The third quarter of 2019 ended with solid returns for global equities, primarily due to US market strength. Political uncertainty and trade concerns weighed on other regions including Australia. Australian bond yields were broadly lower off the back of reductions in the RBA cash rate and worrying developments around slowing global growth and persistently low inflation. The current uncertainty surrounding the ongoing US/China trade war and around the UK election outcome and whether it leads to a no-deal Brexit, combined with the potential for a spike in the oil price due to tensions in the Middle East, mean the global economy faces several headwinds for the final quarter of 2019.
In a period of greater market volatility and with many market commentators predicting a global recession as soon as next year, it has become much harder for investors to achieve defensive income-orientated allocations than in previous times, as overall yields have fallen. This is exacerbated by a bond market which is pricing in significant macro-economic headwinds while equity markets are near all-time highs, aided by an abundance of liquidity in the form of lower interest rates and quantitative easing. Australian and NZ private debt offers a comparatively high income whilst still exhibiting core capital preservation characteristics, which is considered more attractive late in the economic cycle.
The Revolution Private Debt Fund I (the Fund) is performing well and is currently on track to deliver above its target return, which is cash plus 4% to 5% p.a. (gross of fees and expenses). The objective of the Fund is to achieve this return with low volatility and with the benefit of having security over assets.
The large Australian banks have reduced their appetite for lending in the key focus areas of the Fund, and this thematic was reinforced over the first three quarters of 2019. This is further evidenced by a strong pipeline of opportunities for investments that have presented themselves over the year, which sit well within the risk/return spectrum of the Fund’s investment strategy. We continue to maintain a strong credit discipline based on relative value across the three key focus areas of the Fund being: Australian and NZ Leveraged Loans, Asset Backed Securities (ABS) and Real Estate loans. There were a number of attractive investments originated over the last quarter, which allowed the fund to deploy a significant amount of capital across eight new transactions. At this current deployment rate, it is expected that the Fund will be fully invested by year end, which is ahead of its original forecast.
A number of large take-private and refinancing transactions closed over the quarter, for example Quadrant Private Equity locked in A$300m of debt refinancing for its majority owned Amart Group, an Australian discount furniture retailer. The debt-raising is led by four existing Amart lenders for re-financing purposes and growth initiatives. The A$400m bank loan supporting AATS Group’s (owner of SkyBus) acquisition of Transit Australia Group also closed, with the newly formed entity becoming one of Australia’s largest bus operators. And finally, the year-long Arnott’s sale process has come to a conclusion, with KKR being appointed as the successful bidder. KKR will pay $US2.2 billion ($A3.14 billion) for the iconic biscuit business of Campbell’s international portfolio, valuing it at a ~13x EBITDA multiple.
After conducting extensive due diligence, the Fund made three more commitments in the leveraged loan space, supporting Brookfield’s acquisition of Healthscope and a refinance of Ventia – two companies with sound fundamentals and financial profiles, as well as leading market positions. A third leveraged loan was made during the quarter for Genesis Care, a leading provider of cancer and cardiac treatment in Australia, UK and Spain which is owned by a consortium comprised of China Resources and KKR. This financing was initially made prior to the Fund’s inception however Revolution has been able to leverage off long-standing relationships in order to secure an investment in the secondary market which is not very common in performing par loans in Australia.
The Fund targets well established originators of loans that have a demonstrated a long track record in their chosen sub-sector of ABS. For an investment to be approved, an ABS warehouse transaction requires significant alignment through ‘skin in the game’, typically provided via first loss equity from the originator in each transaction.
The Fund invested in three private ABS Warehouse facilities and one public ABS transaction, all to well-established non-bank originators. Three of the four new ABS investments are located in New Zealand, and these exposures target opportunities in prime residential mortgages and consumer finance. Overall, the macroeconomic picture is slightly stronger in New Zealand as it has experienced higher growth and lower unemployment than most of the developed world. We are generally more constructive on New Zealand mortgages than Australian mortgages, due to the lower level of arrears and loan-to-value (LTV) ratios. New Zealand households are also less exposed to debt and debt servicing issues, which is demonstrated by the household debt to income level of 125% compared with 190% in Australia.
During the quarter, the Fund made one investment that met its stringent investment criteria being a stabilised real estate asset in the non-discretionary retail sector. This was a senior secured loan to Noosa Civic shopping centre located in Queensland.
If you would like more information on performance and the portfolio of loans, contact us.
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