July 10, 2023

The Merricks Capital Financial Year 2022/2023 review


The Merricks Capital Partners Fund returned 9.0% for FY23 and a distribution of 8.0% for FY23. Since its inception in 2017, the fund has returned 10.2% on an annualised basis. Underlying fund performance finished +1% over FY22 as the increased return from floating rate loans (est. 188bps) was partly offset against by our hedging strategy.

The Merricks Capital Agriculture Credit Fund returned 10.8% for FY23 and a distribution of 8.0% for FY23. Since its inception, the fund has returned 9.8% on an annualised basis. Underlying fund performance was 2.1% higher than FY22, capturing the increase from floating rate loans (est. 173bps) and the additional earn on new loans with less competition from banks or non-banks.

Portfolio Risk Management

The normalised cost of the Merricks Capital Partners Fund’s credit hedge is 60-80bps per annum and maintaining the macro protection is core to our portfolio risk management.
Looking ahead to FY24, the Merricks Capital Partners Fund’s performance is expected to deliver 10.2% based on the underlying loan income and a normalised portfolio hedging cost.
A 6% premium to current 10yr bond rates after the hedge is designed to capture equity like risk premium whilst taking significantly less risk.

Portfolio Construction

With the cash rate at >4%, our view has been that commercial real estate prices could fall as much as 25% from the 2021/2022 peaks due to cap rate expansion and tighter credit market liquidity. With this as our base case, we proactively sought income-producing assets in FY23 and fully serviced loans, including retail (up 4%) and reducing exposure to construction projects (down 2% to 9% of total loans by NAV), as these can’t pass through inflationary pressures.

We also prioritised residential and completed apartment stock (increasing 12% to 19% of total loans by NAV) as the macro thematic around net migration, low vacancy rates and limited new supply became apparent. In March 2023, we established a Residual Stock Facilities (RSF) Fund to provide investors specific exposure to completed stock in Australian capital cities and quarterly distributions of 2% (target, net of fees and costs), a total annual absolute return of 8%.

Agricultural land values have historically outperformed in times of high inflation. While tighter credit markets have slowed the number of agricultural land sales transactions, many values held or exceeded 2022’s record highs. Our experience, having deployed over $1bn of agriculture senior loans in recent years of the strategy puts us in a good position to grow as many of the major banks are now once again fully allocated to the agriculture sector and will have limited capacity.

Across 60 loans, we haven’t seen a material change from FY22 to FY23 on covenant breaches. Of the 2 total loans that currently requires us to take control via administration or mortgagee in possession we’re not expecting impairment to investor principal (as at 30 June 2023).

FY24 Outlook

Our investment focus will remain only on first mortgage/senior secured loans.

Our forecast for private credit portfolio performance should achieve a current cash rate +6-8% before hedging costs remaining in a defensive position.

Investors should take comfort in senior secured private credit compared to public fixed-income products where we can take direct control of assets outside the financial system should the need arise.

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