Following SQM Research’s decision to place the private sector on watch, Morningstar confirmed it is finalising a new framework to evaluate funds without daily liquidity, while Lonsec has recently enhanced its private markets model to capture risks such as valuation governance and portfolio concentration.
The message from research houses is clear: transparency and governance are under the microscope, and only managers with robust underwriting, diversification, and risk controls will make the cut.
SQM Research managing director Louis Christopher said the ratings house was taking a “precautionary measure”, which it views as a “necessary step” to ensure “appropriate oversight” of an asset class that has been growing in relevance and size over recent years.
He also pointed to an increase in sector-related issues and recent statements from corporate and prudential regulators as key drivers of the shift.
Morningstar is also sharpening its approach. Speaking to InvestorDaily, Matt Olsen, director of manager research, said the firm is in the final stages of developing a global methodology for assessing funds that lack daily liquidity.
“This methodology is in the final stages of development,” Olsen said.
Acknowledging the “key role” private credit can play in portfolio construction, he said that along with liquidity, “an important issue with this sector is transparency”.
“When researching funds, we prefer full transparency of the underlying holdings,” said Olsen.
“That is not always possible with private credit funds. Some don't wish to disclose all of their holdings because of their underlying clients – borrowers who don’t want their lending positions disclosed. We advocate and champion for full transparency of fund holdings in order to assess the full risk and return potential.”
In a statement this week, Lonsec reinforced the importance of a “robust methodology” in private credit research. The agency, which rates 28 private credit funds — 20 of which are Australian — has refined its approach in response to the sector’s rapid growth.
The ratings agency said, having foreshadowed the growth in Australian private credit funds, it updated its “seven-factor private markets model and the governance framework overseeing the initiation of coverage” in early 2024.
“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,” said Darrell Clark, deputy head of research and manager, alternatives, Lonsec Research and Ratings.
“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.”
Clark noted that Lonsec vets all requests for coverage, scrutinising areas of heightened risk such as governance, vertical integration and/or related party issues, overall firm resourcing including workout staff, credit quality, and portfolio diversity.
“Only if a product meets minimum requirements, can it move forward into the Lonsec ratings process,” said Clark.
Morningstar’s Olsen emphasised that fund assessment hinges on three pillars: the parent company, investment team, and process.
“In the private credit space, we would be particularly concerned with the skills and experience of the investment team in credit underwriting and their skill in structuring lending arrangements in a way that protects investors,” he said.
“This can be done either via covenants, the positioning of the loan within the capital structure, or other means. The manager’s skill at handling workouts when a loan goes bad is also crucial.”
He stressed that diversification is key, with exposure and concentration risk requiring careful management.
“With respect to advice licensees or portfolio managers in the market, views will always vary on the desired exposure to private credit depending on risk tolerance, investor objectives and/or the current phase of the economic cycle. That is always their prerogative,” Olsen said.
“Our belief at Morningstar is that thorough due diligence can isolate managers best placed to navigate changing market conditions.”
For Lonsec’s part, Clark said the firm “remains vigilant to evolving market dynamics and ASIC’s ongoing review of private markets”, ensuring its approach aligns with industry best practices and regulatory expectations.
“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 added.
Meanwhile, Rodney Sebire, head of alternatives and global fixed income at Zenith, reaffirmed the firm’s commitment to high standards in private credit.
In a comment sent to InvestorDaily, Sebire said: “The Zenith approved product list (APL) for the private debt sector is limited only to those managers that have a proven track record of originating loans through different economic cycles, apply detailed lending processes and offer their funds within a strong corporate governance framework.
“We reaffirm our support for those managers and funds currently rated on our APL, as they continue to deliver attractive risk-adjusted returns and manage portfolios in line with their stated processes.”
The furore around private capital was sparked by ASIC’s latest discussion paper, which chair Joe Longo called one of its “most important pieces of proactive work”, addressing the shift from public to “opaque” private markets.
Answering questions posed by senator Andrew Bragg at Senate estimates last month, Longo said there are several reasons behind the regulator’s choice to do the paper, including to “shine a light on a section of our markets that we believe is lacking transparency at the moment”.
“As a national markets regulator, I’m concerned about that,” he said.
Denying that ASIC is “agitating for any policy change” – as framed by Senator Bragg – Longo said ASIC is asking Parliament for “more recurrent data-gathering powers”, alongside “other reforms”.
“This is not about – and I’ve made this very clear – re-regulating the private market space. It is about understanding what’s going on there and, secondly, being very open minded about,” he said.
