Why cash yield is eroding

For income-focused investors in Australia who have been able to earn 4-10% in cash yield (depending on risk and term) in past years, the current environment is akin to the brewing of a perfect storm.

Source of yield are set to dry up on multiple fronts:

• Term deposits: after a few years of enjoying deposit returns of 4%+, investors will be faced with large banks cutting rates as the RBA has embarked on its widely anticipated cutting cycle.\
• Investment property: historically robust, is now being burdened by heightened taxes and the possibility of looming policy reviews on negative gearing and capital gains – may be dulling the appeal for steady income-seeking investors.
• Dividend-heavy equities: yields here also get compressed if rates fall and shares rise. Dividend yields on BHP for example were over 10% three years ago – now they are ~4.5%. There is also the added volatility of share prices moving in uncertain times.
• Bank hybrids: long favoured for their steady income and franking credits, are being phased out entirely. APRA has mandated their elimination by 2032 – effectively winding down this $43 billion+ market entirely.

The drivers behind these changes are mostly related to central bank behaviour. But it goes beyond rate cutting to support a slowing economy.

As global governments, including the US, are facing escalating debt piles and structural deficits, they want a low interest rate environment to prevent collapse. This puts central banks under pressure to keep rates low to deliver on their mandate of financial stability.

The resulting low yield environment benefits the debt bingers, while punishing savers through lower yields and higher inflation.

Investors who have relied on any combination of the above income sources may therefore be facing a challenge – where to put funds in order to keep a decent yield going forward?

The search for yield explains the rise of private credit

As always in investing, the return opportunity lies where the money is not going – which brings us to banking regulation.

Global financial regulators have changed the rules over past years, increasingly incentivising banks to move their money into government securities. Conversely, less and less funding has been available for the private sector.

Companies are left underfunded – and hence more willing to pay a higher yield for any funding they can get. This may be the opportunity for non-bank investors to step in and fill the void.

The smart money like KKR or Oaktree has stepped in first, writing bespoke loans with negotiated terms.

This has resulted in the emergence of a new asset class of private credit, which can offer structurally higher cash returns, senior-ranking or secured agreements, and tailored terms suiting borrower and investor.

Unfortunately, access to these deals has been largely reserved for the institutional investors which invest in KKR & Co – like the big super funds. For individual investors, however, they are near impossible to source and structure.

At Reach Markets we’ve positioned accordingly.

What’s the deal?

As always in investing, the return opportunity lies where the money is not going – which brings us to banking regulation.

Private credit has several features that may be especially attractive to sophisticated investors:

• High cash yield – given it’s the underfunded private sector, companies are willing to pay for debt, so the yield is higher.
• Senior ranking/security – many deals are structured with senior rank for debt holders or collateral, offering a cushion against default.
• Customised terms – interest rates, maturities and covenants can be negotiated to meet the investor’s risk/return appetite.
• Diversification benefits – returns may often have low correlation with equity markets, providing a buffer during market volatility.

As interesting as this may sound, the question is how individual investors can get access. It is also important to work with someone who can work through a situation if something goes wrong with the investment.

Reach Markets has long-standing experience in structuring and working through debt investments, but our focus has traditionally been on convertible notes for growth companies.

Since the private debt market opportunity arose, we have come across very interesting deal flow from this space and have since applied our capabilities to provide access to our investors.

For instance, we recently closed a two-year loan to an ASX-listed company which had a 14% interest rate, but first-ranking security on an asset which was valued 6x times the loan amount. This is a good example of the type of opportunities we can capture.

Reach has a number of investments offering cash yields of 13%+, senior ranking and terms of two years or shorter. Click here to receive term sheets for future opportunities (Sophisticated 708 investors only).

Past performance is not a reliable indicator of future performance.

Reach Markets Pty Ltd are the advisers assisting with the management of these offers and may receive fees depending on whether an offer is taken up by investors.