By Meng Shi – Alt Credit, 1 October 2020
US and European direct lending have grabbed headlines over the past several months amid some big allocations from sovereign wealth funds, but the push towards private debt is truly a global phenomenon.
Australian startup manager Revolution Asset Management is a prime example of this.
Launched in 2018, the firm, led by Bob Sahota, Simon Petris and David Saija, has pulled in over A$360m for its second private debt fund, as well as a A$300m separately managed account for the Queensland Investment Corporation.
According to Petris, this push towards private debt by Australian and New Zealand institutions was underway before the start of the coronavirus pandemic, but has been accelerated by a lack of liquidity in the local corporate debt markets since March.
“During the pandemic, investors in Australia and New Zealand seem to be more inclined to lock their money in private credit funds to get the illiquidity premium,” said Petris, a co-founder and senior portfolio manager at the Sydney-based boutique investment firm.
At the outset of the pandemic, funds concentrating on Australian and New Zealand’s corporate bond markets – which are dominated by investment grade issuers – had difficulties of selling out of their holdings to return money to investors, including superannuation funds who at the time sought to rebalance their portfolios in response to equity sell-offs. Investment grade corporate bond funds that promised liquidity to investors failed to fulfil their promise during the crisis, with the bid-and-ask spread having widened sharply in that period, and that limited investors’ ability to nimble quickly and perform the best, he said.
“The only place for real liquidity is sovereign bonds and senior financials, which generate very low yields.” he said.
Three-year Australian bond yields fell to a four-month low in early September while New Zealand’s was near zero amid expectations that central banks in both countries will have to ease policy further to support their economy recovery.
Like their peers across the developed markets, institutional investors in the countries were also under pressure following declining interest rates that have chipped away at returns from their fixed income portfolios. That left investors with two main options: the highly volatile equity markets, and looking to get an appropriate illiquidity premium through allocations to private markets.
“Investors are holding onto the low-yielding sovereign bonds for safety, but also seek to rebalance their portfolios for higher yields, so the barbell portfolio of getting coupons and yields from private debt and having liquidity and duration from sovereign bonds is becoming more appealing to investors,” he said.
Revolution’s has focused its funds on the mezzanine tranche of asset-backed securities such as mortgages, auto loans and consumer loans, with about two-thirds of assets held in private ABS warehouses investments, which has demonstrated strong underlying long-term performance in the history, Petris said. Besides that, the firm also invests in the senior secured debt issued to finance leveraged buyouts deal as well as senior real estate debt to properties with underlying cash flow.
For its ABS investments, Revolution has secured returns in the range of 4% to 6% above the floating-rate benchmark for the mezzanine exposures, he said.
During the pandemic, there were a raft of cheap, high-performing assets in the secondary RMBS and ABS markets being offloaded by offshore credit funds that had to move capital back to the US and Europe to satisfy margin calls or redemptions. Revolution were able to snap up a parcel of assets at discounts, which also allowed the firm to squeeze extra margin from its investments.
Despite these moves, Petris said that he holds a skeptical view on one sector in structured products: commercial property loans, an asset class that Revolution steered clear of for its second fund.
“We feel like there has been bubbles in the sector prior to the pandemic, and we have yet found many deals that meet our criteria beforehand,” Petris said. “After the outbreak of the pandemic, the commercial real estate sector hits reset, that lead to new valuations in the face of a raft of uncertainties about the prospect in retail.”