By Helen Mason, Portfolio Manager, Schroders
Public credit is quickly emerging as a favourite among Australian income investors seeking diversity, transparency, liquidity – and of course, attractive yields.
Public credit – generally defined as publicly traded debt issued by corporates and financial institutions – has previously flown under the radar for Australian retail investors compared to equities, despite being a mainstay of institutional portfolios for decades. But this is quickly changing. Pblic credit serves as a critical pillar underpinning the balance sheets of banks and companies here and abroad, providing a source of capital to fund growth and operations whilst reducing reliance on bank loans and potentially enhancing shareholder returns.
This is still fixed income
Public credit occupies a well-earned place within the broader fixed income universe due to the regular coupons it pays investors.[1] In contrast to equity dividends, which are paid at the discretion of management and heavily influenced by the business cycle, coupon payments in public credit are a legal obligation of the issuer. This makes it an essential source of stable income for investors across all market conditions.
A standout market
Public credit has become an attractive asset class for income investors, and this is especially so in Australia for several reasons.
Attractive income without excess risk
Higher yields are a notable feature of Australian credit, often offering spreads that compare favourably to similar-rated securities in other developed markets. This yield premium over Government bonds enhances income potential without necessarily increasing risk disproportionately. Credit spreads are typically wider in Australia than global peers given the technical demand and supply dynamics in Australia, despite the high-quality of our investible universe.
Reliability of income is a further strength, as most Australian credit instruments deliver predictable, periodic interest payments. This characteristic is particularly valued by investors seeking steady cash flows, whether for reinvestment or to meet ongoing liabilities. Remember that coupon payments are a legal obligation unlike dividends from equity investments, which are discretionary.
High Quality Issuers
The Australian public credit market is dominated by financials, infrastructure, and utilities companies. Many of these businesses benefit from monopoly-like conditions and/or inflation-linked earnings, resulting in remarkably stable cash flows.
Strong Regulatory Oversight
Australian lenders are typically well regulated. Rigorous frameworks foster prudent lending and ensure issuers are well-capitalised, lending additional confidence to investors.
Minimal Default Risk
With little exposure to lower-quality sub-investment grade issuers, the Australian market has a notably low default rate relative to global peers.
Transparency and Discipline
Ongoing scrutiny from investors, rating agencies, and regulators means valuations are market-driven, and risk-adjusted returns tend to be more consistent.
Meaningful Diversification
Investors gain access to a broad mix of sectors, maturities, and credit qualities. This breadth helps balance portfolios and guard against risks.
What are the other options for income and how do they compare?
Before weighing the alternatives, it’s important to understand where public credit fits in the risk and return spectrum. As part of a defensive, fixed income allocation, its purpose is to emphasise capital stability and reliable income.
Other income-generating assets include public equities and private credit, but both are considered growth-oriented, due to their enhanced risk profile.
Source: Schroders, * For illustrating purposes only. Private credit is generally considered to have higher overall risk due to illiquidity, complexity, and transparency issues. However, sub-investment grade public credit exposes investors to higher market volatility. Actual risk depends significantly on the structure, collateral, and borrower quality in each specific investment in a portfolio.
Private Credit
Private credit is increasingly classified as a growth asset, given its risk-return profile. While it can deliver regular income and sometimes lower volatility than equities in benign market conditions, the underlying loans often involve higher leverage, less and lower-quality collateral, and concentration in riskier sectors like real estate. Yields might be higher, but so are the credit risks, illiquidity, and sensitivity to economic shocks – especially when defaults or recoveries become more important during downturns.
Despite the risk, private credit has surged post-GFC as investors sought higher yield in a low-rate world. However, yield premiums have compressed as the sector has become crowded, meaning investors are now often taking on more risk without adequate compensation.
In short, investors are no longer getting paid to take the risk extension to invest in private credit to access income compared to public credit.
Public equities
Public equities, by nature, occupy a higher point on the risk spectrum. In the capital structure, equity holders rank below all debt investors if a company enters financial distress. While dividends can provide income, these payments are not guaranteed and can fluctuate significantly. The current dividend yield on the ASX 200 is 3.43% or 4.46% when franking is included. Compare this to the Australian corporate credit index where the yield has risen to 5%, bearing in mind this is for an average of “A” rated quality. Given the domestic narrative for Australian rates has turned notably more hawkish. Economic data has surprised to the upside: the job market remains robust, wage growth is elevated, and services inflation persists. Consequently, the expectation is for interest rates to remain elevated in 2026, which will mean for income-seeking investors public credit will continue to be attractive.
Bank hybrid (Additional Tier 1) replacement
Regulatory changes to Australian bank capital structure, has meant the removal of bank hybrids as a direct investible option for retail investors. Australian public credit is suitable alternative to these securities, providing the additional benefits of greater diversification, lower volatility and commensurate, if not higher returns even when including the franking component.
A favourable outlook
Since 2022, the economic environment has shifted to one of higher growth, inflation, and interest rates. More recently, there is greater government involvement in capital allocation, with increased spending on social issues, security, energy transition, and aged care, largely funded by debt resulting in higher levels of Government debt in developed markets exceeding 100% of GDP. To sustain this debt, governments must keep economic growth high, resulting in persistently elevated inflation and interest rates. In this environment, public credit becomes an extremely compelling option for investors seeking higher income in their portfolios.
Conclusion
Australian public credit stands out as a vital component for investors seeking to build resilient, income-oriented portfolios in today’s evolving market environment. The asset class not only provides stable income streams, but also offers investors meaningful diversification and liquidity.
With equity markets standing at peak valuations and private debt troubled with over-crowding poor transparency and high fees, income seeking investors should be evaluating how portfolios are structured in the “Higher-for-Longer” investment regime, especially as yield premiums on private credit and equities have significantly reduced.
Conversely, public credit continues to offer a compelling risk-adjusted return profile and with the challenges highlighted, the case for this high-calibre asset class as a cornerstone defensive portfolio allocation has only strengthened. Indeed, for those prioritising yield, quality, capital stability, transparency and liquidity, Australian public credit has proven itself an essential allocation in the well-diversified investment portfolio.
Important information
Schroder Investment Management Australia Limited AFSL 226473 ABN 22 000 443 274. Past performance is not a reliable indicator of future performance. All investment carries risk and may result in loss of capital.
[1] Subordinated debt instruments sometimes retain the right to defer coupon payments under special circumstances such as financial distress.
