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Sector Specialist: Debt

14 May 2018

The sixth largest sector after 12 years with a current yield of 6.2%.

With interest rates at all-time lows over the past decade, investors have increasingly been looking to alternative assets in their search for income. Sector Specialist: Debt is one of the highest-yielding investment company sectors and since launching in 2006 it has grown to become the sixth largest sector with total assets of £8.6 billion.*

Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC) said: “With interest rates at such low levels, demand has been strong for the debt sector which has grown to become the sixth largest AIC sector, with 29 companies, the most in any sector. Investors seeking income have been attracted by the generous yields achieved through a wide range of different strategies including corporate, asset-backed, distressed and peer-to-peer loans. Clearly, these companies invest in alternative assets and should be considered as part of a balanced portfolio for the long term. If investors are in any doubt as to whether investment companies are suitable for them they should speak to a financial adviser.”

On Monday 14 May 2018, the AIC held a media roundtable with managers from the investment company debt sector. Martin Rotheram, Senior Portfolio Manager of NB Global Floating Rate Income Fund, Loic Fery, CEO of Chenavari Investment Managers, Investment Adviser to Chenavari Toro Income Fund and Pietro Nicholls, Portfolio Manager of RM Secured Direct Lending, discussed their investment strategies and how debt investments would be affected by potential volatility. Their views have been collated alongside other managers from the sector.

Investment strategy

Pietro Nicholls, Portfolio Manager of RM Secured Direct Lending (RMDL) said: “In an increasingly volatile market, RMDL’s direct lending strategy offers investors the ability to preserve capital, protect against inflation and rising rates, whilst generating attractive risk-adjusted returns. Since its launch in 2016, the investment trust has invested in over 25 corporates across 16 sectors in the UK and Europe. This includes three investments into healthcare, providing finance to support the care of over 11,000 patients, five investments into renewables, enough to power 35,000 homes and twelve investments into specialist real estate, financing over 250,000 square feet of space.”

Martin Rotheram, Senior Portfolio Manager of NB Global Floating Rate Income Fund said: “The NB Global Floating Rate Income Fund invests in a global portfolio of senior secured floating rate loans. These are loans made to non-investment grade companies to finance some type of corporate activity, typically a merger or acquisition but could be used for other purposes for example a capital expenditure project. They are typically arranged by banks and then syndicated to institutional investors. The portfolio, which typically contains 175 to 225 loans is diversified by borrower and industry. These loans are managed by four experienced portfolio managers and backed by what we believe to be one of the largest and most experienced credit teams in the industry. We are active managers and typically select higher quality assets – around 50% of the portfolio is currently invested in credits rated BB or higher – with a focus on keeping duration low and limiting potential areas of volatility.”

Loic Fery, CEO of Chenavari Investment Managers, Investment Adviser to Chenavari Toro Income Fund said: “As an opportunistic alternative lender, Chenavari Investment Managers, the investment adviser of Chenavari Toro Income Fund provides secured lending to niche and fragmented sectors with high barriers to entry through a precise partnership selection. For instance, Chenavari Toro Income Fund has partnered with an Irish company to originate buy-to-let mortgages on the back of regulatory tightening for Irish banks and an attractive macroeconomic backdrop. The firm intends to securitise the Irish mortgage portfolio and should receive the net excess return between the mortgage pool interest (over 5%) and funding costs.

“Chenavari Investment Managers has invested $3.4 billion in alternative private credit loans in 12 European countries over the past three to four years and Chenavari Toro’s investments consist of residential mortgage loans, senior secured corporate loans and asset-backed lending. Finally, it is important to say that Chenavari’s partners and employees own about 19% of the share capital.”

Ron Miao, Chief Operating Officer of Hadrian’s Wall Capital Limited, Investment Adviser to Hadrian's Wall Secured Investments said: “Hadrian’s Wall Secured Investments Limited (HWSIL) is a London Stock Exchange Main Market listed closed-ended investment company. The company focuses on lending only to UK real economy SME businesses secured by a range of underlying assets and collateral including transportation equipment, production equipment, plant and machinery, property, inventory and financial assets. Hadrian’s Wall Secured Investments focuses on market segments which it believes are under-served by the mainstream banking sector. Among others, the company has provided loans to an auto lease company, social-healthcare developer, equipment manufacturer, construction and engineering company, renewable energy engineering company, and commercial property company across the UK. Typical loan sizes are between £1 million to £15 million. The borrowers are typically seeking funds for growth and expansion.”

Pedro Gonzalez de Cosio, Co-founder and CEO of Pharmakon Advisors, Investment Manager of BioPharma Credit said: “BioPharma Credit provides investors with exposure to debt assets in the growing life sciences industry. The company primarily invests in corporate and royalty debt instruments secured by cash flows from sales of approved life sciences products. We are a relative newcomer to the investment company universe in London having listed on the Main Market of the London Stock Exchange in 2017 but have been applying and honing this investment strategy in private investment funds since 2009. We invested $1.6 billion across four private funds which averaged gross internal rates of return of ~13% and ~10% per annum net of all fees and expenses, without leverage, and with no defaults.”

What this offers to investors

Ron Miao, Chief Operating Officer of Hadrian’s Wall Capital Limited, Investment Adviser to Hadrian's Wall Secured Investments said: “Hadrian’s Wall Secured Investments Limited targets a stable dividend of 6p per share annually, paid quarterly. To date, the company has successfully raised approximately £145 million in capital. All loans are made in sterling. The company believes its strategy provides stable returns to investors with low volatility and low default rates in the targeted sector of SME lending. The company’s strategy is to focus on secured lending, where the company can obtain multiple layers of credit protection and security. The company does not use leverage to achieve its dividend target, but may use financing to manage its cash flow timing. Ultimately the strategy seeks to provide the investor with consistent safe returns over the long term.”

Loic Fery, CEO of Chenavari Investment Managers, Investment Adviser to Chenavari Toro Income Fund said: “Chenavari Toro Income Fund, a listed investment company with a market capitalisation of over £230 million, offers a target net return of 8 to 10% annually and a targeted dividend distribution in excess of 8%. Chenavari Toro Income Fund offers a unique and diverse exposure to European corporate and consumer lending. It leverages Chenavari’s extensive network of long-standing industry relationships as well as proven track record in securitisation to enhance returns via a proprietary source of cheap term financing.”

Pedro Gonzalez de Cosio, Co-founder and CEO of Pharmakon Advisors, Investment Manager of BioPharma Credit said: “BioPharma Credit aims to provide investors with attractive uncorrelated returns of 8-9% and a robust 7% dividend income stream per annum once substantially invested. We intend to achieve this through disciplined investments in debt assets of life sciences companies with approved drugs or medical devices which offer predictable cash flows and significant downside protection.”

Outlook for the sector

Martin Rotheram, Senior Portfolio Manager of NB Global Floating Rate Income Fund said: “Our outlook for the loan market remains positive. The US and European economies continue to show signs of strong growth, and revenue, earnings and cash flow metrics continue to improve while US corporate tax reform should provide a modest benefit to most companies that we are invested in. Given the positive interest rate optionality that floating rate loans exhibit, with the US market currently pricing in two further hikes this year we believe that the asset class should continue to demonstrate lower volatility whilst offering an attractive source of income-driven return for investors.”

Ron Miao, Chief Operating Officer of Hadrian’s Wall Capital Limited, Investment Adviser to Hadrian's Wall Secured Investments said: “As banks have cut back on lending and tightened their criteria for UK SME lending, the prospect for direct lenders in the sector has never been greater.  SMEs are approximately 28% of the UK (non-financial) real economy. According to the Bank of England, the targeted market is greater than £200 billion in size. The company believes its targeted sector will continue to need financing. Given the size of the sector, the company believes its lending opportunities will remain stable regardless of overall financial market sentiment, and its prospects should remain largely uncorrelated with other investment sectors.”

Pietro Nicholls, Portfolio Manager of RM Secured Direct Lending said: “We are cautiously optimistic on the market outlook. US monetary and fiscal policies present a complex picture, whilst European and UK markets are experiencing a slowdown in GDP growth. The UK also needs to contend with Brexit negotiations, a deteriorating credit cycle and rising interest rates. Defensive investment strategies such as direct lending are well positioned to benefit from any normalisation of interest rates and are well protected from a deteriorating credit cycle due to the various security packages in place with underlying borrowers.”

-Ends-

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Notes

  1. *As at 30 April 2018. Source: Morningstar.
  2. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 348 members and the industry has total assets of approximately £178 billion.
  3. Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance.  The value of investment company shares, and the income from them, can fall as well as rise.  You may not get back the full amount invested and, in some cases, nothing at all.
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Annabel Brodie-Smith
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