Market overview
As we look back at the first half of the calendar year, it is somewhat of a surprise to many market commentators that the developed economies have not slipped into recession as many had predicted to have materialised by now.
Equity markets remain elevated above what fundamentals suggest, driven mainly by technology and AI stocks. Fixed income markets continue to point to a deterioration in the macro-economic picture as evidenced by a significantly inverted yield curve in the US. In previous periods where there is a significant divergence of outlooks between equity and bond markets, there has followed a period of market dislocation or correction coupled with heightened volatility. In the US, the transmission mechanism of significantly tighter monetary policy to the economy is not very efficient due to the vast majority of mortgages being fixed rate. In Australia, there has been a longer lag in the impact of the twelve interest rate increases to date, as a result of many borrowers taking advantage of low introductory fixed rate mortgages that were offered during the Covid-19 period, together with fiscal stimulus that bolstered consumer balance sheets at the time.
There is now evidence in Australia that many consumers are facing much higher cost of living pressures as a result of higher inflation across all discretionary and non-discretionary expenses – including sharp rises in rental costs, groceries, energy (heating and fuel costs) and services. It now appears that we may witness what the RBA has been desperately seeking – a moderation of spending and a slowdown in the economy.
Manager’s Skill in Avoiding Defaults and Loan Impairments Crucial for Delivering Targeted Returns
In this environment, amid increasing nervousness about the state of the economy looking forward, many market researchers and asset allocators have begun highlighting the attractive characteristics of private debt and are looking to increase allocations to the sector. The proposition of stable, non-correlated income which continues to increase with interest rate rises, while offering security and capital preservation are increasingly attractive as the cycle progresses. This has led to Revolution having the strongest months of capital inflows since inception.
At Revolution, we frequently encounter the question “is now a good time to invest in private debt?”. The answer is not a simple yes or no. Whilst the key features of private debt remain attractive, the ability to deliver targeted returns relies on the manager’s ability to avoid defaults and loan impairments. Furthermore, in Australia and New Zealand, these private debt loans are illiquid even in the most buoyant markets, hence there is no ability to trade out of loans as there is in the US or European markets.
The investment strategy of Revolution maintains a core philosophy of capital preservation. In practice, this effectively means that loans to pro-cyclical industries are avoided such as property development/construction, discretionary retail, tourism, hospitality, advertising and mining. Instead, sectors such as mission-critical software, consumer staples and healthcare are preferred. In private Asset Backed Securities (ABS) transactions, Revolution has supported well established non-bank lenders with a demonstrated track record of accessing equity and capital markets maintaining exposure to prime borrowers across various collateral types.
All loans in Revolution’s portfolios have been carefully assessed to be able to withstand the macro-economic headwinds that the economy may face over the next 12-18 months, and there is a high degree of governance, with each loan being independently reviewed on a monthly basis by a third party that determines each loan’s carrying value in accordance with the Revolution Credit and Valuation Policy.
While we expect a more challenging environment ahead, we remain confident of the quality and composition of the portfolios to be able to deliver the target yield for our investors.
Fund I – Portfolio and Pipeline Review
The Revolution Private Debt Fund I (Fund I) currently has a total fund size of A$165.3m. There is a cash buffer retained for hedging purposes which means that Fund I is currently fully deployed. The objective of Fund I is to actively invest in a portfolio of Australian and New Zealand loans and ABS with the target return of cash plus 4% to 5% p.a. (net of fees and expenses) with low volatility and with the benefit of having security over the 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 (LBO), Asset Backed Securities (ABS) and Real Estate loans. Fund I is now past its investment period with no new investments or reinvestments occurring.
Fund I held a total of 19 loans as at 30 June 2023, with the average expected life of the portfolio being 1.1 years. The portfolio yield is 9.7% and the credit spread of the portfolio above bank bill swap rate (BBSW) is 547 basis points. The average credit rating of the portfolio is BB.
Fund II – Portfolio and Pipeline Review
The Revolution Private Debt Fund II (Fund II) currently has a total fund size of A$1,827.9m. Fund II has outperformed its target return of cash plus 4% to 5% p.a. (net of fees and expenses) since inception. The objective of Fund II is to achieve this return with low volatility and with the benefit of having security over the 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 (LBO), Asset Backed Securities (ABS) and Real Estate loans.
Fund II held a total of 47 loans as at 30 June 2023, with an average expected life of the portfolio being 1.4 years. The portfolio yield is 10.2%, with a credit spread of the portfolio above BBSW of 580 basis points. The average credit rating of the portfolio is BB+.
The deal pipeline in Australia and New Zealand remains robust, which should allow for continued strong deployment. In LBO, activity has been gradually picking up, with several landmark transactions being launched into the market in Q2 2023 and expected continued pipeline for the remainder of the year. The ABS market remains stable and active. Revolution has been focused on upsizing and repricing many of its existing private warehouse investments. Additionally, we continue to find and capitalise on attractive secondary market opportunities across sectors.
Revolution Private Debt Fund I (CHN7934AU) – Performance as at 30 June 2023*
| 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 (after fees) | 0.73% | -0.04% | 0.72% | 3.16% | 3.47% | 3.86% | 4.37% |
| RBA Cash Rate | 0.33% | 0.95% | 1.78% | 2.93% | 1.51% | 1.03% | 1.00% |
| Active Return (after fees) | 0.40% | -0.99% | -1.06% | 0.23% | 1.96% | 2.83% | 3.37% |
Revolution Private Debt Fund II (CHN3796AU) – Performance as at 30 June 2023*
| Return | 1 month | Rolling quarter | 6 months | 1 year | 2 years p.a. | 3 years p.a. | Since inception p.a. (31 Dec 2019) |
|---|---|---|---|---|---|---|---|
| Fund II (after fees) | 0.79% | 1.96% | 3.92% | 7.56% | 6.56% | 6.23% | 6.13% |
| RBA Cash Rate | 0.33% | 0.95% | 1.78% | 2.93% | 1.51% | 1.03% | 0.94% |
| Active Return (after fees) | 0.46% | 1.01% | 2.14% | 4.63% | 5.05% | 5.20% | 5.19% |
* Performance is based on month end unit prices before tax. Net performance (after fees) is calculated after management fees and operating costs, excluding taxation. This is historical performance data. The value of an investment can rise and fall and past performance is not indicative of future performance. ** The comparison to the RBA Cash Rate is displayed as a reference to the target return for the fund and is not intended to compare an investment in the fund to a cash holding. Loans held by the fund are subject to borrower default risk and as such the Fund is of higher risk than an investment in cash.
Portfolio characteristics as at 30 June 2023
| Fund characteristics | Fund I | Fund II |
|---|---|---|
| Yield to Maturity | 9.7% | 1.02% |
| Credit Spread | 547 bps | 580 bps |
| Interest Rate Duration (years) | 0.1 | 0.1 |
| Weighted Ave. Credit Rating | BB | BB+ |
Source: Revolution Asset Management. See below for defined terms. These ‘forward-looking statements’ are not guarantees or predictions of future performance, and involve known and unknown risks, uncertainties and other factors, many of which are beyond our control, and which may cause actual results to differ materially from those expressed. Although we believe that the Fund’s anticipated future results, performance or achievements expressed or implied by those forward-looking statements are based upon reasonable assumptions and expectations, the reader should not place undue reliance on forward-looking statements.
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. Annualised Net Return is the monthly net return of the Fund annualised for the next 12 months.
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.