Lonsec confirms private credit research model changes

In the wake of fellow Australian research house SQM Research recently putting the private credit sector on “Watch”, Lonsec Research and Ratings has confirmed it made adjustments to its research process at the beginning of 2024 to better align with the growing private credit sector and address its “risks and challenges”.

Similar to SQM Research’s increase of its “initial due diligence screening”, Lonsec said in a statement that it had reviewed its “seven-factor private markets model” used to oversee its coverage of private credit products to focus more on governance.

Lonsec also suggested that the research move came about as more retail investors looked to private credit as a portfolio diversification strategy, given the ongoing ‘democratisation’ of private markets to provide non-institutional investors with access to previously untapped opportunities.

“Private credit can present compelling opportunities for both investors and borrowers but it also brings significant risks and challenges. Balancing opportunities with risk management is essential,” Darrell Clark, Deputy Head of Research & Manager, Alternatives at Lonsec Research and Ratings, said.

“We use a seven-factor model as the foundation for research ratings, with the Product factor specifically designed to evaluate the structure of the investment product under review.

“Prior to our Alternatives Sector Review last year, we enhanced the Product factor within our private markets model to better capture the additional risks associated with private market funds, such as illiquidity and valuation governance.”

The research house confirms the process change as other industry and market moves point to private credit being under scrutiny, after the Australian Securities and Investments Commission (ASIC) released a discussion paper citing a “lack of transparency and the need for more data” and later denied that it was “agitating for any policy change”.

SQM Research also cited the ASIC discussion paper in its decision to place the private credit sector on ‘watch’, in the aftermath of reports that publicly-listed financial advice firm, Count Limited, had decided to not include some Metrics Partners funds – including the Metrics Master Income Trust, Metrics Income Opportunities Trust and the unlisted Direct Income Fund – from its approved product lists (APLs).

Lonsec also highlighted several areas of ‘heightened risk’ that have been integrated into its rating process, including governance, start-ups, vertical integration and/or related party issues, expertise and independence, complexity of Warehouse structures, overall firm resourcing, credit quality, portfolio diversity, and risk management and underwriting standards.

“Lonsec has been providing product ratings to Australian advisers for over 30 years, with our Alternatives rating team having a broad range of private market experience across several market cycles. We are highly aware of the trust placed in us by Advisers and their clients and as such, end investors are top of mind when we evaluate and rate funds,” Clark said.