Welcome to the Fear and Greed Business interview. I'm Sean Elmer. Private credit has exploded in recent years. Tighter restrictions on banks has led to some corporate borrowers going elsewhere, and the private credit market has expanded to meet that demand both here and overseas. But as you might expect, when an industry grows so quickly, there's a need to ensure regulation can keep up. These questions were highlighted in an article in the Australian Financial Review earlier this week. It examined some of the challenges for the sector, including fees in due diligence over investments, and some of the instances where the high returns being offered by private credit haven't been realized. I wanted to take a closer look at the state of the industry and whether those operating in this space think that it could benefit from additional regulation or transparency. Patrick William is the co- founder and managing director of Rixon Capital, a private credit investment manager established a couple of years ago. Patrick himself has been involved in the industry since 2018. Rixon Capital is a great supporter of this podcast. Remember, this is general information only and you should seek professional advice before making investment decisions. Patrick William, welcome to Fear and Greed.

Welcome to the Fear and Greed Business interview. I'm Sean Elmer. Private credit has exploded in recent years. Tighter restrictions on banks has led to some corporate borrowers going elsewhere, and the private credit market has expanded to meet that demand both here and overseas. But as you might expect, when an industry grows so quickly, there's a need to ensure regulation can keep up. These questions were highlighted in an article in the Australian Financial Review earlier this week. It examined some of the challenges for the sector, including fees in due diligence over investments, and some of the instances where the high returns being offered by private credit haven't been realized. I wanted to take a closer look at the state of the industry and whether those operating in this space think that it could benefit from additional regulation or transparency. Patrick William is the co- founder and managing director of Rixon Capital, a private credit investment manager established a couple of years ago. Patrick himself has been involved in the industry since 2018. Rixon Capital is a great supporter of this podcast. Remember, this is general information only and you should seek professional advice before making investment decisions. Patrick William, welcome to Fear and Greed.

Thanks for having me, Sean.

Thanks for having me, Sean.

Wel; l, in that introduction I mentioned that Rixon Capital has been in Australia since 2018, 6 years, so it's not like it's a new industry, and there's many funds that have been around for a lot longer than you. We're just hearing about it more, but there is quite a history with private credit.

Wel; l, in that introduction I mentioned that Rixon Capital has been in Australia since 2018, 6 years, so it's not like it's a new industry, and there's many funds that have been around for a lot longer than you. We're just hearing about it more, but there is quite a history with private credit.

Yeah, look, the sector's been around for a long time. It used to be called non- bank lending, and it just picked up niche segments that the banks didn't bank. But come 2018, post the Hay Royal Commission, we saw the banks really begin to pull out, particularly in SME lending at that point in time. And that's what saw the explosion of private credit because all these businesses could no longer access bank debt when they're looking for checks of below $ 20 million. So that was really the catalyst for the emergence of mainstream private credit in the Australian market.

Yeah, look, the sector's been around for a long time. It used to be called non- bank lending, and it just picked up niche segments that the banks didn't bank. But come 2018, post the Hay Royal Commission, we saw the banks really begin to pull out, particularly in SME lending at that point in time. And that's what saw the explosion of private credit because all these businesses could no longer access bank debt when they're looking for checks of below $ 20 million. So that was really the catalyst for the emergence of mainstream private credit in the Australian market.

Okay, so if we look at the market, broadly, the criticism really comes down to transparency. How transparent is the private credit market in Australia?

Okay, so if we look at the market, broadly, the criticism really comes down to transparency. How transparent is the private credit market in Australia?

That's a very good question. It comes down to how new the player is. The newer you are, the more transparent you are because you've got to compete and get capital. But some of the more mature players that started in 2017, '18, '19, by virtue of it being a very new asset class, were probably less transparent and there's nothing sinister about it. Most investors are familiar with how an equity fund operates. You pick a sector, you pick a manager you like and off you go. And those funds were set up on that basis. Unfortunately, without the underlying detail, it becomes harder and harder for investors actually to vet what the underlying risk is. Because with equity it's you get all the upside, you wear all the downside. It's really not that hard. Whereas with private credit, it's not a single asset class. You've got to consider the risk of the sector, the availability or unavailability of security, ranking of the debt, whether it pays interest, whether it doesn't, whether it pays cash interest or does not pay cash interest. So there are lots and lots of variables and if you don't understand what all those variables are and what those categories are for a fund, it's actually very hard to make an investment decision.

That's a very good question. It comes down to how new the player is. The newer you are, the more transparent you are because you've got to compete and get capital. But some of the more mature players that started in 2017, '18, '19, by virtue of it being a very new asset class, were probably less transparent and there's nothing sinister about it. Most investors are familiar with how an equity fund operates. You pick a sector, you pick a manager you like and off you go. And those funds were set up on that basis. Unfortunately, without the underlying detail, it becomes harder and harder for investors actually to vet what the underlying risk is. Because with equity it's you get all the upside, you wear all the downside. It's really not that hard. Whereas with private credit, it's not a single asset class. You've got to consider the risk of the sector, the availability or unavailability of security, ranking of the debt, whether it pays interest, whether it doesn't, whether it pays cash interest or does not pay cash interest. So there are lots and lots of variables and if you don't understand what all those variables are and what those categories are for a fund, it's actually very hard to make an investment decision.

So does that mean that it is far better set up for institutional or wholesale or even home offices, assuming they have the skills, to get involved in private credit much more than a retail investor, for example?

So does that mean that it is far better set up for institutional or wholesale or even home offices, assuming they have the skills, to get involved in private credit much more than a retail investor, for example?

I'd say they've got an advantage in diligencing the funds because they get more access and they can ask or know to ask more detailed questions, whereas it still works for retail. But I find in our experience, retail investors tend to face that chase, the reward without understanding what the risk is. So you have a fund delivers 14%, it's better than a fund that delivers 10, without actually understanding there's a reason one's delivering 10 and one's delivering a higher number.

I'd say they've got an advantage in diligencing the funds because they get more access and they can ask or know to ask more detailed questions, whereas it still works for retail. But I find in our experience, retail investors tend to face that chase, the reward without understanding what the risk is. So you have a fund delivers 14%, it's better than a fund that delivers 10, without actually understanding there's a reason one's delivering 10 and one's delivering a higher number.

Okay. So in terms of the Australian market, how do we rate compared to somewhere like the US? Inevitably we follow the US in many of these markets. Is it something that we can learn from what's happened in the US to address some of the criticisms here?

Okay. So in terms of the Australian market, how do we rate compared to somewhere like the US? Inevitably we follow the US in many of these markets. Is it something that we can learn from what's happened in the US to address some of the criticisms here?

Definitely. There's been a bit of press this morning in overseas publication about this, where they talk about how in the US... There are the things that are standard there that will come into play here over the next six months, 12 months... the use of third party trustees. So if something's going wrong with the loan book, you have a third party that says you need to call a default, as opposed to the investment manager being their own trustee. In the US they require quarterly valuations. So if anything's wrong with a business, you are forced to call it out and inform your investors. So the US has come a long way in terms of disclosure. We've just got to catch up to them.

Definitely. There's been a bit of press this morning in overseas publication about this, where they talk about how in the US... There are the things that are standard there that will come into play here over the next six months, 12 months... the use of third party trustees. So if something's going wrong with the loan book, you have a third party that says you need to call a default, as opposed to the investment manager being their own trustee. In the US they require quarterly valuations. So if anything's wrong with a business, you are forced to call it out and inform your investors. So the US has come a long way in terms of disclosure. We've just got to catch up to them.

Stay with me, Patrick. We'll be back in a minute. My guest today is Patrick William, co- founder and managing director of Rixon Capital. I mean, one of the great things about private credit is that private credit allows SMEs or medium- sized businesses to access capital that they may not have done otherwise. Being devil's advocate on what you've said there, you don't want to make it overly bureaucratic. You certainly don't want to go down the route that one of the bank CEOs suggested in terms of having to hold reserves, capital requirements similar to banks. Suddenly you don't become competitive. So where's the line between being able to lend $ 20 million or $ 10 million to an SME that's growing fairly fast verse regulation?

Stay with me, Patrick. We'll be back in a minute. My guest today is Patrick William, co- founder and managing director of Rixon Capital. I mean, one of the great things about private credit is that private credit allows SMEs or medium- sized businesses to access capital that they may not have done otherwise. Being devil's advocate on what you've said there, you don't want to make it overly bureaucratic. You certainly don't want to go down the route that one of the bank CEOs suggested in terms of having to hold reserves, capital requirements similar to banks. Suddenly you don't become competitive. So where's the line between being able to lend $ 20 million or $ 10 million to an SME that's growing fairly fast verse regulation?

Look, this is a personal opinion. I think regulation will hinder the sector. What we're better off doing is actually having industry get together and say, we need to self- regulate. We need to all agree that you need to be disclosing particular variables in your advertising material, your marketing material, your investment documents, and in your fund reporting. Because once you start doing that, you're allowing investors to make a very educated decision on the risk profile. So if heaven forbid something goes wrong with the loan, per the article yesterday, investors shrug their shoulders and say, look, I knew about it, and that's fine because the return makes sense for that level of risk.

Look, this is a personal opinion. I think regulation will hinder the sector. What we're better off doing is actually having industry get together and say, we need to self- regulate. We need to all agree that you need to be disclosing particular variables in your advertising material, your marketing material, your investment documents, and in your fund reporting. Because once you start doing that, you're allowing investors to make a very educated decision on the risk profile. So if heaven forbid something goes wrong with the loan, per the article yesterday, investors shrug their shoulders and say, look, I knew about it, and that's fine because the return makes sense for that level of risk.

Fees, we always talk about fees and for many retail investors, fees matter. Are they particularly high in private credit investments?

Fees, we always talk about fees and for many retail investors, fees matter. Are they particularly high in private credit investments?

It's also a very good question. So the headline fees in private credit aren't particularly high. They range from zero to about 1. 5% to 2% per annum. But the hidden fees are where private credit's taking a bit of criticism at the moment. So particularly with funders that lend to borrowers in the property space, but also in the corporate space, what you're seeing is some funds that are taking upfront fees for themselves as well. So to illustrate, you go to borrower and the borrower says, " Look, my board's approved a 15% cost to finance to you for 12 months. You do what you need to do." And what the fund does is they say, " Look, we'll take 3% as an upfront fee. We'll pay 12 to investors gross, and then we'll take a 1% fee off that as well." So the fund can disclose to investors, we have a 1% management fee, but the reality is they're booking a 4% fee. Where that comes undone is A, investors don't know the scale of the fee the fund's getting, and B, it's actually investing capital at risk. So you've got investors put their hard earned money at risk. They're earning 11 to 12% when in fact they're exposed to 15% risk.

It's also a very good question. So the headline fees in private credit aren't particularly high. They range from zero to about 1. 5% to 2% per annum. But the hidden fees are where private credit's taking a bit of criticism at the moment. So particularly with funders that lend to borrowers in the property space, but also in the corporate space, what you're seeing is some funds that are taking upfront fees for themselves as well. So to illustrate, you go to borrower and the borrower says, " Look, my board's approved a 15% cost to finance to you for 12 months. You do what you need to do." And what the fund does is they say, " Look, we'll take 3% as an upfront fee. We'll pay 12 to investors gross, and then we'll take a 1% fee off that as well." So the fund can disclose to investors, we have a 1% management fee, but the reality is they're booking a 4% fee. Where that comes undone is A, investors don't know the scale of the fee the fund's getting, and B, it's actually investing capital at risk. So you've got investors put their hard earned money at risk. They're earning 11 to 12% when in fact they're exposed to 15% risk.

Yeah, okay. What about in terms of private credit as a liquid asset? So that's another issue that many investors worry about. Is it particularly liquid?

Yeah, okay. What about in terms of private credit as a liquid asset? So that's another issue that many investors worry about. Is it particularly liquid?

Not particularly. It depends on the asset class. So you've got private debt funds that focus on bank debt, subordinated debt, listed debt. So there are liquid options. The returns aren't particularly compelling relative to the unlisted option. So it's not a liquid asset class in general, and my advice to investors is, look, you get compensated with an illiquidity premium. So if you want those double- digit returns, you get quarterly liquidity. If you're happy to take 6 to 7%, you can have nearly liquidity, but you're compensated for it.

Not particularly. It depends on the asset class. So you've got private debt funds that focus on bank debt, subordinated debt, listed debt. So there are liquid options. The returns aren't particularly compelling relative to the unlisted option. So it's not a liquid asset class in general, and my advice to investors is, look, you get compensated with an illiquidity premium. So if you want those double- digit returns, you get quarterly liquidity. If you're happy to take 6 to 7%, you can have nearly liquidity, but you're compensated for it.

Okay. So the bottom line in all investing is that the return you're getting and where you are on the risk reward spectrum. The returns are pretty good though, aren't they? I mean, those are arguing against private credit. I suppose the point is if transparency can be improved, so people know what they're getting into, and that's important. They understand the risk reward, the actual returns are really good.

Okay. So the bottom line in all investing is that the return you're getting and where you are on the risk reward spectrum. The returns are pretty good though, aren't they? I mean, those are arguing against private credit. I suppose the point is if transparency can be improved, so people know what they're getting into, and that's important. They understand the risk reward, the actual returns are really good.

The returns are exceptional for what they are. The all odds delivered, I think 7% return over the last 12 months, and that's equity exposure. You can get a double- digit return with a good quality private credit fund sitting in debt, which ranks ahead of the equity. So it is a very compelling proposition, particularly in this market.

The returns are exceptional for what they are. The all odds delivered, I think 7% return over the last 12 months, and that's equity exposure. You can get a double- digit return with a good quality private credit fund sitting in debt, which ranks ahead of the equity. So it is a very compelling proposition, particularly in this market.

So where do you think we'll go in terms...? Something will crack eventually. Do you think that the industry will come together and self- regulate? Do you think eventually ASIC and others will force the government to regulate? Where do you think we're heading?

So where do you think we'll go in terms...? Something will crack eventually. Do you think that the industry will come together and self- regulate? Do you think eventually ASIC and others will force the government to regulate? Where do you think we're heading?

My prediction is the industry will self- regulate before ASIC cracks down. Articles like the piece by Jonathan Shapiro yesterday, it embarrasses a few players. Not particularly fair sometimes when you pick one or two people, but it is what it is. And I think it's a wake- up call for the sector to go, look, we need to be a lot more open and a lot more honest with our investors because by and large, the sector is doing the right thing. But you don't want a few stories that are a little unsavory, seeing ASIC come in and to the point that the bank as CEO may start forcing people to hold reserves because all of a sudden it becomes a very unattractive sector because you're holding dead money.

My prediction is the industry will self- regulate before ASIC cracks down. Articles like the piece by Jonathan Shapiro yesterday, it embarrasses a few players. Not particularly fair sometimes when you pick one or two people, but it is what it is. And I think it's a wake- up call for the sector to go, look, we need to be a lot more open and a lot more honest with our investors because by and large, the sector is doing the right thing. But you don't want a few stories that are a little unsavory, seeing ASIC come in and to the point that the bank as CEO may start forcing people to hold reserves because all of a sudden it becomes a very unattractive sector because you're holding dead money.

Do you think it'll keep growing, private credit, as it has done in more recent times post banking Royal Commission?

Do you think it'll keep growing, private credit, as it has done in more recent times post banking Royal Commission?

Oh, it's got a long way to go in the Australian market. The Big four banks are still withdrawing out of, well, they've already withdrawn from small SME. They're withdrawing from large SME lending as well. So we've easily got 3, 5, 6 years of very strong growth, just filling in that gap, and then once we fill that gap, it's about catering to the growth in the space.

Oh, it's got a long way to go in the Australian market. The Big four banks are still withdrawing out of, well, they've already withdrawn from small SME. They're withdrawing from large SME lending as well. So we've easily got 3, 5, 6 years of very strong growth, just filling in that gap, and then once we fill that gap, it's about catering to the growth in the space.

Patrick, thank you for talking to Fear and Greed.

Patrick, thank you for talking to Fear and Greed.

Thank you for the time, Sean.

Thank you for the time, Sean.

That's Patrick William, Co- founder and managing director of Rixon Capital, a great supporter of this podcast. This is the Fear and Greed business interview. Remember, this is general information only and you should always seek professional advice before making investment decisions. Join us every morning for the full episode of Fear and Greed, daily business news for people who make their own decisions. I'm Sean Elmer. Enjoy your day.

That's Patrick William, Co- founder and managing director of Rixon Capital, a great supporter of this podcast. This is the Fear and Greed business interview. Remember, this is general information only and you should always seek professional advice before making investment decisions. Join us every morning for the full episode of Fear and Greed, daily business news for people who make their own decisions. I'm Sean Elmer. Enjoy your day.