Why private debt investors are less worried about a market correction

A looming market correction and inflation expectations are keeping equity investors on their toes. But investors of another asset class are finding this time of volatility a lot less stressful. Here’s why.

Billions of dollars being wiped from the ASX made headlines in September 2021 – twice. And with a market as volatile as equities, $50 billion tumbles are not unusual. With so much accessible data available to so many people, it’s no wonder the equity markets are driven by ‘animal spirits’ – prices can fall rapidly and sharply, often with no clear logical explanation. The conundrum facing the equity investor is they don’t want to miss the gains, but are forever in fear of losing from the rapid falls – ‘should I stay or should I go?’ is never far from their minds.

Equity prices are determined by supply and demand. If the demand for a company’s stock is high, prices rise. But if demand drops, prices follow.

Demand for a stock can be influenced by a range of things, including a company’s financial performance or reputation. Macro-economic factors like interest rates, inflation, stagnant economic growth and unemployment can also send prices spiralling. And the past two years have clearly shown the impact of disasters, such as a pandemic, on the stock market.

With inflation expectations at a near three-year high,[1] it’s no wonder that the wall of worry equity investors are used to climbing is only getting higher.

But there are some investors that are notably less worried right now – those with money in private real estate debt.

The protective buffer of private debt

Returns in listed equities can be high, but their volatility means so are the risks.

In contrast, investors in private debt have complete visibility of their risk. Because they are lending directly to borrowers, and property is the underlying security, they can use factors like the Loan to Value Ratio (LVR), as well as the borrower’s track record and exit strategy, to assess the risk of their investment not performing.

And of course, private real estate investors enjoy the benefit of a ‘buffer’ that insulates their capital from market falls.  The lower the LVR, the more ‘buffer’ there is to protect your investment.

For instance, if you lend $500k on a property-backed loan with the property’s value at $1million, your LVR is 50%. If the borrower defaults, there is a lot of headroom between your exposure and the value of the property, so if it needs to be sold it is extremely unlikely you will incur a capital loss. 

Don’t leave your money in one basket

Diversifying your investments is always a good idea, but never more so than in a volatile market.  When you consider how to spread your investments across various asset classes, look at how they correlate with each other. Many assets move in tandem, which means if one falls, the others will follow.

When you have a mixture of non-correlated assets, you’re creating a diversified portfolio that is less volatile and will give you fewer surprises when it comes to returns.

Private debt gives investors an opportunity to diversify their portfolio with an asset that has low correlation to other investments, and provides more certain returns in an unpredictable market. So, even when markets turn volatile the product is designed so that you should continue to receive consistent returns. And that’s reassuring if you rely on regular income to maintain your lifestyle.

If you’ve been procrastinating, perhaps now is a time to review your asset allocation and consider looking beyond traditional asset classes. Private real estate debt can be a valuable addition to a more stable, reliable and less volatile portfolio.

[1] Roy Morgan, Inflation Expectations up 0.2% points to 4.3% in August; highest for nearly three years since November 2018, September 21 2021

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