There has been a boom in credit fund offerings of various types over the past 18 months, giving investors access to yields of 5 to 8 per cent through exposure to corporate debt, secured small business loans, consumer credit, high-yield bonds and mortgage-based securities.
Credit managers with products in the market include Metrics Credit Partners, Perpetual Investments, Thinktank, SocietyOne, Gryphon Capital Investments, Neuberger Berman and Qualitas Group
Their funds, some of which are listed on the Australian Securities Exchange, provide an alternative to franked dividends for investors looking for income. They also offer significantly higher yields than bond funds or term deposits. But there is a wide range of assets and risks in this growing segment of the market
Metrics managing director Andrew Lockhart says: “Investors need to look at the underlying risk. The profiles of these funds can vary greatly.”
Metrics Credit Partners. Commercial lender Metrics launched its second listed credit fund earlier this year, the MCP Income Opportunities Trust, with the new fund holding a portfolio of sub-investment grade debt and targeting a return of 8 to 10 per cent.
Metrics has been in the commercial loan market since 2013, backed by institutional, high net worth and retail investors. It has originated 200 loans worth $5.5 billion since then, including corporate loans, property development, project and infrastructure finance and acquisition loans.
It participates in syndicates and club loans and originates on a bilateral basis. And it lends right through the capital structure, including structuring equity returns through warrants and options.
In 2017, it launched the MCP Master Income Trust, which has a majority of its funds in investment grade loans and targets an income return of the cash rate plus 3.25 per cent.
Metrics managing partner Andrew Lockhart says that fund has 98 individual loans, has not lost any money and has exceeded its target return consistently. The trust has traded at a premium to its net asset value since listing.
The new fund is targeting income of 7 per cent and some participation in upside gains through exposure to derivatives.
“We are giving investors the opportunity of investing in high yield without the volatility of high-yielding equities,” Lockhart says.
SocietyOne. Consumer lender SocietyOne has joined the growing list of lenders offering investors access to income from a credit fund, but in this case it is consumer credit. It is aiming to pay a 6 per cent return, with distributions paid monthly.
The Personal Loans Unit Trust is open to wholesale investors, with a minimum investment of $100,000. Investments are for a minimum term of 12 months.
Returns above the targeted rate will be split between investors and a reserve account, which will be used to “smooth volatility”.
SocietyOne provides unsecured personal loans to consumers of between $5000 and $50,000 over terms of two to five years.
The company claims that since opening for business in 2012, it has originated more than $600 million of loans for 24,000 borrowers. At the end of last year the loan book was worth $235 million.
SocietyOne chief executive Mark Jones says the business picked up momentum last year. “Twelve months ago we were doing $8 million or $9 million of loans a month. Now we are doing $25 million.”
The average customer interest rate is 13 per cent. Society One’s fee is 2 per cent and the loss rate is 4 per cent. The average return to investors is currently at 6.7 per cent.
The portfolio will be made up of a representative sample of loans – with different maturities, loan sizes and credit grades.
Perpetual Investments. Perpetual’s new ASX-listed fund, the Perpetual Credit Income Trust, will invest in a portfolio of 50 to 100 credit and fixed income assets, with a spread of credit quality, loan maturity, country and issuer. It will not hold any government or semi-government debt securities.
Perpetual has more than $7 billion in credit and fixed income. The group’s head of credit Michael Korber will manage the portfolio.
The fund will target an income return of the Reserve Bank cash rate plus 3.25 per cent, net of fees. The estimated management cost is 88 basis points.
The fund can hold up to 70 per cent in unrated or sub-investment grade securities. It can hold up to 30 per cent in foreign currency securities.
Typical investments will include corporate bonds, floating rate notes, securitised assets and corporate loans.
Perpetual says its credit team uses a proprietary credit scoring process to assess the risk of individual exposures and the overall credit market.
Exposure to corporate loans may be gained directly or through investment in the Perpetual Loan Fund. The Perpetual Loan Fund was established last June and has $38 million of assets. Perpetual has not included much information about the loan fund in the product disclosure statement.
Investors in credit and debt funds will find there is often a frustrating lack of disclosure about what actually goes into the funds.
Thinktank. When commercial property lender ThinkTank launched a high-yield mortgage fund last year, offering an 8.5 per cent yield, it faced plenty of questions about the risks that investors would be taking to get such a high return on property loans.
ThinkTank chief executive Jonathan Street pointed out that since the company launched in 2006 it had originated $1.3 billion of secured commercial loans and suffered just $1 million of losses. That is a loss ratio of around 0.08 per cent, which any big bank would be happy to report to investors.
“We have a conservative approach. We do not do development loans, land banking or anything with environmental issues,” Street said.
After a year of operation the High-Yield Trust and its lower risk companion, the Income Trust, have had zero arrears and zero defaults.
If there had been any losses they would be covered by cash surpluses in the trusts. Each fund includes a loss provision to cover defaults – 1 per cent of the loan pool for the Income Trust and 2 per cent of the loan pool for the High-Yield Trust.
The HighYield Trust is paying 8.4 per cent currently, with income distributed monthly. The Income Trust is paying 5.5 per cent. The yield has shifted a little over the past year because ThinkTank provides variable rate loans, with the rate set at a margin above the bank bill swap rate.
The funds are open to wholesale and sophisticated investors, with a minimum investment of $10,000. Funds must be invested for a minimum term of one year.
The management fee is 70 basis points and there are no entry or exit fees (there is a 2 per cent charge for redemptions within 12 months). Both funds have income reinvestment options.
Street says the fall in the residential property market has had some flow-on effect in the commercial market.
“There has been some softening. It is the wealth effect. The SMEs and investors we deal with may be more reticent to borrow if the housing market is soft.
“However, economic fundamentals are the real driver in this market. Commercial values have softened a little.”
Qualitas Group. Last November, Qualitas Group listed the Qualitas Real Estate Income Fund on the ASX, providing income from a portfolio of secured commercial property loans and targeting a net return of 8 per cent a year.
The loan portfolio will be a mix of senior and mezzanine debt. Qualitas was established in 2008 and since then has allocated $1.7 billion of debt and equity capital to real estate assets worth around $7.3 billion. It has made 84 loans.
The Real Estate Income Fund invests in a number of established Qualitas funds. It has been slow to allocate all the funds raised and earlier this year sought approval from investors to invest money in another Qualitas fund.
Neuberger Berman. The NB Global Corporate Income Trust invests in a portfolio of global high yield bonds. These are non-investment grade securities, with a focus on B and BB rated bonds. The manager is targeting monthly distributions equivalent to at least 5.25 per cent per annum, with modest growth in asset value over time.
Because non-investment grade bonds have a higher probability of default, the fund plans to have a well-diversified portfolio to 250 to 350 issuers.
The Neuberger Berman fund is the only one of the recent entrants into this market that offers global exposure. This offers the advantage of a much bigger pool of assets for the manager to choose from but it also exposes investors to currency risk.
Gryphon Capital Investments. The ASX-listed Gryphon Capital Income Trust invests in a portfolio of floating rate asset-backed securities and residential mortgage-backed securities (RMBS). The target return is 3.5 per cent above the cash rate. The portfolio will be actively managed and securities will generally have floating interest rates.
At June 30 last year, 84 per cent of the portfolio was invested in investment grade securities, with 44 per cent in AAA rated securities. The bulk of the portfolio is invested in prime RMBS.
Residential mortgage-backed securities (RMBS) are collections of mortgages that have been bundled together and sold off a lender’s balance sheet in the form of a bond. They produce an income by providing exposure to repayments on the underlying mortgages.
While RMBS is the most common form of asset-backed security in the Australian market, other types of loans can be securitised in the same way. These include credit card debt, car loans and commercial finance.
Gryphon Capital Investments is an institutional fixed income manager, established in 2014 and with mandates currently valued at around $1.7 billion.