September 16, 2022

The “Fed put option” is dead and buried: our portfolios are set up to generate returns in the face of a long grinding unwind of central bank balance sheets.


Many investment market participants were punished this week for believing Central Banks would behave in a similar fashion to the last 20 years and ease the trend of tightening monetary policy in the hope inflation has peaked. Our views of maintaining portfolios that are resilient in the face of ever reduced stimulus remain strong.

Some key macro factors influencing our thoughts this week include:

The European energy crisis: According to Goldman Sachs research released this month, energy bills for a typical European family could be up 200% on 2021 levels by 2023 and the natural gas spot price is more than 10x the 10-year average. Lower industrial manufacturing activity on the back of higher energy prices has increased the likelihood of recession on the European continent by the end of the northern winter.

US inflation: CPI data released on Tuesday exceeded estimates with headline inflation at 8.3% year-on-year (YoY). While energy inflation decreased with lower fuel prices, rental and consumer food prices continued to climb. The market is forecasting the US Federal Reserve to hike interest rates by another 75 bps when it meets next week, setting the target rate range at 3.00-3.25%. Competing priorities of curbing inflation and maintaining economic performance will likely persist during 2022 and into 2023.

China’s debt markets: Confidence in the household and private sectors is weak. Chinese real estate has a significant impact on consumer confidence in the broader economy as it impacts employment and local government finances. Weakness in the property sector will likely drag on China’s growth. As of June 2022, the volume of Chinese housing starts – a key indicator for steel use in real estate – declined by 34.4% YoY (China National Bureau of Statistics). The slowdown could be contributing to one positive movement in the market – lower material prices and easing supply chain pressures for development in Australia.

The Merricks Capital Partners Fund (Partners Fund) and Merricks Capital Agriculture Credit Fund (Agriculture Credit Fund) have been strategically constructed to navigate uncertain macro conditions, including:

  1. First mortgage security over real estate assets that have long-term supply/demand drivers – commercial real estate, agricultural farmland & specialised infrastructure.
  2. Reduced portfolio LVR. Weighted LVR on the Partners Fund has reduced from 65% to 62% over the past 12 months, providing further equity buffer. The weighted portfolio LVR for the Agriculture Credit Fund is 55%, reduced from 60% in September 2021.
  3. Floating rate loans to pass through interest rate rises. Currently, 54% of the Partners Fund and 53% of the Agriculture Credit Fund loans have floating rates.
  4. Investment diversification across the 51 loans in the Partners Fund and 20 loans in the Agriculture Credit Fund.
  5. The use of a ‘macro credit hedge’ in the Partners Fund by holding a basket of CDS positions. This hedge provides a form of potential Fund liquidity if credit spreads widen due to increased macro uncertainty.

This week two new investments settled, a $23m commercial office loan in Parramatta, NSW, and a $34m horticultural business loan in New Zealand. Both are floating rate loans and have an average weighted LVR of 60% secured by income producing real estate assets.

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