cheap money.

As famed investor John Kenneth Galbraith once wryly observed,

“I think without a doubt, that what is called financial genius is merely a rising market”.

That tide, the one that lifted all boats, can be relegated to the annuls of history. It will be a period we look back on most fondly, but it will be firmly in the rearview mirror. But make no mistake; we will still have booms, bubbles and busts, but the booms might last four years, not four decades.

The coming years will paint a very different picture for asset ownership and asset class returns.

Private credit’s time in the limelight

Enter private credit. It has been growing for the last 13 years – since the GFC – but really had no time in the limelight. Until now it was an asset class before its time. But that time has now come – also helped by a cohort of baby boomers who may soon grow tired of the volatility associated with managing a portfolio entirely comprised of equities.

The present shifts in the financial milieu cast private credit in a new, much more favourable light. The ebbing tide of easy money paves the way for private credit to emerge as a bastion of stability and attractive returns. In an era of flux, the allure of consistent monthly cash income and attractive absolute returns from private credit might just be the beacon investors have been yearning for.

As we brace for a world where interest rates remain more elevated, the stage seems set for private credit investments to take their well-deserved place at the front of the line when structuring a balanced portfolio. 

 Table 1. Private Credit’s features and benefits

After all, in the realm of finance, it’s the blend of adaptability and vision that crafts the most enduring success stories, and private credit is an asset class whose role in portfolios will likely take more prominence.

Find out more about the Aura Private Credit Funds

You should read the relevant Product Disclosure Statement (PDS) or Information Memorandum (IM) before deciding to acquire any investment products.

Past performance is not an indicator of future performance. Returns are not guaranteed and so the value of an investment may rise or fall.

This information is provided by Montgomery Investment Management Pty Ltd (ACN 139 161 701 | AFSL 354564) (Montgomery) as authorised distributor of the Aura Core Income Fund (ARSN 658 462 652) (Fund). As authorised distributor, Montgomery is entitled to earn distribution fees paid by the investment manager and, subject to certain conditions being met, may be issued equity in the investment manager or entities associated with the investment manager.

The Aura Core Income Fund (ARSN 658 462 652)(Fund) is issued by One Managed Investment Funds Limited (ACN 117 400 987 | AFSL 297042) (OMIFL) as responsible entity for the Fund. Aura Credit Holdings Pty Ltd (ACN 656 261 200) (ACH) is the investment manager of the Fund and operates as a Corporate Authorised Representative (CAR 1297296) of Aura Capital Pty Ltd (ACN 143 700 887 | AFSL 366230). 

You should obtain and carefully consider the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the Aura Core Income Fund before making any decision about whether to acquire or continue to hold an interest in the Fund. Applications for units in the Fund can only be made through the online application form. The PDS, TMD, continuous disclosure notices and relevant application form may be obtained from www.oneinvestment.com.au/auracoreincomefund or from Montgomery.

The Aura High Yield SME Fund is an unregistered managed investment scheme for wholesale clients only and is issued under an Information Memorandum by Aura Funds Management Pty Ltd (ABN 96 607 158 814, Authorised Representative No. 1233893 of Aura Capital Pty Ltd AFSL No. 366 230, ABN 48 143 700 887).

Any financial product advice given is of a general nature only. The information has been provided without taking into account the investment objectives, financial situation or needs of any particular investor. Therefore, before acting on the information contained in this report you should seek professional advice and consider whether the information is appropriate in light of your objectives, financial situation and needs.  

Montgomery, ACH and OMIFL do not guarantee the performance of the Fund, the repayment of any capital or any rate of return. Investing in any financial product is subject to investment risk including possible loss. Past performance is not a reliable indicator of future performance. Information in this report may be based on information provided by third parties that may not have been verified.