From ETFs to emerging markets and private equities, discover the funds well-placed to drive inflation-beating returns
The best advice for reading the market when times get tough
An upward tracking chart is usually a sight worth savouring for investors, though 2023 to date has thrown some curveballs against conventional wisdom.
Inflation has been front and centre in the early months of the year as the nation grapples with rising costs and an increasing cash rate. Upward movement of a different kind.
It’s the sort of investment environment we haven’t seen in the Lucky Country for a very long time. Until last May, it was possible for an Australian homeowner to have held a mortgage for more than 11 years without experiencing a cash rate rise. Those days are clearly well behind us now. But as with every moment of economic pivot, new investment opportunities present for those who are poised and ready.
How exactly do you identify opportunity in times of economic turbulence? Well, no one is better placed to read the economic tea leaves than Australia’s best and brightest investment managers. And no publication will offer retail investors the same level of insight and introduction to the minds that read the market as we hope to do here at Outperform.
The investment management industry covers more scope than at any time in human history. Fixed interest, domestic equities, small cap equities, sector funds, digital assets, ETFs, residential and commercial property offerings.
Financial security and freedom are the end goal but given the sheer range of options out there and the importance of a diversified portfolio, you could mount a case that there
has never been a better time for a professional’s investment touch.
Through the pages of this edition of Outperform you will find timely commentary and advice from relevant industry specialists, as well as introductions to some of Australia’s most respected and successful boutique money managers – the sort who can properly inform your investment decisions and deliver outcomes to suit your financial needs.
Opportunity is borne of change. You just need to know where to find it.
A different perspective
MASTHEAD
Publisher NMV1 Pty Ltd
t/a Outperform Magazine
CONTRIBUTORS
Peter Strachan
Tim Boreham
ADVERTISING
Steve Koutsoukos
Ph: +61 (0) 406 557 817
E: steve.koutsoukos@ mediumrarecontent.com
To see true potential you need to look at things differently.
“Opportunity is borne of change. You just need to know where to find it”JACK McGINN
Inflation’s bite can inflict investment pressure across the board. But security can be found if you know where to look.
As we enter 2023 inflation is very much back in the spotlight. How did we get here?
The current cycle of headlinegenerating global inflationary pressure began back in 2020, when production and transport costs rose for many goods and services as the global pandemic constrained supply chain logistics. Subsequent stimulatory government spending added fuel to the inflationary fire, before Russia’s invasion of Ukraine boosted energy costs, turbocharging inflation through 2022. Higher prices for oil, gas and coal, along with the electric power generated from these fossil fuels, fed inflationary price pressure onto consumers so that households, manufacturers, and transport companies have all experienced rising costs, lifting prices through the economy.
To guard against inflation, investors should avoid eroding the value of cash that is held at interest rates below the inflation rate. Investment should be directed towards real assets with monetary value that rises with inflation
– things like equities backed by inflation-busting assets, quality industrial real-estate, commodities or collectables that hold value through inflationary periods.
An inflationary environment favours consumer spending on necessities, leaving discretionary spending vulnerable. Profit for companies relying on nondiscretionary spending on consumer staples like food, healthcare, utilities and alcohol is less affected by inflation. Businesses operating in discretionary spending areas, such as hospitality, clothing, travel, or entertainment, may struggle to maintain sales, cashflow and profitability as inflation bites.
While inflation lifts the monetary value of real assets in a balance sheet, the relative value of offsetting debt is reduced, improving gearing. Effectively, inflation reduces the burden of debt while revenue rises. Cash flow lifted by inflation renders debt repayment more secure. A higher risk approach to investing through an inflationary cycle may involve a selection of companies that offer expanding revenue from a solid asset base, supported by a moderate level of debt.
After many years of underperformance, the energy sector is now outperforming the broader market on the back of stronger energy markets.
A lack of investment in new fossil fuel production capacity since 2014, when oil and coal prices slumped, left supply lines in a fragile state. A similar story has emerged for copper, aluminium, and nickel, where a period of marginal metal pricing held back investment in new capacity.
This market dynamic is likely to support higher metal prices through the 2020s, making investment in
mining production companies and physical metals a reasonable bet through the current inflation period. Many resource companies have also become the new high yielding investment option. Companies such as Fortescue, BHP, Rio Tinto, South32, New Hope and Woodside are now offering dividend yields over 7% per annum.
Listed real estate investment trust securities (REITS) offer high yielding exposure to all real estate classes. In an inflationary environment, most retail, residential and office focused REITS should be avoided as their underlying value could be at risk. Investment in industrial property and ‘big box’ shopping or logistics asset backed REITS should be preferred. Property trusts that have modest gearing, low vacancy rates, long-lived leases to a strong tenant register with annual rent reviews, as well as some development options, can sail through an inflationary period as assets appreciate, debt is devalued, and cash flow provides supporting dividend yields.
Rising prices for goods and services reduce the purchasing power of cash. Gold has maintained its relative value over many years, proving to be a good hedge against inflation. Think of it this way – the price of an ounce of gold continues to match the value of a quality business suit over time. More cash is required to buy that suit, because its value declines as inflation erodes its purchasing power, but gold has proven to be a hedge against general price inflation over the long term.
While cash is usually an underperforming asset, it’s always sound policy for investors to hold, providing an option on the future, sitting poised to take advantage of opportunities that arise. Investment in highly liquid, capital stable near-cash, floating rate notes that varying at a premium to the 90-
day bank bill rate, offer enhanced franked dividends of 3.5 to 6% pa to provide a level of buffer against inflation. Inflation linked bonds are also available in some markets, protecting cash against value erosion.
ETFS
Exchange traded funds can offer direct exposure to metals and other commodities such as cotton, sugar or grains, as well as mining companies and a basket of property equities. ASX listed GOLD.ASX and PMGOLD.AXW are examples of ETF gold exposure. Care should be taken to ensure that the underlying assets are not over geared or subject to loss of cash flow as prices rise.
Reading the market in inflationary times can be a challenge, but it also highlights the value of seeking out the right advice and expertise when making investment decisions.
“Investors should avoid eroding the value of cash that is held at interest rates below the inflation rate. Investment should be directed towards real assets with monetary value that rises with inflation”GOLD
As transparency and access improve, mainstream investors are waking up to private equity’s enormous potential.
Property’s high investment entry point may prove challenging, but there is still value to be found in Australian markets.
JACK McGINN
While a backdrop of rising mortgage repayments and dipping housing valuations may not inspire confidence, prominent economist Warren Hogan says now is the time to look for value in Australian property markets.
The advisor to HALO Technologies’ (ASX:HAL) property investment analysis software capability, whose reputation is built on work as chief economist at ANZ and Credit Suisse and as a principal advisor to the Federal Treasury, Hogan believes housing investment value will present for those who are well researched and ready.
“The nature of property is that you need to start doing your homework now, looking at which markets offer the best value in terms of capital growth and dividend yield potential,” he says.
“Now is the time, because I think 2023 and maybe early 2024 are going to show some of the best value in Australian property markets that we’ve seen for over a decade.”
Value in property is not always uniform – Hogan says sweeping generalisations of the overall market are not the way to go.
“There are hundreds, if not thousands of different property
markets in Australia, and if you break down between capital cities and regional areas, and then between apartments and houses like we do at HALO, then you begin to see divergences in performance,” he says.
Hogan identified apartment markets in Brisbane, Sydney and Melbourne, as well as housing in Perth and Darwin, as markets where investment value could currently be found. But he also warns that financial institutions could soon start tightening lending criteria.
“An important element of property investing in 2023 will be to ensure you can secure financing at the best possible terms. Just like the property selection process, you will need to do your homework,” he says.
“It’s worth getting the financials lined up as early as possible.”
■ Australian property is made up of thousands of smaller markets, each with their own value proposition based on a wide range of factors.
■ Warren Hogan highlights the Brisbane, Sydney and Melbourne apartment markets as those where value is present right now.
■ However, securing finance could become more challenging as banks adjust to a higher interest rate environment in 2023.
TIM BOREHAMTypically, investors associate private equity funds with mysterious behind-the-scenes deals or – worse – buying companies using excessive debt and slashing costs to achieve an inflated return.
But as with the earlier stage venture capital industry, the private equity sector has greatly matured in terms of governance practices and the quality of investments.
Once the preserve of institutions, private equity has become more accessible to individual investors seeking to expand their horizons from the short-termism of public markets.
Private equity refers to funds that either invest in undervalued private companies, or buy out public ones. The private equity approach is all about actively managing an underperforming business to increase the value of the asset.
Private equity funds usually hold the asset for a set period, before attempting an initial public offer (IPO) or trade sale. The ‘closed end’ structure means that investors commit a specific amount of capital and then receive distributions as assets are sold along the way.
This is a key difference to an ‘open-ended’ fund, by which investors remain fully invested until they choose to redeem.
According to LGT Crestone senior investment specialist (alternatives) Martin Randall,
private equity enables investors to access a far greater array of businesses and sectors.
“You have this huge opportunity relative to the public market, which is shrinking,” he says.
The trend is borne out by numbers from the US-based private market specialist Hamilton Lane: currently there are 18,000 US private companies with turnover of more than $US100 million, compared with only 2800 public companies of that size.
What’s more, there were 7800 US listed companies in 2000; now there are only around 4800.
Randall says companies are staying private for longer, while more public companies are deciding to go private via buy outs or mergers.
“You will still have the monster stocks that are public, but increasingly we will see this value creation shift from public to private market,” he says.
Locally, a private-equity consortium acquired revered retailer Myer and floated it in 2009. The deal was great for the vendors who made six times their money but a disastrous one for subscribers to the IPO, which famously had model Jennifer Hawkins on the prospectus cover.
But such window dressing of assets – literally or otherwise – seems long gone. The latest local private equity ASX buyout – Allegro Fund’s intended $150 million purchase of Slater & Gordon – looks more a case of
taking the long-underperforming law firm quiet so the restoration can be done away from the public market’s unhelpful gaze.
Randall says private equity owners increasingly are encouraging CEOs and other top executives to contribute equity so their interests are aligned. Their remuneration is not tied to meeting a quarterly profit target, but to long-term outcomes.
Unlike with public companies, the directors are relevant specialists.
“Everyone is focused on getting the best possible outcome to grow that company to get a better exit for underlying investors,” he says.
Randall says the time frame for private equity investment is becoming elongated, partly because companies are choosing to stay private for longer. In other words, they are choosing not to IPO because of market conditions and the pressure imposed on listed companies to achieve short term returns.
While a fund typically might have a 10-year horizon, the individual investments are typically ‘repaired’ within two to three years.
“Most committed capital is back by the sixth or seventh year and investors might get some early distributions within three to four years,” he says.
As asset values become less frothy after a turbulent 2022, private equity acquisitions are likely to re-spark after a quiet patch.
Perversely, good private assets are
likely to become available because of private equity’s outperformance.
As Randall explains, an institution’s mandate might determine an asset allocation of 50 per cent to equity, 30 per cent to bonds and 20 per cent to private equity.
If the private equity component increases beyond 20 per cent because of relative outperformance, these institutions are required to rebalance their portfolios.
“For us it is good opportunity to pick up some really high-quality deals being sold less for financial reasons, but to readjust portfolios.”
A global wealth manager, LGT Crestone has addressed the obstacles preventing individuals from accessing private equity. In a similar vein, Hamilton Lane refers to the “democratisation” of private equity.
One challenge is that the closed end nature of private equity funds means they have not been open to new capital and are illiquid. But financial technology advances now allow for semi-liquid openended structures, enabling inbound liquidity and redemptions.
Hamilton Lane CEO Mario
Giannini concurs that while private equity has enormous potential, it is an entirely new frontier for many individual investors.
“This is a very challenging asset class,” Giannini says. “For us it means bringing you products that give you ... great access and great
4800 Listed companies trade publicly in the US, down from 7800 in 2000
terms and doing it in a way that prevents some of the headaches of private markets investing.”
Given private equity has a long history of outperforming the public market, those headaches might well be worthwhile.
While the public-private
$150m
The value of Allegro Fund’s intended purchase of law firm Slater & Gordon
comparisons are not straightforward, Hamilton Lane estimates that private equity globally achieved a 15-year compound growth rate of just over 12 per cent per annum, outperforming the S&P 500 index by at least 300 basis points.
+12% pa Hamilton Lane’s estimated 15-yr CAGR for private equity globally
“Companies are staying private for longer, while more public companies are deciding to go private via buyouts or mergers”
FSSA Investment Managers’ long-term, bottom-up approach:
◾ Long-term orientated, invests in businesses with structural competitive advantages, attractive reinvestment potentials, stewarded by great management teams.
◾ Bottom-up investors with an absolute return, benchmark agnostic mind-set.
It’s a great time to be a bottom-up, long-term investor in emerging markets, says Rasmus Nemmoe, Portfolio Manager, FSSA Investment Managers.
Amid uncertainty caused by market volatility and pandemic disruptions, secular trends powering growth and opportunities for investors across the different regions are alive and well.
These include the expanding middle class in China, the continuing formalisation of the Indian economy, the financialisation of the South African population, and the growing adoption of enterprise planning software by Brazilian SMEs.
Many of the companies best placed to tap into these trends are
not well represented in the broader indices of these respective regions, which is why it takes a bottom-up active investment approach to seek them out.
Bottom-up investors like FSSA closely follow management teams with a track record of building quality franchises with defensive characteristics, such as high returns and recurring cash flows.
China’s re-emergence has Nemmoe particularly excited about the companies he’s invested in, with competitive advantages in the form of strong brands and proven management teams and leverage to Chinese consumers as the country roars back from three years of hard lockdowns.
“I think we will be surprised by how fast things normalise,” says Nemmoe, who is the lead portfolio manager for the FSSA Global Emerging Markets Focus strategy, which launched in December 2017 and recently passed its 5-year anniversary.
“While mask-wearing is still common, this is much less so in an outdoor setting and even indoor masking is not strictly enforced. From our conversations with the various people that we met, I get the sense that everyone just wants
to get their normal life back.”
While unprecedented lockdowns during the global pandemic had a huge impact on many companies, both in developed and less developed countries, a return to normality in China could see a significant opportunity emerge for discerning long-term investors.
“After the lockdowns occurred, we took a step back and did a deep-dive on all our holdings. We had calls with management teams and re-evaluated their businesses. Fortunately this gave us great confidence in the longer term trajectory of our holdings,” says Nemmoe.
One of Nemmoe’s key takeaways was cost focus. By renegotiating rental agreements and supplier contracts, portfolio companies significantly improved operational leverage, which Nemmoe believes could create a situation where margin expansion outstrips prepandemic highs as regular social activities return.
He notes portfolio companies came out of the pandemic period generally in better shape than their peers.
“The majority of our holdings are market leaders, and we realised that if they were struggling, competitors would be even worse off,” Nemmoe says.
“By talking to the management teams in China, it became increasingly clear that coming out of the crisis many of our holdings would have even greater market share and face less competition.”
Even though many companies in China and across emerging markets had a challenging period in the early stages of the pandemic, Nemmoe believes now is a good time to take advantage of the situation and find some attractive bargains.
He adds, “We believe the current correction in share prices presents an excellent opportunity for long-term investors like us to accumulate leading franchises at attractive prices.”
■ As one of the oldest and most famous beer brands in China, Tsingtao1 is the poster child of ownership reforms, where strategic investors buy stakes in China’s state-owned enterprises.
■ Ownership reforms in China tend to be beneficial to shareholder returns as the new investors appoint board members and introduce management stock options to incentivise better performance.
■ While Tsingtao’s first decade of private ownership was characterised by brand building, its strategy in more recent years has been to focus on efficiencies and improving profitability.
■ The company has closed down plants and launched high-end products – such as Tsingtao Draft, IPA and Pilsner – to tap into the premiumisation trend in China’s beer market.
■ Since its focus on profitability and efficiency, margins have improved, and higher sales volumes and selling prices have contributed to faster bottom-line growth.
“We believe the current correction in share prices presents an excellent opportunity for longterm investors like us to accumulate leading franchises at attractive prices”
Opportunity is alive and well in re-invigorated emerging markets, according to the investment experts at FSSA Investment Managers.
◾ Capex – Drivers suggest companies and governments are embarking on a major cycle of capital spending.
◾ Technology – While investors are too focused on near-term cyclical concerns, the technology industry is now poised in the foothills of the AI opportunity.
◾ Energy trilemma – The war in Ukraine has forced governments globally to prioritise energy security and affordability while addressing climate change.
New York-based fund manager Steve Wreford says picking key global themes that will drive investment returns over the next decade is no easy task – and identifying the shares that will deliver tangible returns to investors is even harder.
A senior portfolio manager with Lazard Asset Management LLC, Wreford co-manages the 25-yearold Zurich Investments Global
Fund name: Zurich Investments
Global Thematic Share Fund
Style: Thematic
Retail Investors: Yes
Portfolio Managers: Lazard Asset Management Pacific Co. (Lazard)
KEY POINTS
◾ Green and social bonds are growing in popularity
Recognising the world’s structural changes early and building a portfolio to capitalise on them is the key to thematic investment success.
Thematic Share Fund available to Australian investors.
“It really goes down to identifying the biggest structural changes happening in the world over the next decade … and designing a portfolio that plays into those big themes,” he says.
The inherent problem is that by the time a theme hits the cover of a newspaper, the assets have become too expensive. To unearth truly fresh trading ideas, the fund avails of Lazard’s 80-strong army of analysts, who talk to more than 4000 companies annually.
“It’s quite amazing to be able to sit down with management from companies all around the world and tap their views,” Wreford says.
“As a result, we are building our view of the world bottom up, rather than imposing a top-down view.”
There’s no more topical an example of the ‘big theme’ than artificial intelligence (AI), exemplified by the race to build the perfect ‘chatbot’.
Wreford refers to “AI at a
reasonable price”.
“It’s tempting for investors to chase any company that puts AI in its title,” he says. “While it’s exciting, investors need to approach this with a suitable degree of cynicism as well.”
The fund’s portfolio includes the New York listed ‘intelligent’ buildings specialist, Johnson Controls International. The company’s operating system, Open Blue, can do everything from turning the aircon and lights off to managing security.
“We envisage buildings talking to each other and sharing how they become more efficient,” Wreford says.
While Microsoft and Google duke it out for ‘chatbot’ supremacy, Wreford says the likely winners are big cloud platforms (including Amazon) that already handle copious amounts of data.
Companies with proprietary data are also likely beneficiaries, such as the Dutch-based Wolters Kluwer which owns one of the world’s biggest legal databases.
Rather than having a junior lawyer pore for days over legal precedents, a subscribing law firm could apply AI and get it done in minutes.
“AI will turn many clerical jobs into the 1950 equivalent of the typing pool,” he says. “Jobs will migrate up the value chain and if you don’t follow that you will be left behind.”
■ Our primary source of alpha is structural change - we capitalise on this through the successful identification of themes which benefit from long-term drivers, and the population of these themes with relevant stocks.
■ Key differentiators vs other generic thematic strategies: the team creates its own differentiated proprietary themes, themes evolve over time, rigorous implementation in terms of stock fit to theme, disciplined approach to valuation.
■ Our Global Thematic strategies are style agnostic rather than embedding a permanent growth or value bias. Style has not been a significant driver of returns for the strategy. We feel this is a key differentiator vs peers.
■ We believe our thematic approach is a natural fit for investors seeking a sustainability solution, considering risks and opportunities at every stage of our process.
◾ Provide regular income and positive environmental and social benefits
3 months: 5.90% (vs 3.95%)
1 year: -10.93% (vs -12.52%)
◾ Can perform better than conventional bonds
3 years: 6.55% p.a. (vs 6.22%)
5 years: 10.37% p.a. (vs 9.25%)
Contact: 131 551 (Australia-wide),
+61 2 9995 3777 (Overseas), zurich.com.au
At any time, the fund is invested in about 100 companies, across 8-12 themes. The managers adopt a ‘style agnostic’ approach, which means there’s no bias to value or growth stocks or particular geographies.
“Clients appreciate it’s an allweather portfolio that should do well in different market environments,” Wreford says.
■ Managed by a highly experienced Thematic team with an average of 25 years industry experience, we offer a proven approach to long-term investing with a strong track record of outperformance.
“Identifying the biggest structural changes happening in the world over the next decade … and designing a portfolio that plays into those big themes”
The economic contribution of Western Australia’s mining sector to national prosperity is long held and well known, but the trends on show in the mining space in 2023 defy even those seen during previous booms.
At the centre of it all right now is lithium, a key component of the EVs needed to transport the world in emissions reduced future.
It may surprise to hear that WA-focused specialist investment manager Precision Funds Management is looking beyond lithium stocks.
The firm, which has unique insight into the resources opportunities on offer in WA, has cast its expert eye to materials and services with a little froth
With the world on the cusp of an unprecedented global transition, one well-endowed state is again proving to be the luckiest of the Lucky Country.
around them.
“We estimate the Greenbushes lithium mine, which is partly owned by IGO, partly owned by Albemarle and partly by Tianqi, is going to be selling spodumene at 32 times its cash cost this quarter,” Dermot Woods, executive director at Precision told Outperform.
“That’s the result of an amazing short squeeze in lithium – this is stuff that was selling for circa $300/t about two and a half years ago, versus as much as $6000/t in recent times. We expect prices to decline from here, so we are not chasing lithium at the moment.
“Looking at oil and gas markets globally and on the east coast, I’d be very surprised if we didn’t see a real squeeze in that market at some point.
“Further down the track you’d probably expect to see it in copper and nickel – it’s very difficult to find these deposits and even harder to actually get them online.”
Precision expects the LNG construction industry to kick off over the next few calendar years, while appetite for energy transition metals copper and nickel is expected to increase.
WA’s mineral endowment, combined with its resources-
friendly jurisdiction – last year’s Fraser Institute Annual Survey of Mining Companies ranked the state #1 in the world for resources investment attractiveness – make it a compelling investment proposition.
The energy transition will be about more than mining. Western Australia’s abundance of coast, wind and sunshine put it in good stead to fuel the infrastructure its resources will be used to build.
While that future looms large, the state is also well positioned to supply a gradual energy transition, according to Woods.
“There’s opportunity in renewables, but also the blessing of cheap gas which will be the transition fuel to get there,” he says.
Mining services have also drawn attention, with Precision identifying value in the sector.
“Many of these companies are just shaking off lingering impacts of COVID costs now and as a consequence are trading at incredibly cheap valuations versus their future cash flow growth potential.”
■ Lithium is the commodity generating the most buzz in Western Australia at the moment, but Precision believes there’s more to come for the resources sector in the state.
■ Natural Gas is considered a vital transition fuel for a greener future, while nickel and copper are likely to be in high demand in the longer term as the world looks to put together the infrastructure it needs for an energy revolution.
■ WA is well endowed with all three of these commodities, and in the most recent Fraser Institute Annual Survey of Mining Companies ranked #1 globally as a jurisdiction for resources investment attractiveness –a good place to do business.
■ The state’s mining services sector could also hold value as it shakes off the lingering impacts of COVID costs with a busy pipeline ahead.
■ Longer term, WA’s size, scale and sunshine make it a great candidate as a renewable energy hotspot in Australia and globally.
"“Looking at oil and gas markets globally and on the east coast, I’d be very surprised if we didn’t see a real squeeze in that market at some point"
The scientific method – the application of logical, informed and methodical thinking to decision making – is often missing in an investment world where hype can take hold.
Talk of green shoots, hot sectors and potential booms sometimes lead to poorly guided choices. But multi-asset, income-focused, ESG-friendly Clime Australian Income Fund (CAIF) seeks to better navigate such challenges.
The fund has been designed with an aim to generate regular income above the RBA cash rate in the form of consistent quarterly cash distributions, with volatility at onethird of the ASX 200.
It’s designed with the objective to provide steady income to its investors.
Fund name: Clime Australian Income Fund (APIR Retail SLT1239AU APIR Wholesale CLA0002AU)
FUM: $43.8m
Style: Income focused multi-asset fund, with an ESG emphasis
Minimum Investment: $10,000
Retail Investors: Retail and wholesale
Portfolio Managers: Dr Vincent Chin, Spiro Courtis, Hugo De Vries
Performance: 5.79% p.a. return since inception 1 July 2015
Contact: 1300 788 568 or info@clime.com.au
“The benchmark for the fund is the RBA cash rate plus 3%, with no performance fees. If we do well that’s great – that’s what we want to do,” Dr Vincent Chin, Clime head of income strategies and ESG, says.
“In the total return, we aim for two-thirds income distribution throughout the year, quarterly, and one-third growth. Over a cycle of five years or so, assuming a total return of 6%, we hope to distribute 4% in income and 2% in capital growth.
“The fund is designed for an audience that is probably looking at transitioning into retirement, and those who have just retired. We are all living much longer, so you need some capital growth when you retire as well as income.”
CAIF benefits from the experience of Dr Chin, who’s 22 years in investment are complemented by an esteemed background in science.
This drives an approach to ethical investing – the fund holds just one stock with fossil fuel exposure –and a methodical decision-making strategy.
“Applying a rational, logical mind, and approach to investment
really helps, because the market can sometimes behave irrationally in the short term,” Dr Chin says.
“I prefer to observe. Pattern recognition and trends are also very important to me, and they guide the decisions we make for the fund.”
The results would suggest the approach has worked for CAIF, which is a strong performer against its peers.*
Since inception in July 2015 the fund has achieved a total return of 53.26%, with a per annum return of 5.79% while maintaining relative price stability against the broader market.
The fund is balanced around 40% equity and 60% fixed income including cash, a scale that helps it achieve its performance goals.
Dr Chin notes that when people reach a certain stage of life, they start to look for ways to give back. This plays in well with the underlying ESG themes of the CAIF.
“I think as people grow older, they become more conscious of doing things for the good of society,” he says.
◾ Running yield of 5% (including franking).
◾ Low volatility.
◾ Quarterly income distributions.
■ A multi-asset class portfolio that invests in high-quality income-generating assets.
■ Provides exposure to higheryielding securities in both listed and over-the-counter markets.
■ Aims to achieve a total return of 3% p.a. (after fees) over the RBA cash rate - whilst maintaining relative price stability.
■ The fund is managed to a risk of one-third of the volatility of the ASX200 by diversifying across shares and income securities.
■ Emphasis on quality, cash generation, low financial leverage and high predictability of income - including a focus on ESG considerations.
“Applying a rational, logical mind, and approach to investment really helps, because the market can sometimes behave irrationally in the short term”
Vincent Chin Spiro Courtis
◾ Australian-based private credit asset manager
◾ Providing growth loans to middle market businesses
◾ Offers wholesale investors access to this asset class
Epsilon Direct Lending is an Australian private markets investment manager focused on lending to middle-sized companies, having identified that this section of the private credit market offers relatively better returns compared to other private credit strategies, according to Mick Wright-Smith, founding partner of Epsilon.
Direct lending to middle market companies has emerged in Australia as traditional bank lenders have reduced lending activities to these companies, due to regulatory, capital and cost pressures. Epsilon has entered the space to meet corporate borrowers’ demands for loans and says the returns are attractive.
“We like mid-market corporate lending because the market is still dominated by the Big Four banks and the availability of capital is limited. So, from a lender’s perspective, there is an opportunity to access loans which offer good relative value, that is, loans with
The Australian private credit market encompasses a broad range of strategies, including direct lending.
relatively higher returns and lower risks compared to other private credit strategies such as larger broadly syndicated corporate loans, for example,” says Wright-Smith.
The corporate loan market (excl. bonds) in Australia is worth over $1 trillion. Unlike bonds, private credit is not issued or traded in public markets. Wright-Smith defines midmarket loans as those sized between $10 million and $100 million.
Above that level, larger loans become broadly syndicated and there are many lenders (domestic and offshore banks and credit funds) who participate in this segment.
“In the mid-market, borrowers don’t have much choice of lenders other than the Big Four banks.”
Corporate loans deliver a regular income stream for lenders, and it often comes with a hedge against inflation. Corporate loans typically have floating rate coupons, which are linked to the bank bill swap rate and reset regularly, often every 90 days. The interest rates on loans have a wide range of between 4 per cent through to 15 per cent depending on the borrowers’ risk profiles, which also varies widely.
Overall returns from mid-market direct lending are typically in the high single digits, whereas large
syndicated loans are a little lower than that as lenders compete on price. Interestingly, long term rating agency statistics suggest that the risk of suffering losses are lower when lending to medium-sized companies than larger companies.
“Middle market borrowers have defensive characteristics. In an inflationary environment where interest rates are rising, the loan interest rates that borrowers commit to increase because of the floating rate coupons,” says Wright-Smith.
“Corporate borrowers can deliver consistent cash yields, capital preservation and low volatility. An increasing interest in direct lending globally suggests that borrowers are happy to compensate lenders for the illiquidity risk and credit risk involved.”
Middle market corporate loans are predominantly bilateral in nature – that is, there is one borrower and one lender as party to the loan agreement. Lenders need broad industry contacts to access the most compelling lending opportunities. Loan terms and pricing are often idiosyncratic, so private credit managers with expertise and experience are best placed to lend to borrowers; the asset selection process is key to creating a solution for borrowers that combines a good return with managed credit risks.
“To build a sustainable private credit business, we’ve made a conscious decision to focus on lending to companies in defensive sectors such as healthcare, food staples and telecommunications. We think this will serve us well as we head into potential economic headwinds.”
Epsilon is a non-bank lender and private market asset manager specialising in middle market direct lending, providing bespoke financing to high quality, resilient Australian and New Zealand middle market companies.
■ The Australian private credit market encompasses a broad range of strategies, including direct lending. It provides lenders and investors with exposure to companies, mostly private, and the risk/ return profiles are very diverse depending on the risk of the borrower and loan.
■ The corporate or business private credit market is worth about $1 trillion in Australia, with middle market growth loans comprising a $70 billion segment of this. Middle market companies in Australia have annual revenues between $25 million and $500 million. In the middle market most loans are provided directly, hence the term “direct lending”, which means the lender doesn’t have to work through intermediaries in order to evaluate, structure and document a loan.
■ Private credit can take different forms, including direct lending, real estate loans and many other loan types.
■ The non-bank corporate loan market has been difficult for middle market borrowers to access in Australia, with lenders focussed on real estate and larger corporate borrowers, where lending opportunities are largely arranged and structured by banks, investment banks and brokers.
■ Middle market companies have less influence over loan structure, terms and conditions than larger borrowers. That is because there are fewer lenders in the middle market, with more competition between borrowers for loans.
"The non-bank corporate loan market has been difficult for middle market borrowers to access in Australia"
