The Fund delivered +0.79% in May, 9.56% over 12 months and 6.94% annualised since inception (April 2016), continuing to deliver over 5% net return above the RBA cash rate.
In our eight years, credit has never been a more in favour asset class than currently experienced. Investors are drawn to the potential for higher absolute expected returns, given the higher cash rates globally, capital stability vs other asset classes, and the need for income in their portfolios. Most encouragingly, the asset class is no longer viewed as a single bucket, rather, there are underlying sectors along a risk/return continuum, much like what is seen in other asset classes. By understanding these credit sectors, investors can be more discerning about how they approach credit and identify the area best suited to their objectives.
In our view, within private markets, three main credit subsectors are prevalent within Australia, each with unique investor considerations.
- Non-investment grade corporate loans: Companies who view credit funds as an alternative to seeking finance from a traditional bank. As a traditional bank is typically cheaper than a credit fund, these companies may look to such funds when they are outside the appetite of traditional banks, either due to credit or non-credit reasons, e.g. ESG related reasons, or the company simply wants a more flexible or timely solution. Lending decisions of the credit fund are based on the fundamentals of the company, which inform the risk/attractiveness of the loan. Leveraged finance is common within this sector, as it provides loans to assist private equity firms in purchasing companies that use significant debt capital to do so. While banks do play in this space, the key challenge in this sector is diversification as investor capital can be spread across a limited number of larger deals, meaning any one event can be impactful, and the chance of capital loss heightened if the company taking out the loan fails, given there can be few assets left to repay investors.
- Construction finance: Involves lending to Property Developers to acquire land, seek planning approval to change or enhance the use of that asset, construct or redevelop and then sell the finished product, with financing being either a part of this process or in its entirety. Australian bank’s appetite for such lending varies significantly given the macroeconomic outlook, as highlighted in our article Elevated Stakes: Assessing the risk premium of construction finance. Lending decisions are based on the likely value of the project once completed rather than the fundamentals of the property developer’s business. Its risk profile and challenges are akin to those of the prior sector, which is around diversification and higher loss given default. Most importantly, we see Construction Finance and Non-investment grade lending as having cyclical characteristics, which can be more problematic if an investor doesn’t have diversification in their holdings (i.e. 100+ underlying loans).
- Asset-backed securities: This involves providing wholesale finance to banks and non-banks so that they can originate loans themselves. The underlying loans secure these asset-backed securities, and thus, lending decisions are primarily made based on the quality of the lender and the underlying pool of loans. For example, a residential mortgage is viewed more favourably than an unsecured business loan on a like-for-like basis. Manning is a specialist in this sector, as it can offer yields that are nearly equivalent to those of other sectors, although it is far more robust in nature and less cyclical in its performance. For example, if the lender who receives the financing defaults, a more readily available pool of underlying assets can be realised to repay the debt. The key challenge in this sector is access to opportunities as lenders discern who they will share their information with and work with. Asset-backed financing has a long history in Australia and Manning utilise all available historical performance data which affords us the ability to robustly back-test pools of assets against future possible economic scenarios.
Across all sectors, the terms that govern how the money is extended to the recipient (company, property developer, or lender) are very important and vary significantly in nature. Manager skills via an established team with decades of experience in the space remain of the utmost importance.
As an investment house, we believe the level of capital stability an investor achieves will ultimately be based on the level of assets backing that loan. In this regard, asset-backed securities offer the strongest level of investor protection, followed by construction finance and then non-investment grade corporate loans providing the least.
At Manning we prioritise capital stability ahead of all else, a testament to this is the Fund’s 8+ year track record that has resulted in no negative months from credit/loss of capital. We are pleased to report the Fund’s portfolio of assets continues to perform strongly, and we believe, is well positioned to continue delivering strong income returns with capital stability.
