The New Criterion: the benefits and risks of credit-focused listed investment trusts

Tim Boreham

Independent Investment Research

With investors clamouring for better yields than paltry returns on cash deposits, the world’s top debt whisperers have obliged with an expanding cluster of ASX-listed funds to give retail punters an exposure to a $US2 trillion global sector hitherto the preserve of institutions and sophisticated investors.

The imperative to find alternatives to term deposits has just become more acute with the Reserve Bank of Australia’s decision to further punish naughty savers with another 25 basis point rates cut.

In short, the credit investment trusts (LITs) offer exposure to a parcel of corporate debt (and possibly bonds) with the promise of much higher yields than cash in the bank and with better capital protection than dividend paying shares.

The funds play in the private debt market, which refers to loans extended to companies outside of the banking sector.

(‘Private’, by the way, refers to the paper rather than the issuer, which is often a brand-name listed entity).

Being listed, the LITs are easily tradable which is usually not the case with the underlying investments. Investors receive a monthly distribution, usually at a floating rate based on a margin above a benchmark rate, such as the RBA’s cash rate.

If all goes well, the fund will recoup the capital amount on maturity. And if the issuer goes pear-shaped, debt holders are further up the creditor’s queue than equity holders.

Such paper is also considered safer than hybrid securities, which share the characteristics of debt and equity. Hybrids have been popular – especially those issued by the banks – but have been criticised for having the same risk of shares without the capital gains upside.

As with any investment offering superior returns, the LITs are hardly risk free, with returns subject to interest rate movement, economic conditions and the chance of corporate defaults.

As of June 30 the listed trusts had raised more than $4 billion – and that number is rapidly increasing.

In late September Partners Group Private Markets listed its Partners Group Global Income Fund (PGG, $2.05) having raised $550 million compared with the targeted $500m.

Globally, the private markets investment manager has more than $188 billion of assets under management, with $10bn raised from Australian investors for other products.

Not to be outdone, global investment behemoth Kohlberg Kravis Roberts is seeking to raise $750m for its KKR Credit Income Fund (KKC), with a further $75m in oversubscriptions.

Initially at least, the fund is a ‘fund of funds’ in that it will invest in two of KKR’s existing vehicles, the KKR Global Credit Opportunities Fund and the European Direct Lending fund.

KKR describes the flagship Opportunities fund as a “high conviction, value oriented” venture, investing in sub-investment grade markets. The European fund lends to mid-sized companies with underlying profits between $80-160 million.

Overall, the credit income fund targets a yield of 4 to 6 per cent, with overall medium term returns of 6-8 per cent.

Metrics Credit Partners kicked of the credit-focused LIT push in October 2017 by launching its MCP Master Income Trust (MXT, $2.07). In April this year it followed up with its MCP Income Opportunities Trust (MOT, $2.06), raising $300m in an oversubscribed issue.

Metrics Credit Partners contends that by moving up the risk curve “just slightly”, it can provide investors with consistent and stable income. The MCP Income Opportunities Trust targets a total return “through the cycle of 8-10 per cent.

“We have seen a lot of investors in hybrids and term deposits. SMSFs alone have $170 billion of cash in the bank,” Metrics Credit Partners managing partner Andrew Lockhart says.

“Investors can do better than having money tied up in term deposits or a low yielding cash management trust.”

Other extant credit LITs are the Neuberger Berman’s NB Global Corporate income Trust (NBI, $2.08), the Perpetual Credit Income Trust (PCI, $1.15) and the Gryphon Capital income Trust (GCI, $2.07).

The Qualitas Real Estate income Fund (QRI, $1.61) also plays in the space, but as the name implies it is focused on property loans.

The Neuberger Berman trust aims to hold paper in 250 to 350 companies globally, diversified by industry, country and credit quality. These include non-investment grade bonds issued by large and liquid global companies.

The Perpetual Credit Income Trust, which listed in May, invests in both domestic and global credit and fixed income, including corporate bonds, floating rate notes, securitised assets and private debt.

As of August the fund held 93 securities across 67 issuers, including Qantas, Australian Pacific Airports, Australia Pacific Airports and Westpac.

Both the MCP Master Income Trust and the Perpetual Credit Income Trust strive for a return of the RBA cash rate (currently a meagre 0.75 per cent) plus a 3.25 per cent margin.

Of course, investors need to understand the risks they are taking, which is not that easy given the breadth of the underlying investments and their non-transparent nature.

As Partners Group cautions, public information exists about the senior secured loan market, but otherwise there is “little verifiable data” on lesser rated private debt

Private debt confers a key advantage over corporate bonds, which tend to be publicly listed and more liquid. In the case of the former, the lenders have access to due diligence not available on a public market.

In essence, it’s really a case of trusting that the managers know what they are doing in terms of both risk mitigation and being able to sniff out the juiciest of the private deals (which can be very attractive when companies need short term funds).

It’s also a case of trusting one’s financial adviser.

They should also ensure the managers aren’t creaming too much of the top with management fees.

In theory, the performance of the credit-focused LITs has a low correlation with both shares and public market debt.

While the credit-focused LITs are, by nature, listed they trend to trade at or around the value of the underlying assets and are not subject to the wider vagaries over the share market.

MCP Master Income Trust – the trust with the longest track record - has traded between $1.98 and $2.07. The Partners Group trust debuted at $2.06 – a 3 per cent premium on its $2 a security IPO price.

Metric Credit Partners’ Lockhart notes that credit funds have been far less volatile than banks shares, which look as wobbly as jelly after the National Australia Bank’s revelation that it would need to provision an extra $1.19bn for “customer related remediation”.

Shares in former dividend darling AMP have also tanked, while the company has also suspended its dividend payouts.

“We are trying to provide investors with a unique way of generating income but so their capital is not at risk,” Lockhart says.

Even so, investors are advised not to plonk all their eggs in the one LIT basket and to maintain a diversified asset allocation strategy.

That’s a piece of motherhood advice that even the debt gurus would not argue with.

Special disclosure: IRR covers the NB Global Corporate Income Trust, the MCP Master Income Trust, the Perpetual Credit Income Trust, the Gryphon Capital Income Trust and the the Qualitas Real Estate income Fund.

Tim Boreham edits The New Criterion



Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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Tim Boreham
Tim Boreham
Editor of New Criterion
Independent Investment Research

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

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