August 10, 2023

Merricks Capital Partners Fund Portfolio and Market Update July 2023


The Merricks Capital Partners Fund (the Fund) returned 0.7%* in July and 10.2%* on an annualised basis since inception. The FY23 final distribution of 4.0% will be paid in the third week of August 2023.

Underlying loan performance returned 93bps for the month and the Fund’s hedging cost was 22bps. The downgrade of US debt by Fitch from AAA to AA+ has seen a mostly muted reaction by markets but highlights sovereign credit risk at a time when governments are carrying record debt.

There were no new loan settlements in July. There was one loan repayment during the month, a specialised industrial and infrastructure investment which was a 0.4% allocation to the Fund.

Through portfolio risk management we’re closely tracking possible asset revaluations across our target investment sectors, with particular focus on office and New Zealand (NZ) assets. We expect these to have the largest peak-to-trough, potentially 20-25% declines from 2021 peaks. The Fund has 35% allocation to NZ (max geographic allocation) across 12 senior secured commercial real estate and agricultural loans. Based on retested valuations for our key NZ commercial real estate investments over the last 6 months, values have held up reasonably well (3 higher and 2 lower, all within 7% of original valuations). This reflects our investment strategy to target where borrowers are creating value to the underlying asset base we hold security over. For example, we recently revalued the Indigo Hotel at 51 Albert Street, Auckland under development. The project value has increased by 3.7% from the May 2021 valuation with forward trading assumptions no longer being impacted by the pandemic.

The most significant price corrections occurring are in the commercial office sector on older assets with shorter lease durations and lower tenant demand (15-25% declines), 44 Market Street, Sydney (transacted) and 1 Margaret Street, Sydney (on market) by example. While this correction is material to the office market sentiment and the property funds holding the equity of these assets, our office investments (22% of the Fund) are strategically focused on newly delivered prime assets with defensive attributes such as loan-to-value ratios with a 35-40% asset price buffer (borrowers’ equity) and precinct demand in capital cities (Melbourne, Sydney & Auckland).

We’re seeing an increase in new credit opportunities for agricultural lending with existing bank customers seeking transitional capital solutions to scale operations. It’s clear many banks are overweight on agricultural exposure and exploring options to risk-transfer performing loans to make more capital allocation available for new credit. With drier conditions forecast, we’re targeting sectors that are less reliant on rainfall to meet production yields (e.g. horticulture with permanent water) and funding businesses where commodity price corrections have removed some of the downside price risk (i.e. meat and livestock).

During July we progressed due diligence on $730m of new loans across residual stock facilities, commercial mixed-use, horticulture and specialised industrial and infrastructure. We expect the credit environment to remain highly opportunistic in 2023 with significantly more demand for senior secured loans than available capital which, in our view, will translate to senior debt outperforming other asset classes on a risk adjusted basis.

*These returns are stated net of fees and costs

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