Market overview
The beginning of 2022 has heralded several challenges that have come to the fore – perhaps the most influential being inflation leading to higher interest rates. The dramatic increase in inflation and further forecasts of accelerating inflation, in particular, the US, has laid bare some of the unintended consequences of a prolonged period of very accommodative monetary policy, coupled with unprecedented levels of quantitative easing (QE). While many would agree this was necessary in the environment of a worldwide pandemic, the effect was to create asset price bubbles as evidenced by record highs recorded in equity markets, real estate, bond markets, infrastructure and even art and vintage cars. The increase in inflation and in particular, wage inflation, has meant that central banks are now dramatically winding back QE and preparing to raise interest rates – with the US Federal Reserve likely to hike rates most aggressively looking at the forward yield curve.
Closer to home, we have witnessed the RBNZ already raising interest rates to 0.75%, two successive rate hikes of 0.25%. The RBA has stated that it does not intend to increase rates in Australia until 2023 at the earliest. However, this may have to be brought forward if inflation breaks above the target 2% to 3% band. This looks more likely as labour market shortages are expected to persist with anaemic foreign immigration and supply lines of consumer goods continuing to be disrupted by the newer variants of the Covid-19 pandemic, ultimately leading to wage inflation.
The threat of inflation leading to increasing interest rates across the developed world has already had some dramatic impacts, for example, growth stocks (including tech stocks) have dramatically fallen in value as have cryptocurrencies, as investors move away from the mentality that rates will be lower for longer. Higher interest rates means that the discount rates applied to the valuation of any companies with a future promise of positive cashflows are particularly vulnerable to falls in value, as are any asset classes with interest rate duration embedded in them – government bonds, wider equity markets, real estate and infrastructure being the most at risk. In addition to the risk of inflation on the financial markets, the ongoing risks of new variants of Covid-19 and how the world will fare in ‘living with Covid-19’ as it moves from being a pandemic to endemic continues to be at the forefront of investors’ minds.
Geopolitical risks also remain at elevated levels with Australia continuing to have an ‘icy’ relationship with its largest and most influential trading partner of China, as that country progressively seeks to exert its political and economic clout in the wider Asia-Pacific region and beyond. The build-up of armed forces by Russia on its Ukrainian border is also one to watch with a heightened risk of conflict now a real possibility under Putin’s administration.
Preservation of capital through private debt
Revolution’s investment philosophy and underlying exposures provide investors with a welcome relief from much of the risks that are facing investors. Private debt is floating rate in nature, which means the yield on each investment is comprised of the prevailing floating cash rate (which resets monthly or quarterly) plus a pre-negotiated margin. This means that if rates do rise as expected, the yield on Revolution’s portfolios will increase in line with the increase in base interest rates, without incurring capital losses seen in traditional fixed rate duration sensitive bonds. A feature that preserves capital and is particularly attractive at this point of the investment cycle.
Furthermore, as our investment philosophy dictates a conservative and defensive income-orientated strategy, we are focused on sectors that are not generally correlated to the economic cycle/markets – as a result, there are no exposures to construction/development real estate, retail, tourism, hospitality and mining. Instead, sectors that offer strong and transparent cashflows are favoured, such as healthcare, mission critical software, prime end of consumer and commercial lending, infrastructure and telecommunication services. Our focus is purely on Australian and New Zealand domiciled borrowers, which shelters much of the geopolitical risk while maintaining a strong focus on income with little correlation to the broader economic cycle and markets.
Fund I – Portfolio and Pipeline Review
The Revolution Private Debt Fund I (Fund I) currently has a total fund size of A$204m of which total investments (excluding cash and hedges) that have been made as at 31 December 2021 was A$188m. There is a small cash buffer retained in Fund I for hedging purposes, and an asset awaiting settlement which means that Fund I is fully deployed.
Fund I is performing well and continues to deliver above its target return, which is cash plus 4% to 5% p.a. (gross of fees and expenses). The objective of Fund I is to achieve this return with low volatility and with the benefit of having security over underlying assets.
During portfolio construction, Revolution maintained a strong credit discipline based on relative value across three key focus areas of Fund I being: Australian and New Zealand Leveraged Loans, Asset Backed Securities (ABS) and Real Estate loans.
As at 31 December 2021, Fund I held a total of 33 individual investments with an average remaining life of the portfolio of 1.3 years. The credit spread of the portfolio above BBSW is 516 bps – which is above the stated target of Fund I and the average credit rating of the portfolio is BB with an estimated yield to maturity of 5.31% (gross of fees and expenses).
Fund II – Portfolio and Pipeline Review
The Revolution Private Debt Fund II (Fund II) currently has total fund commitments of A$1.1bn of which total investments (excluding cash and hedging) that have been made as of 31 December 2021 was A$892m. Including investments awaiting settlement, the total deployed capital for Fund II will shortly be in excess of A$1bn, which is a pleasing rate of deployment since inception of Fund II in December 2019.
Fund II is performing well and continues to deliver above its target return, which is cash plus 4% to 5% p.a. (gross of fees and expenses). The objective of Fund II is to achieve this return with low volatility and with the benefit of having security over underlying assets.
During portfolio construction, Revolution maintained strong credit discipline based on relative value across the three key focus areas of Fund II being: Australian and New Zealand Leveraged Loans, Asset Backed Securities (ABS) and Real Estate loans.
As of 31 December 2021, Fund II held a total of 74 individual investments with an average life of the portfolio of 1.5 years. The credit spread of the portfolio above BBSW is 590 bps – which is above the stated target of Fund II and the average credit rating of the portfolio is BB+ with an estimated yield to maturity of 6.08% (gross of fees and expenses).
The deal pipeline remains robust across private and leveraged buyout loans and ABS both in Australia and New Zealand. 2021 has proven to be the most active M&A year on record with a record number and volume of publicly listed companies being taken private. As a broad rule these acquisitions are funded 50/50 between debt and equity. At the same time both Australian and New Zealand banks continue to lose market share to non-banks in formally core products such as mortgages, auto and consumer loans. As non-bank lenders in these categories grow, they are increasingly looking to specialist private debt lenders such as Revolution to support their growth.
These factors have allowed the pace of capital deployment to increase for Revolution over the course of 2021 with these trends to continue into 2022 and beyond.
Revolution Private Debt Fund I (CHN7934AU) – Performance as at 31 December 2021*
Return | 1 month | Rolling quarter | 6 months | 1 year | 2 years p.a. | 3 years p.a. | Since inception p.a. (11 Dec 2018) |
---|---|---|---|---|---|---|---|
Fund I (before fees) | 0.46% | 1.35% | 2.69% | 5.38% | 5.55% | 5.98% | 5.95% |
RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.03% | 0.14% | 0.48% | 0.50% |
Active Return (before fees) | 0.46% | 1.34% | 2.67% | 5.35% | 5.41% | 5.50% | 5.45% |
Fund I (after fees) | 0.40% | 1.16% | 2.31% | 4.60% | 4.74% | 5.04% | 5.00% |
RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.03% | 0.14% | 0.48% | 0.50% |
Active Return (after fees) | 0.40% | 1.15% | 2.29% | 4.57% | 4.60% | 4.56% | 4.50% |
Revolution Private Debt Fund II (CHN3796AU) – Performance as at 31 December 2021*
Return | 1 month | Rolling quarter | 6 months | 1 year | 2 years p.a. | Since inception p.a. (31 Dec 2019) |
---|---|---|---|---|---|---|
Fund II (before fees) | 0.52% | 1.55% | 3.33% | 6.58% | 6.54% | 6.54% |
RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.03% | 0.14% | 0.14% |
Active Return (before fees) | 0.52% | 1.54% | 3.31% | 6.55% | 6.40% | 6.40% |
Fund II (after fees) | 0.46% | 1.37% | 2.95% | 5.77% | 5.65% | 5.65% |
RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.03% | 0.14% | 0.14% |
Active Return (after fees) | 0.46% | 1.36% | 2.93% | 5.74% | 5.51% | 5.51% |
* Performance is based on month end unit prices before tax. Gross performance (before fees) is stated excluding all fees and costs. Net performance (After fees) is calculated after management fees and operating costs. Individual Investor level taxes are not taken into account when calculating returns. This is historical performance data. It should be noted the value of an investment can rise and fall and past performance is not indicative of future performance.
Portfolio characteristics as at 31 December 2021
Fund characteristics | Fund I | Fund II |
---|---|---|
Yield to Maturity | 5.31% | 6.08% |
Credit Spread | 516 bps | 590 bps |
Interest Rate Duration (years) | 0.1 | 0.1 |
Weighted Ave. Credit Rating | BB | BB+ |
Deal Approval Rate | ~20% | ~25% |
Source: Revolution Asset Management. See below for defined terms.
For more information on performance and the portfolio of loans or about the Revolution Private Debt strategy, contact us.
Yield to Maturity (YTM) is the current total return anticipated on the portfolio if the portfolio is held until it matures. Credit Spread is the weighted average credit margin over the bank bill swap rate (BBSW), which is the market benchmark rate. Interest Rate Duration measures how much bond prices are likely to change if and when interest rates move and is measured in years. The Weighted Average Credit rating is used to indicate the credit quality of a portfolio and is an aggregate of the internal credit ratings of the portfolio’s holdings, weighted by exposure size. Internally rated by Revolution on the basis of ratings substantially equivalent to Standard & Poor’s ratings. Examples of ratings include credit ratings issued by Moody’s, Fitch and Kroll Bond Rating Agency.
This information is for institutional and professional investors only and has been prepared by Revolution Asset Management Pty Ltd ACN 623 140 607 AFSL 507353 (‘Revolution’) who is the appointed investment manager of the Revolution Private Debt Fund I, the Revolution Private Debt Fund II and the Revolution Wholesale Private Debt Fund II (together ‘the Funds’). Channel Investment Management Limited ACN 163 234 240 AFSL 439007 (‘CIML’) is the Trustee and issuer of units for the Funds. Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (‘Channel’) provides investment infrastructure services to Revolution and Channel and is the holding company of CIML. None of CIML, Channel or Revolution, their officers, or employees make any representations or warranties, express or implied as to the accuracy, reliability or completeness of the information, including forecast information, contained in this document and nothing contained in this document is or shall be relied upon as a promise or representation, whether as to the past or the future. Past performance is not a reliable indication of future performance. All investments contain risk. This information is given in summary form and does not purport to be complete. To the extent that information in this document is considered advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling units in the Funds please note that it does not take into account your particular investment objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information having regard to these matters, any relevant offer document and in particular, you should seek independent financial advice. For further information and before investing, please read the relevant Information Memorandum available on request.