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Defensive senior secured loans are now enjoying the benefits of rising rates.

  • For many years we have been waiting for Central Banks and Governments to be forced to increase rates and remove bond buying.
  • Politically, it has been easy for all arms of Government globally to keep money free and flood the market with liquidity.
  • As a result, over 7 years’ ago, we switched out of ownership of equities (listed and private) and focused on senior debt secured by real assets.
  • Australia and New Zealand presented attractive investment opportunities lending money for risk-adjusted returns of 8-10% p.a. within the backdrop of rising global markets.
  • Inflation, climate change, and geopolitical tensions have now forced the hands of Government agencies, and the “free money” is being withdrawn.
  • The gyrations and speed of change are proving ugly for markets but the outcome of 2-year bond yields returning to the current 3-4% range (last witnessed in 2015) should not be shocking.
  • We did not predict the timing or speed of market moves but we have been preparing our portfolios for this potential outcome.
  • Both the Merricks Capital Partners Fund and Merricks Capital Agriculture Credit Fund are benefiting from rising rates and are currently able to take advantage of some of the market dislocation that is driving record levels of borrower demand.

As we have communicated often over the past 12 months, we have proactively prepared our funds for central banks to unwind the monetary stimulus of the Covid-19 pandemic and since July 2021, we have increased the number of floating rate loans. With both the Merricks Capital Partners Fund and Merricks Capital Agriculture Credit Fund unlevered, we expect each movement in market rates to increase fund performance. Based on our current expectation of the Fund’s existing loans maturing and new investments settled, we estimate that a 50 basis point (bps) rise by the RBA and RBNZ in July, increases the annual fund performance by 30bps in August.

We recently met with several existing and potential borrowers in New Zealand, which reinforced our views that the economic shocks playing out in global macro markets have already severely tightened capital liquidity. A local cash rate is currently at 2%, a housing market that has retreated to November 2021 levels (QV House Price Index) and a retail banking sector that appears to be reducing lending to maintain capital adequacy ratios is creating compelling risk adjusted opportunities a non-bank lending market with limited participants. As this combination of macro headwinds and wider pricing on real asset lending tailwinds persists, we have entered due diligence on number of new NZ commercial real estate and agricultural loan opportunities.

During this period of market volatility, the Merricks Capital Partners Fund’s hedging strategy (utilising credit default swaps) has been performance additive and remains a key feature of our multi asset class credit strategy. Cheap insurance purchased over the last few years gives us the confidence to continue prudently lending money in these uncertain times. In the most extreme macro environments this hedge could add 10-15% performance to portfolio returns.

Having played a defensive hand in portfolio management for many years we feel our portfolios are well placed to weather the current storm and allow our investors to participate in rising interest rates.

 

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