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Hedging Systematic Risk

  • At the beginning of 2022, Credit Suisse Credit Default Swaps (CDS) were trading at 42bps, a similar level to major Australian banks. In the weeks prior to Credit Suisse’s collapse, its senior CDS spiked to +1,000bps before the Swiss government and UBS rescue plan was negotiated over the weekend. Among many lessons, this event emphasized the importance of managing systematic risk in a private credit portfolio.
  • While we do not expect the current banking crisis in the US and EU to have significant contagion risk to the Australian banking system, the low cost of maintaining credit insurance in Australia is attractive relative to its exponential payoff in major crises.
  • The expected insurance payoff if we had a similar banking event in Australia as what happened to Credit Suisse, is estimated to be a 32% gain in performance to the Merricks Capital Partners Fund. While this is a very remote likelihood, Credit Suisse’s collapse and the banking collapses of 2007/2008 are a reminder credit market risks are often underestimated until too late.
  • Our distinctive pedigree of operating hedging strategies enables us to mitigate systematic risk for a modest insurance premium (approximately 50-60bps of annual fund performance).
  • With the Merricks Capital Partners Fund’s current portfolio weighted LVR at 62%, we are confident that even a 50% fall in asset prices from today’s levels would not see a significant risk of capital impairment with the forecast insurance payoff from this scenario contributing an estimated 25-30% to NAV based on current market assumptions.
  • We have not seen any first or second order consequences to our +$2b senior secured lending book from the market events over the past week.