Market overview
Central banks worldwide have managed to ease inflation, leading to a potential global shift towards neutral interest rates. However, Australia’s RBA, despite recent rate hikes to 4.35%, faces stubborn inflation around 4%, exacerbated by government fiscal policies and anticipated election spending. Revolution believes we are entering an era of ‘higher for longer’ rates in Australia, influenced by factors like a prosperous ‘baby boomer’ demographic, rising house prices, strong equity markets, and high cash returns.
In this environment, we are pleasantly surprised by the growing awareness and unprecedented focus on the private debt asset class, both globally and domestically. Never before have so many investors and investment managers highlighted the virtues of private debt as a viable asset class. Whilst we wholeheartedly agree that private debt promises some very attractive attributes in a rising and higher interest rate environment ― such as a floating rate that promises to distribute high non-correlated income to investors ― Revolution would argue that not all private debt strategies are created equal. The ability to perform in a backdrop of weaker macroeconomic conditions vary significantly among strategies.
Private Debt’s Rise: Differentiating Strategies in a Shifting Economic Landscape
The following chart compiled by Citigroup shows the rise of non-bank credit growth vs bank credit growth. It highlights the non-bank sector, whilst coming off a low base, is growing at a much faster pace than the bank sector which is being subject to increasing regulation.
Financing Growth, Year on Year* (points)
Source: Australian Financial Review, Citigroup, RBA.
This rapid growth has been facilitated by the establishment of new private debt funds, which now exceed 200 in Australia. Many of these target property development and construction lending which appear secure due to real estate backing and the promise of double-digit returns. However, insolvency rates in Australia have now reached levels not witnessed in over a decade, with the construction industry being the most affected. This sector has been most acutely affected by rapidly rising costs of raw materials, labour and interest rates, as well as supply disruptions due to geopolitical risks. In a more challenging macroeconomic environment, this sector may come under sustained pressure.
Other private credit funds focus on lending to smaller companies or businesses on a bilateral basis, where the fund acts as the sole lender. During economic downturns, these companies are at higher risk of default due to difficulties in passing on higher costs without losing demand. Additionally, the recovery rate on defaulted loans from smaller companies is typically much lower than for larger market-leading firms.
Many private credit funds lack regulation, allowing managers to take upfront fees and misalign interests, which reduces investor returns. Governance issues also exist in reporting loan health. Managers can restructure underperforming loans by capitalising interest (rather than receiving cash), extending maturity dates, or converting debt to equity.
Revolution’s Approach to Private Credit and Risk Management
Revolution sees a prime opportunity in private credit, but investors should be mindful of potential risks. We prioritise capital preservation and align our interests closely with investors, ensuring rigorous oversight with monthly independent evaluations of each loan.
For leveraged buy-out transactions, we prioritise market-leading companies that can pass on input cost increases to customers with inelastic demand. In asset backed securities, we focus on well-established and profitable non-bank lenders that originate loans to prime borrowers, who are better equipped to navigate challenging macroeconomic conditions than non-prime borrowers. In real estate, we provide loans to stabilised commercial real estate only (office, industrial and retail) that generate cash flows from tenants. Revolution has not, and will not, issue loans for construction or development purposes due to their inherently higher risks.
As the world faces prolonged higher rates and the RBA contends with high inflation, economic stress is inevitable. Discipline and selectivity will be key to achieving promised returns.
Portfolio and Pipeline Review
The Revolution Private Debt Fund II (the Master Fund) has a total fund size of A$2.49 billion, as at 30 June 2024. The Master Fund has been performing well, meeting its target return of cash plus 4% to 5% p.a. (net of fees and expenses) since inception. The objective of the Master Fund 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 the Fund being: Australian and New Zealand Leveraged Loans (LBO), Asset Backed Securities (ABS) and Real Estate loans.
The Master Fund held a total of 54 loans as at 30 June 2024, with an average expected life of the portfolio being 1.1 years. The portfolio yield is 10.2%, with a credit spread of the portfolio above BBSW of 567 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 second half of the year. The ABS market also remains active. Revolution has been focused on upsizing many of its existing private warehouse investments as the size of facilities and fund’s appetite grows in tandem. Additionally, Revolution continues to find and capitalise on attractive secondary market opportunities across sectors.
Source: Revolution Asset Management. See below for defined terms.
Revolution Private Debt Fund II (CHN3796AU)*
Performance as at 30 June 2024. Open for investment.
| Return | 1 month | Rolling quarter | 1 year | 2 years p.a. | 3 years p.a. | Since inception p.a. (31 Dec 2019) |
|---|---|---|---|---|---|---|
| Fund II (after fees) | 0.70% | 2.19% | 9.19% | 8.37% | 7.43% | 6.80% |
| RBA Cash Rate | 0.33% | 1.10% | 4.31% | 3.62% | 2.43% | 1.68% |
| Active Return (after fees) | 0.37% | 1.09% | 4.88% | 4.75% | 5.00% | 5.12% |
* Performance is for the Revolution Private Debt Fund II – APIR: CHN3796AU, and is based on month end unit prices before tax. 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. The comparison to the RBA Cash Rate is displayed as a reference to the target return for Fund II and is not intended to compare an investment in Fund II to a cash holding. Loans held by Fund II are subject to borrower default risk and as such Fund II is of higher risk than an investment in cash.
Portfolio characteristics as at 30 June 2024
| Fund characteristics | Fund II |
|---|---|
| Yield to Maturity | 10.2% |
| Credit Spread | 567 bps |
| Interest Rate Duration (years) | 0.1 |
| Weighted Ave. Credit Rating | 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.
Definition of terms
- 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.
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 has been prepared by the Investment Manager, Revolution Asset Management Pty Ltd ACN 623 140 607 AFSL 507353 (‘Revolution’). Channel Investment Management Limited ACN 163 234 240 AFSL 439007 (‘CIML’) is the trustee and issuer of units in the Revolution Private Debt Fund II and Revolution Wholesale Private Debt Fund II (collectively ‘the AU Funds’). Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (‘Channel’) is Revolution’s non-investment services provider and the holding company of CIML.
FundRock NZ Limited is the issuer of units in the Revolution Private Debt PIE Fund (NZD) (the ‘NZ Fund’). Public Trust is the independent trustee of the Scheme of the Fund. Revolution is the appointed Investment Manager for the NZ Fund. Refer to fundrock.com/fundrock-new-zealand for more information. The NZ Fund is intended for the exclusive use of wholesale investors, as defined by the Financial Markets Conduct Act 2013.
This information is supplied on the following conditions which are expressly accepted and agreed to by each interested party (‘Recipient’). The information is general financial product advice only and has been prepared without taking into account the objectives, financial situation or needs of any particular person. The information is not intended for any general distribution or publication and must be retained in a confidential manner. Information contained herein consists of confidential proprietary information constituting the sole property of Revolution and respecting Revolution and its investment activities; its use is restricted accordingly. All such information should be maintained in a strictly confidential manner. This information does not purport to contain all of the information that may be required to evaluate Revolution, or its investment strategy and the Recipient should conduct their own independent review, investigations and analysis of Revolution and its investment strategy and of the information contained or referred to in this document. Neither Revolution, Channel, CIML, FundRock NZ nor their related bodies corporate, representatives and respective employees or officers (collectively, the Beneficiaries) make any representation or warranty, express or implied, as to the accuracy, reliability or completeness of the information contained in this document or subsequently provided to the Recipient or its advisers by any of the Beneficiaries, including, without limitation, any historical financial information, the estimates and projections and any other financial information derived there from, 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 indicator of future performance. The information in this document has not been the subject of complete due diligence nor has all such information been the subject of proper verification by the Beneficiaries. Except insofar as liability under any law cannot be excluded, the Beneficiaries shall have no responsibility arising in respect of the information contained in this document or subsequently provided by them or in any other way for errors or omissions (including responsibility to any person by reason of negligence). An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. For further information and before investing, please read the offer document which is available upon request.