Market overview
Financial markets have thrown a number of ‘curve balls’ to contend with for the remainder of 2022 and in the medium term for investors to consider when setting their asset allocations. The main issue that has the markets fixated is the spectre of rising inflation, leading to higher interest rates across the developed economies globally, led by the US. Another factor is the pursuit of zero Covid-19 cases in China leading to widespread lockdowns. This caused major supply chain disruptions with knock-on effects in many businesses that have grown increasingly dependent on China. Add to this the dramatic increase in oil prices leading to higher costs of transport due to the Ukraine-Russia conflict, as well as natural disasters on the eastern seaboard of Australia and you end up with many risks that have arisen in 2022 that were not contemplated at the end of 2021.
In this environment, investors have been increasingly asking, what role does private debt play against the backdrop of these emerging risks? Furthermore, how does the asset class perform during this period of rising inflation and higher interest rates and how will investments made by Revolution Asset Management (Revolution) perform in this emerging situation?
We responded by reiterating the investment philosophy and ‘DNA’ which is a keen focus on capital preservation through all market cycles. In practice, Revolution can point to the attribute of its investments being floating rate in nature. In effect, as rates rise (as expected) the yield on all investments increase in line with these rises – thereby being an effective hedge against the erosion of capital value in an inflationary environment. However, it does not end there. We have targeted those sectors and industries that display a very low level of volatility through the cycle in private company and leveraged buyout lending and focused on market leading businesses with strong pricing power that are likely to weather an inflationary environment. In private Asset Backed Securities (ABS) investments, our focus has been on funding pools of loans with higher credit quality prime borrowers, as they have historically proven to be able to withstand different economic conditions and have traditionally fared better in market downturns and recessions.
Closer to home, a topical area is the real estate construction sector in Australia and the significant headwinds that are emerging in 2022. This proves to remind why since Revolution’s inception, development or construction loans were specifically excluded from the investment strategy. This year the construction industry is facing the sternest test from the following factors:
- Supply chain disruption for all components required as key inputs in the development projects – much of which are manufactured offshore – causing time overruns on projects.
- Rising costs of inputs for both supply for all key goods and construction labour which will be exacerbated by higher transport costs for shipping as well as domestic freight from higher oil prices, causing cost overruns.
- A shortage of labour, both skilled construction labour in all trades as well as unskilled labour for building sites. With a national unemployment rate of 4% and forecast to fall with immigration still at a standstill this issue is expected to become acute. Add to this, the task of rebuilding existing housing stock destroyed or damaged by Australia’s eastern seaboard floods and you end up with a severe skills shortage of all new construction/development projects.
- The prevalence of fixed price, fixed term contracts on a vast majority of new projects means that any cost and time overruns are borne by builders and developers. Many of these have thinly capitalised balance sheets as they undertake many projects concurrently.
- On the demand side, with interest rates set to rise many former buyers of real estate will find it difficult to gain loan approvals for amounts they could previously and banks are unlikely to value real estate purchased off the plan at original purchase prices when it comes time to settle these properties.
These factors have already claimed some builders such as Probuild, Condev and Hotondo Homes Hobart that have gone into receivership, having become insolvent leaving many billions of partly completed developments and many unsecured creditors left to contend with only small recoveries from monies owed to them. In our view, these factors are likely to impact the whole industry, both large and small alike. As such, these are far from isolated cases.
Revolution’s investment philosophy deliberately excludes very cyclical industries such as construction and property development from the investment strategy, alongside other industries that display high peak to trough volatility such as retail, tourism, hospitality and mining to name a few.
Overall, this high credit discipline has allowed all our funds to meet the target return of the RBA Cash Rate plus 4% to 5% (net of fees) since inception with no impairment or defaults. Importantly, this performance has come from stable income, which is distributed to investors quarterly, with very low volatility and correlation to liquid 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 March 2022 are A$201m. There is a small cash buffer retained in Fund I for hedging purposes which means that Fund I is currently fully deployed.
Fund I is performing well and continues above its target return, which is cash plus 4% to 5% p.a. (net 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 strong credit discipline based on relative value across the three key focus areas of Fund I being: Australian and New Zealand Leveraged Loans, ABS and Real Estate loans.
As at 31 March 2022, Fund I held a total of 37 individual investments with an average remaining life of the portfolio of 1.4 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 5.32% (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$1.2b of which total investments (excluding cash and hedging) that have been made as of 31 March 2022 was A$1.07b. This 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. (net 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, ABS and Real Estate loans.
As of 31 March 2022, Fund II held a total of 76 individual investments with an average life of the portfolio of 1.6 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 in Australia and New Zealand. Strong M&A activity and demand for non-bank lenders has allowed a fast pace of capital deployment over 2021 and into 2022, which is expected to continue.
Revolution Private Debt Fund I (CHN7934AU) – Performance as at 31 March 2022*
| 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) | 0.44% | 1.25% | 2.62% | 5.33% | 5.40% | 5.85% | 5.89% |
| RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.04% | 0.07% | 0.37% | 0.47% |
| Active Return (before fees) | 0.44% | 1.24% | 2.60% | 5.29% | 5.33% | 5.48% | 5.42% |
| Fund I (after fees) | 0.38% | 1.07% | 2.24% | 4.56% | 4.61% | 4.99% | 4.95% |
| RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.04% | 0.07% | 0.37% | 0.47% |
| Active Return (after fees) | 0.38% | 1.06% | 2.22% | 4.52% | 4.54% | 4.62% | 4.48% |
Revolution Private Debt Fund II (CHN3796AU) – Performance as at 31 March 2022*
| Return | 1 month | Rolling quarter | 6 months | 1 year | 2 years p.a. | Since inception p.a. (31 Dec 2019) |
|---|---|---|---|---|---|---|
| Fund II (before fees) | 0.56% | 1.53% | 3.11% | 6.54% | 6.82% | 6.52% |
| RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.04% | 0.07% | 0.13% |
| Active Return (before fees) | 0.56% | 1.52% | 3.09% | 6.50% | 6.75% | 6.39% |
| Fund II (after fees) | 0.50% | 1.35% | 2.74% | 5.75% | 5.97% | 5.64% |
| RBA Cash Rate | 0.00% | 0.01% | 0.02% | 0.04% | 0.07% | 0.13% |
| Active Return (after fees) | 0.50% | 1.34% | 2.72% | 5.71% | 5.90% | 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 March 2022
| Fund characteristics | Fund I | Fund II |
|---|---|---|
| Yield to Maturity | 5.32% | 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 | N/A | 27% |
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.