The alternative investment that has outpaced the ASX bull market
The equity markets have been nothing short of a frenzy this year. Investors are starting the new financial year with recession at the front and back of their minds. And although the ASX 200 is down ~10% (even more at the small and microcap end), equities are just one of many asset classes. Here at Aura Group, the Private Credit team invests in pools of Australian
SME business loans, originated by tech-enabled non-bank lenders and aims to deliver
strong and stable returns for our investors through the lens of private credit.
If investors can turn their eyes away from the market for a moment, they’ll find themselves (like us) gazing at the Australian SME lending space.
Hiding there in plain sight is, what we believe to be, an untapped diamond mine. Tied with the strategies fueling our lasting performance, we believe commercial fixed income could become your next great investment.
So why are we still optimistic in these troubling times, and what tailwinds do we expect to ride?
In this edition of Fund in Focus, we will take a look at securitised assets - and examine some of the hidden gems in the Australian SME market. Finally, we'll share how we are positioned to take advantage of this investment opportunity.
To find out more, please read the edited transcript or watch the video below.
Hello everyone. My name's Brett Craig. I'm the portfolio manager of the Aura High Yield SME Fund and the upcoming Aura Core Income Fund. Today, we wanted to introduce you to both Funds and show you how we invest across the private debt space in the Australian market.
Introducing Brett Craig & the Australian business lending market
My background is in securitisation. I was at Macquarie Bank for 11 years prior to joining Aura Group where we really focused on securitised assets. Looking at providing capital to lenders for them to on-lend to their client base. This is a core concept in what we do in the Aura High Yield SME Fund and the Aura Core Income Fund.
Our focus within both of these Funds is business lending in the Australian market.
Now, the reason that we're really focused on these markets.
The major banks have been stepping back due to changes in regulatory capital laws and provisions. Enabling non-bank lenders to target that market and assist Australian businesses in gaining debt finance for their business.
This is something we've been doing for five years now. We are not a new market entrant. In the five years since inception, we've produced consistent monthly positive returns. So, for 100% of our months, our net asset value has sat at a dollar achieving returns ranging anywhere from 60 bps up to 92 bps per month. Consistency is something that we are very much focused on.
We wanted to fund Australian businesses because they are the provider of employment to over 70% of the Australian workforce. And we see a number of foregone opportunities within the Australian SME lending market due to a lack of capital availability.
Recent reports by Judo suggests that the unbanked SME lending market could tap $100 billion in unmet demand, and that is something that we're looking to address.
The Aura High Yield SME Fund
Looking at the Aura High Yield SME Fund, we've been running the Fund for five years now, and we've had a very strong track record, which we are particularly proud of.
100% of months with a $1 NAV in the 5 year timeframe
We're very much focused on capital preservation. We are targeting returns in that 9% to 12% band for investors.
Our Aura High Yield SME Fund is a wholesale Fund that invests in pools of Australian SME business loans, originated by tech-enabled non-bank lenders.
- Management fees are 1.25% p.a. with a 20% performance fee.
- The maximum concentration of 5% for any one underlying loan exposure of 5% within the Fund.
- All of our investments in this strategy must have an SME lending focus within the Aussie market.
- Monthly distributions are paid out to investors. Investors may also elect to reinvest their monthly distributions.
- The Fund is audited by PwC.
The key asset class that we invest in is securitised assets. So, we're looking at funding lenders. So, any lender in the Australian market will require capital to on-lend to their underlying borrowers.
There are many ways you can look at financing these lenders. You can either provide a corporate facility to that lender, which is not our preferred way of doing things. Or, what we like to do, is fund receivables within a bankruptcy-remote trust.
Multiple tranche structure
Securitisation vehicles will generally have at least two tranches. One being equity or first loss piece, and then a senior piece.
The key advantages of having multiple tranche structures are that at different levels within that credit waterfall, you are provided different levels of protection and different return profiles.
This is our preferred method of financing business lenders in the Australian market.
Diversification: Some of the advantages of these structures are the significant amounts of diversification, achieved by ensuring we have a good spread of underlying exposures. We have a distinct preference for floating rate structures. In an environment where you're starting to see interest rates moving upward, you can ensure a locked-in credit margin that enables you to take advantage of the upswing in interest rates.
Lenders and Aura Group are aligned: Most importantly, the lenders that we're looking to support are aligned with us. They have their own equity in the structure that is at risk first before our investor's capital. Looking at direct lending, we see that there are definite positives in direct lending, but the warehouse financing side of the business is something that we're very focused on.
Seniority provides downside protection
Looking at the seniority within pools. The way we've set up our business, we've got our marque strategy, which has been the Aura High Yield SME Fund, which has been operating for five years, that has the ability to operate throughout the risk structure.
So, we consider at the senior or at a mezzanine level within that fund. That enables us to come in and take an early stage view on lenders, sit senior within a structure and then transition down to allow cheaper funding to be sourced by the lenders.
We've got an upcoming Fund, the Aura Core Income Fund, which will be a retail strategy, and will have a focus on sitting senior to the Aura High Yield SME Fund. That Fund will have a lower risk profile than the SME Fund, but also lower returns, as you would expect. Allowing us to provide strong financing to Australian SME lenders.
Originators and underlying security
Now, we look at providing capital across a diverse range of SME lenders within the Australian market. Currently, within the portfolio, we are exposed to working capital loans, asset-backed loans, property-backed loans, livestock-secured loans, and invoice-secured loans.
We look at providing the capital to those underlying loan exposures through bankruptcy-remote trusts to segregate the risk for our investors' capital away from the balance sheet of the underlying lender.
At an underlying loan balance level or at an underlying loan level, we're looking at taking director's guarantees, general security agreements, and specific security against specific types of assets. Additionally, our lenders will have their own capital, fees, and income at risk.
What we want to see within a pool is a lender that provides capital prudently with strong risk assessment criteria to ensure that the underlying borrowers are in good standing, have a good, solid business that's profitable, and are looking for growth capital, but all they need is that extra bit of debt capital to push them through.
In the five years since inception, we've had very stable returns, and we put that down to our structuring of the portfolio. If you were to look at our Fund, we look at a benchmark return of the RBA cash rate, plus 5%.
If you were to invest in government bonds throughout the five years where our Fund has been in existence, you would have seen fairly low returns given the low cash environment.
However, our Fund has shown strength and stability by returning 56.26% to investors in the five years since inception, with annualised compounding returns sitting at 9.68%.
Consider if you were to invest in the ASX200 on an adjusted close basis. If you had invested a million dollars, your million dollar investment would be worth $1.26 million today.
Comparatively, looking at our performance benchmark, you would see that it exceeds the ASX200 level, sitting in at $1.32 on a $1 million investment over that five year timeframe.
If you were to invest in the Aura High Yield SME Fund, taking your distributions on a monthly basis, your investment would have been worth $1.451 million. If instead you reinvested your distributions and took that compounding impact, your investment will be worth $1.567 million.
So, you can see we've had a very strong stable return with the benefit of that compounding impact with distributions reinvested.
The returns have actually exceeded the performance of the ASX200.
This result is something that we didn't really set out to beat at the outset, but it is something that we have been able to achieve.
Looking at the Fund's regular monthly income. As a fund manager, we're very much focused on preserving capital for our investor base and maintaining a net asset value of a dollar.
In the five years since inception, we've maintained a consistent $1 NAV
Then looking at our income profile. If you were to invest a million dollars in the Aura High Yield SME Fund at inception in August 2017.
In the first 11 months, you would have seen an income of $98,000. In year two, the income level would have come in at $102,000. Year three, $88,000. Year four, $87,000. And to date in year five, we have another month left, however, we've seen $74,000 in income in the 11 months since the start of the year.
As you can see, we've produced very consistent income for our investor base to date.
We have seen a distinct correlation between the cash rate and our returns. And we'll have a look at it a little bit later on, on how we are poised to take advantage of the increasing interest rate environment.
The Fund has been rated by both Foresight and Evergreen. We're sitting at the second top level on both of those scales. We've maintained these ratings, particularly with Foresight since we started the Fund. Evergreen has been rating us for over three years and we've maintained a strong level throughout that time.
Higher interest rate environment
As we move into an interest-rate hiking environment, we've seen a number of hikes recently and we expect more to come.
Why are we well-positioned?
Firstly, floating-rate exposures really help our portfolio. We're locking in a credit margin, and we're running short-duration loans. So, our portfolio has very short duration exposures, with an average life of around four months. Additionally, the fixed-rate exposures that we do have within the portfolio are short durations under 12 months, and we can look to re-price those.
We do stress test our portfolio, looking at historical defaults, going back to 1981 on S&P data, and we look to build in credit enhancement based on some of those loss scenarios that we've seen out there in the market. I think we're well poised to take advantage of interest rate increases.
On our final point, ultimately our portfolio is really looking to be well protected through the use of securitisation structures, where we have first lost pieces sitting below us and very well curated portfolios from the distinct lenders that we work with.
We are comfortable with our positioning, moving into an interest rate hike environment
Aura Core Income Fund
The Aura Core Income Fund will be launched in the coming months. This is the retail version of the Aura High Yield SME Fund, but looking to participate higher up that capital stack.
We are really looking at a lower-risk alternative for retail investors or wholesale investors looking at a lower return profile.
We'll be looking at a target return in the cash rate, plus 3.5% to 5.5%, net of fees and expenses, and relatively low management fees in the mix. All in looking at 69bps. This will be a nice low-cost alternative to allow you or your clients access to the private debt market.
Thank you all for your time. If you have any more questions in relation to either of the Funds, please contact us at the details on the links below.
Strong risk-adjusted returns
The Aura High Yield SME Fund has a track record of delivering stable monthly income returns via exposure to a diversified portfolio of loans to small to medium businesses.
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