The Merricks Capital Partners Fund (the Fund) returned 0.6% in January and 10.3% on an annualised basis since inception.
Global markets started the year with a positive tone driven by the expectation that central banks will be less aggressive in hiking rates in 2023, and with US inflation data showing a plateau in Q4 2022. This optimism contributed to the tightening of credit spreads with the Credit Default Swap portfolio (CDS) detracting 27bps from January performance. With implied volatility in bond markets likely to remain elevated in 2023, CDS protection continues to provide the Fund with a cost-effective macro credit hedge and we will take the opportunity of cheaper insurance to increase our protection.
The underlying loan income for the Fund was 87bps for the month with no new loans added to the portfolio during January. Due diligence progressed on $850m of exclusive new opportunities across commercial real estate and agricultural lending investments with approximately $500m expected to be allocated to the Fund. With 34% investment allocation to New Zealand across 12 loans and 9 sub sectors the recent floods in Auckland were a focus for the month. We have assessed all the risks associated with the Fund’s New Zealand exposure and had direct dialogue with borrowers. There has been no material impact on assets.
We continue to watch the drop in residential property values across Australia and New Zealand and maintain a house view that prices may fall 20% from the peak. CoreLogic’s House Price Index (HPI) most recent release showed a 0.3% fall in January for Australian residential, the tenth consecutive month of decline. An area of opportunity arising from the residential market dislocation is ‘residual stock facilities’ or newly completed apartments to which the Fund currently has a 5% exposure. We see a deep pipeline of opportunities in residual stock facilities as tight supply/demand for housing (~1% vacancy), overseas migration returning and increasing rental yields will put a floor on valuations well above our lending levels. According to SQM Research, rental yields for units in Sydney and Melbourne increased by 17.1% and 13.9% respectively during 2022 and yields continued to increase in January 2023 (4.9% and 2.4%). This is a function of lower prices and rapidly rising rents.
