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New Zealand

A golden period for private credit

William Wong: iPartners Funds Management CIO

William Wong, Chief Investment Officer, iPartners Funds Management, explains why private credit is having its time in the sun…

 

We believe market conditions are highly favourable for private credit. As one of the leaders in alternative investments, we at iPartners are fortunate to be able to take full advantage of the current capital constrained environment for capital raisers.

While equity markets continue to be volatile and uncertain, returns on private credit have been increasing, with higher yielding private credit now able to provide equity-like returns without the volatility and uncertainty of equities. Our diversified wholesale PIE funds are ideally placed:

iPartners Diversified Private Income Fund (Wholesale PIE)

From inception of the underlying Australian unit trust in March 2020 to 31 July 2023, the Fund delivered a net return of 10.71% p.a. in NZD. Performance continues to meet our objectives, with a diversified portfolio of high-quality assets delivering superior risk-adjusted returns and stable monthly income. The underlying iPartners Investment Fund (into which this fund invests) has a current running yield of 10.75% p.a. The Fund continues to diversify across asset-backed debt, corporate credit and property debt.

The Fund is also highly diversified across individual exposures with many of the fund positions being allocated to diversified portfolios of loans. Spread across more than 50 holdings, the Fund has exposure to over 60,000 underlying assets.

iPartners Core Income Fund (Wholesale PIE)

Since inception of the underlying Australian unit trust in May 2021, the Fund delivered a net return of 8.4% p.a. in NZD to 31 July 2023. With a low risk profile focused on senior secured assets, returns reflect increases in base rates and new deployment at attractive yields. The underlying iPartners Core Income Fund (into which this fund invests) has a current running yield of 9.71% p.a., with over 90% of the portfolio being held in senior debt.

At a high level, there are currently 30 separate positions in the Fund. Some of these positions are in diversified portfolios of loans. Overall, the Fund’s portfolio is spread across over 60,000 underlying assets.

Current Market Conditions

We set out below more detail on current conditions in private markets, how we incorporate economic conditions in our investment process, and how we position our portfolios defensively for any potential downturn.

Continued Market Volatility and Uncertainty 

Whilst we do not benchmark against equities or traditional fixed income, it is instructive to view the return levels of the various asset classes as well as the profile and variability of returns. The chart below shows the returns of our Funds compared with benchmark New Zealand equities and bonds for the year to 31 August 2023.  Please note our NZ PIE funds are currently unhedged.

The benchmark S&P/NZX50 Index shows a -0.4% return over the year, although it took a relatively volatile path along the way.   S&P/NZX Composite Investment Grade Bond index was basically flat over the year, with a return of -0.04%.

 

 

 

 

 

 

 

 

 

When returns are extended out over a longer period, the picture becomes much clearer and the impact of forex volatility is diminished. The S&P/NZX 50 Gross index return over 2 years to 31 August 2023 was -12.59%, and the return from the S&P/NZX Composite Investment Grade Bond index was -8.88%. (Source: S&P)

 

 

 

 

 

 

 

With running yields from private credit having risen into the double digits, high yield private credit can now provide equity like returns without the volatility and uncertainty of equities.

 

Higher Interest Rates

The Reserve bank of New Zealand’s (RBNZ) official cash rate increased to 5.5% p.a. in June 2023, and has remained on hold since then.   In its latest (August 2023) statement the RBNZ noted that “the current level of interest rates is constraining spending and hence inflation pressure, as anticipated and required. The Committee agreed that the OCR needs to stay at restrictive levels for the foreseeable future to ensure annual consumer price inflation returns to the 1 to 3% target range, while supporting maximum sustainable employment.”

 

Looking forward, the RBNZ anticipates cash rates will start to fall in early 2024, moving back towards 3% by Q3 2024.

 

 

 

 

 

 

 

 

Protecting against a Potential Downturn

We expect market volatility to continue, but we avoid trying to predict where rates are going in the future and we do not invest based on any particular interest rate view.   However we remain conscious of the uncertain macro environment, and we incorporate the potential for a more prolonged economic downturn in our investment process by:

  1. a more general defensive positioning across the portfolio. In particular, we have taken advantage of the rate hiking cycle to move into more senior debt positions without impacting our targeted returns; and
  2. carrying out detailed assessment of individual investment opportunities and their ability to cope in a potential downturn. We have been moving to more conservative positioning over the past 18 months. Senior assets have increased to 94% of the Core Income Fund and the majority (over 50%) of the Diversified Private Income Fund.
  3. increasing allocation to floating rate assets. New asset acquisition since early 2022 has been on a floating rate basis that automatically adjusts for increases in base rates. Of course, as rates fall we will consider moving to more fixed rate exposures to capture higher rates for longer.
  4. increasing allocation to short maturity profiles, providing ample flexibility to adjust portfolios according to market conditions. The Core Income Fund currently has an average maturity of 0.6 years, with 90% of the portfolio expected to mature in the next 12 months.
  5. a focus on high quality assets that should be less impacted by any potential downturn. This includes targeting higher grade credits, lower loan to value ratios, strong structural protections and limiting exposure to some specific sectors such as construction.

Where is the Value in the Market?

Private Credit:  Private credit is now providing exceptional value. Increases in base rates and credit margins are combining to provide attractive total returns. Credit margins have widened driven by a reduction in capacity available to capital raisers and an increased demand for arrangers able to structure around more unusual situations.  The value exists across the spectrum of private credit from lower risk senior, with more conservative gearing levels, to the higher yielding segment with returns in the more equity like range. We therefore do not see the need to stretch into equity exposure given the inherent volatility and uncertain in the sector.

Property Credit:  Specific areas of property credit are emerging to provide value for investors. Conditions for property borrowers have become more challenging over the past year, and borrowers are now coming to terms with the market. Gearing levels have been reducing and yields have been increasing, with the result that parts of the sector are now providing value.  Land purchase finance opportunities are arising, providing short term bridge loans with first mortgage security over real estate without construction exposure, with moderate loan to value ratios and double digit returns for relatively short holds.

Construction: The construction sector generally warrants caution with potential delays, cost increases and labour tightness persisting.  In the property credit sector, care should be given to exposures with construction and development risk. Consideration should be given to the level of difficulty (with land subdivision being at the lower end) and the strength of the sponsor and contractor. In the private credit sector, preference should be given to business lenders who avoid construction vs. those with material exposure to the sector.

Lower Grade Consumer: Higher rates and inflation will not have an even impact. Whilst employment remains strong, there will likely be pockets of stress in the economy. We take particular care around exposure to lower grade consumer credit which would be the first to be impacted, and focus on higher grade credit with appropriate underwriting and security in place.

 

If you’d like to find out more, iPartners is running roadshow events in Auckland (18th September), Tauranga (19th September) and Wellington (20th September). Please contact thom.bentley@ipartners.com.au for more information or a copy of the Information Memorandum.  

 

Disclaimer  iPartners NZ PIE funds are only available to qualified wholesale and eligible investors. This report has been prepared and issued by iPartners NZ Ltd. (iPartners). iPartners (NZ) Nominees Limited is the issuer of units in the iPartners Diversified Private Income Fund and iPartners Core Income Fund (the Fund). This material may not be reproduced, distributed, or transmitted to any other person or incorporated in any way. The information contained in this report is general information only. This report does not (and is not intended to) contain any recommendations, statements of opinion or advice. In any event, the information in this report does not consider any individual person’s objectives, financial situation, or particular needs.

 

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