December 12, 2022

Merricks Capital Partners Fund Portfolio and Market Update November 2022


The Merricks Capital Partners Fund returned 0.5% in November and 10.3% on an annualised basis since inception. Underlying loan income performed strongly for the month, 0.9% with floating rate loans passing through rising interest rates in Australia and New Zealand.

The macro credit hedge in the Merricks Capital Partners Fund which consists of a basket of long Credit Default Swap (CDS) detracted –0.45% for the month as credit spreads significantly tightened on the back of market optimism around China reopening and initial signs of softening global inflation. Performance of the CDS portfolio is up 0.34% since the start of year and is expected to continue providing cost-effective credit protection for the fund at a time when global recession risk remains high.

Three loans were repaid during November and two new loans settled totalling $39m of new investments.

As part of portfolio monitoring and optimal portfolio construction during the month we examined the
following investment trends:

Office: In the post-COVID environment, tenants are demanding high-grade amenities and convenient commuter locations. Developer appetite to deliver new stock in Sydney and Melbourne CBD
locations are present but debt funding options have tightened and some projects that didn’t have sufficient developer equity are no longer feasible in a higher interest rate environment. We anticipate
lower-grade offices to continue to be difficult to tenant and are observing whether this creates opportunities around alternate use/ repurposing for residential. The Merricks Capital Partners Fund
has a 15% portfolio allocation to the office sector.

Hotels: In November, Merricks Capital placed the Melbourne Place project into Voluntary Administration following payment defaults by the borrower. The borrower default was not related to rising construction costs or supply chain issues but rather matters specific to the borrower. There is strong interest from prospective buyers for the project and the Administrators have received approximately 40 expressions of interest to date. More broadly, the sector has rebounded faster than expected as domestic tourism and business travel have driven the revival of hospitality and tourism assets in Australia. The Merricks Capital Partners Fund has a 4% portfolio allocation to the hotel sector.

Residual Stock: Dislocation caused by rising replacement costs resulting in fewer developers commencing residential developments, lack of housing supply in key capital cities, and the rebound
in net overseas migration is expected to contribute to further supply shortages. The attractiveness of Residual Stock Facility (RSF) investments is security against existing, completed commercial real
estate that have clear exit strategies (sale of units). We are now seeing increased RSF opportunities with wider pricing, IRRs between 9-10%, in an environment where there continues to be lower lending
capacity by retail banks and non-banks. The Merricks Capital Partners Fund has a 2% portfolio allocation to the Residual Stock sector.

Agriculture: Flooding in the Murray Darling Basin is expected to peak in Mildura early December with much of the north-east coast already returning to normal. Our investment exposure to the impacts
of floods remains minimal. The Merricks Capital Partners Fund has a 26% portfolio allocation to the agriculture sector.

We are in advanced due diligence on approximately $175m of commercial real estate opportunities for the Merricks Capital Partners Fund with a focus on office and RSF. The expected weighted average IRR across the new investment opportunities is 11-12% (forecast, net of fees) at <65% LVR.

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