Market overview
As we look forward to a new year, it is a good time to reflect on what has transpired throughout 2023. Despite inflation running rampant across the developed world and central banks unleashing unprecedented tightening in interest rates to fight it, there has been no ‘hard landing’ as many economists and investors predicted at the beginning of the year. In economies where central banks were more aggressive in hiking interest rates, like the United States and New Zealand, there is solid evidence that inflation has peaked and more confidence that a hard landing will be avoided. In fact, equity markets are at or near historical highs which no one would dare have predicted given the tighter monetary policy settings that persist.
Closer to home, the Reserve Bank of Australia (RBA) was much slower in hiking interest rates to combat inflation and hence our economy continues to be hampered by persistently higher inflation that is well above its target range of 2-3%, driven predominantly by services, rental and higher oil/fuel prices. Economists and the bond market have had a year that they would rather forget with many being wrongfooted about interest rate calls in Australia, highlighting how difficult it is to predict the path of GDP growth, inflation and the hence direction for interest rates. The RBA faces a unique challenge in how it utilises its only real tool, monetary policy. The RBA must carefully navigate through many opposing factors. These considerations include a nationwide housing market marked by scarcity and soaring prices, putting significant pressure on the cost of living and impacting lower -wage earners and renters. Additionally, the RBA must anticipate the potential appreciation of the currency against the greenback, particularly if the US Federal Reserve aggressively cuts interest rates as widely expected. Such a move could diminish the competitiveness of domestic exports. Moreover, the RBA grapples with the lagged impact of monetary policy, particularly in a post-Covid period, where substantial monetary and fiscal stimulus has shored-up consumer balance sheets.
The bond markets and indeed a high proportion of economists are now of the opinion that the RBA will pause its hiking phase, and by September 2024 there will be interest rate cuts in Australia. While this would offer a welcome reprieve for numerous households grappling with steep cost-of-living pressures, it carries the risk of reigniting an already stubbornly high inflation and triggering another surge in house prices. This, in turn, would exacerbate the challenge of housing affordability for those seeking to enter the market.
As mentioned above, predicting forward interest rates is a very difficult task given the number of considerations that central banks must weigh-up when making any changes to existing settings. At Revolution Asset Management (Revolution) we maintain a conservative approach when assessing the impact of higher inflation and interest rates on all loans that we make. Hence, we assume that there is a high chance that the RBA will not err on the side of complacency, and so if inflation continues to be well above the stated target, it will have no choice but to hike one or two more times. Furthermore, it is our thesis that once inflation breaks out of a range it does not come down very quickly, hence we feel interest rates will be higher for longer and would be surprised if we see any interest rate cuts this calendar year. That said, we are not in the business of making or relying on interest rate calls as all our portfolio loans are floating rate loans with credit margin over the prevailing benchmark floating rate.
We adopt this more conservative ‘higher for longer’ stance in interest rates as we can only ever get interest payments on our loans as they are due, and receive our original loan principal back at the end of the loan. We do not have any upside beyond being able to deliver a steady income to our clients that is uncorrelated to the broader public markets. As such, we feel that the global economy will be more challenging in 2024, fuelled by increased volatility caused by ongoing geopolitical risks across many parts of the world, as well as growing right -wing support that may manifest in several elections in 2024 in key countries such as Taiwan, India, UK, Russia and the US in November.
Capital preservation drives our investment approach
In this environment, the core philosophy that has always been adopted by Revolution comes to the fore. Capital preservation is at the heart of our investment process, wherein every loan must pass through rigorous downside scenarios akin to a widespread recession, before inclusion in the portfolio. The adoption of this approach results in the rejection of numerous loans that prove unable to withstand such conditions, prompting their financing by other lenders. This stringent approach is key from the outset of loan origination, particularly in Australia and NZ where private loans lack a secondary market, unlike the US and Europe. As such all loans are made on a ‘buy to hold’ approach. The portfolio undergoes independent monthly reviews by Leadenhall, a third -party valuation firm. These assessments utilise private, non-public information provided regularly and promptly to assess current performance. Notably, all loans held by Revolution have been certified as ‘performing,’ with none classified under ‘watch’ status.
As we look forward to a new year, we wish to thank you for your support and placing your trust in Revolution. We look forward to continuing to deliver stable income on a quarterly basis from a diversified portfolio of carefully selected loans, that we believe will continue to deliver our stated objective of RBA Cash plus 4% to 5% p.a. (net of fees and expenses).
Fund II – Portfolio and Pipeline Review
The Revolution Private Debt Fund II (Fund II) has a total fund size of A$2.1 billion as at 31 December 2023. 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 48 loans as at 31 December 2023, with an average expected life of the portfolio being 1.2 years. The portfolio yield is 10.4%, with a credit spread of the portfolio above BBSW of 587 basis points (bps). 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 increased heading into the first quarter of the new year. The ABS market also remains active. Revolution has been focused on upsizing and repricing many of its existing private warehouse investments. Additionally, Revolution continues to find and capitalise on attractive secondary market opportunities across sectors.
Fund I – Portfolio and Pipeline Review
The Revolution Private Debt Fund I (Fund I) has a total fund size of A$104m as at 31 December 2023. There is a cash buffer retained in Fund I 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 Asset Backed Securities (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), 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 15 loans as at 31 December 2023, with the average expected life of the portfolio being 1.2 years. The portfolio yield is 9.8% and the credit spread of the portfolio above BBSW is 549 bps. The average credit rating of the portfolio is BB.
Source: Revolution Asset Management. See below for defined terms.
Revolution Private Debt Fund II (CHN3796AU)*
Performance as at 31 December 2023. Open for investment.
| 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% | 2.39% | 4.42% | 8.51% | 7.32% | 6.80% | 6.48% |
| RBA Cash Rate | 0.34% | 1.06% | 2.09% | 3.90% | 2.55% | 1.71% | 1.34% |
| Active Return (after fees) | 0.45% | 1.33% | 2.33% | 4.61% | 4.77% | 5.09% | 5.14% |
Revolution Private Debt Fund I (CHN7934AU)*
Performance as at 31 December 2023. Closed to new investors.
| 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) | 0.70% | 2.19% | 1.35% | 2.08% | 2.99% | 3.52% | 4.20% |
| RBA Cash Rate | 0.34% | 1.06% | 2.09% | 3.90% | 2.55% | 1.71% | 1.31% |
| Active Return (after fees) | 0.36% | 1.13% | -0.74% | -1.82% | 0.44% | 1.81% | 2.89% |
* 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 31 December 2023
| Fund characteristics | Fund II | Fund I |
|---|---|---|
| Yield to Maturity | 10.4% | 9.8% |
| Credit Spread | 587 bps | 549 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.