James Carthew assesses RM Secured Direct Lending, the latest closed-end income fund to focus on loans to credit-starved businesses.
Just one new fund launched in January, TOC Property Backed Lending (PBLT). It was not a particularly high profile new issue, raising just £17 million mainly from existing customers of the manager.
The attraction for investors is, once again, the dividends these funds hope to generate. RMDL targets a yield of 4% of the issue price in 2017 rising to 6.5% in 2018. It will pay dividends quarterly. PBLT is going for annual income of 7% with an equity kicker of 1%-2% on top.
Both these funds will hope they can expand over the coming months and years, but experience tells us it is very hard for a small fund to hit that critical size where the bigger players will take it seriously and all too easy to fall into the trap of 'I would put more money into it if it were larger’. Both funds are at least trading on premiums (4.1% in RMDL’s case and 5.6% for PBLT) which makes fund raising a bit easier.
I thought this week I would focus on RDML. It invests in loans to smaller and medium-sized companies mainly in the UK, but 30% of the portfolio can be invested in currencies other than sterling. As the name suggests, the loans will be secured against tangible assets or income streams such as money due from customers (receivables).
As I have said before, there is little doubt there is a huge unmet demand for credit in the UK from small and medium-sized enterprises (SME) and I much prefer funds lending money to companies rather than consumers.
The investment manager RM Capital Markets has been around since 2010 and was set up originally as a fixed income broker. It operates from offices in Edinburgh, London and Paris and is headed by chief investment officer James Robson. He is supported by a team of four. Since 2012 they have advised or originated on loans totalling £1 billion and €600 million in Europe.
The direct lending business commenced in 2015. Loans have to be approved by a credit committee that includes RM’s chairman and two external members.
RDML has specifically ruled out investing in loans originated on peer-to-peer lending platforms, although they do not explain why, instead the loans are sourced/originated by the investment manager.
The advantage of sourcing loans from other lenders is that it should allow them to invest the issue proceeds faster than if they were investing solely in loans originated by the manager. They had a pipeline lined up that could have absorbed a much larger fundraising and so I would expect them to be fully invested relatively quickly.
RMDL will, typically, lend sums of £2 million to £10 million for periods of two to 10 years. The implication of this should be that this is a long-term investment. They plan to offer investors the opportunity to sell their holdings close to net asset value (NAV) every three years starting in early 2021. This will probably be done through a tender offer for the shares and is a good idea as it should prevent the stock rising too far above NAV.
The pipeline of loans they included in the prospectus had yields of 6.89% to 15%, more than adequate to accommodate an element of unrecoverable losses, overheads and the planned dividends.
The main aim for the managers will be to secure the income stream needed to fund the dividend, but the fund may end up with equity, warrants or options as part of the loan package that could deliver some capital gain. The loans will have a mix of fixed and floating interest rates and so, if interest rates rise, so will returns to some extent.
RMDL has no plans to gear the portfolio as a way of enhancing returns (borrowings are allowed but only on a short-term basis, to manage cash flow). For investors in P2P Global Investments (P2P) and VPC Specialty Lending (VSL), who have been experiencing first hand the potential dangers of gearing in some of these funds, this will be seen as good news.
The managers get 0.5% on the first £75 million of assets and 0.875% on the balance. Half this fee will go to buy shares in the fund. There is no performance fee which also seems reasonable by comparison with other debt funds.
RMDL built a share placing programme into its prospectus that should allow it to expand to meet demand. Interestingly it gives it the flexibility to choose whether to issue new ordinary shares or C shares.
The method will depend on the potential size of the issue and the directors’ assessment of how this might impact existing shareholders. Given the investment focus, the projected returns and the sensible capital structure, I think this fund deserves to be bigger.
James Carthew is a director of Marten & Co