Fixed Income
2019 in Review
Macro View
As we noted in the 2018 review of the fund, we came into 2019 with concerns in relation to the soft macroeconomic environment in Australia, and the potential impacts on the SME market. Globally tensions between the US and China were the main driver of volatility, as global growth estimates were revised based on the tariff negotiations between the superpowers. We anticipate this tension will continue into 2020.
The federal election caused a significant amount of uncertainty in the Australian market until the outcome of the election was confirmed on the 18th of May. There were concerns that several policies proposed by the Labor party, particularly with respect to negative gearing and Capital Gains Tax (CGT) could negatively impact economic growth, property prices, and financial markets negatively. A win to the Liberal and National Party Coalition seemed to create some optimism in financial markets with the All Ordinaries Index moving from 6370.9 on the 15th of May before the election, to 6584 on the 21st of May. The All Ordinaries closed out the year at 6821.60, up 21% for the year, a great result for the Australian equity market.
The fallout from the Hayne Royal Commission into Banking and Financial Services had an impact on the Australian economy, with falling property prices being partly blamed on a lack of credit availability. Banks had tightened their credit standards, reacting to the scathing findings in relation to some bank practices by Commissioner Hayne. This saw several clients who had previously accessed credit from the banks being denied funding in the first half of 2019. This led to some additional deal flow to the originators we are funding, as businesses sought debt capital away from the major banks.
The largest boost to the Australian market was provided by the Reserve Bank of Australia (RBA), who cut interest rates 3 times in 2019, the first change to the cash rate since August 2016. The three 25 basis point cuts commenced in June, with the last for the year in October, leaving the cash rate 0.75% at year end. The RBA noted subdued inflation, an increasing unemployment rate, weak consumer confidence and a lack of wage growth in its rationale for the cuts.
Australian property prices had come off the late 2017 national peak throughout 2018 and the first half of 2019. Clarity on property related taxes (CGT and negative gearing) following the election, the RBA cutting the cash rate and the lending market adjusting, provided a rebalance and higher levels of confidence, which lead to property price increases nationally. The RBA is monitoring this closely, not wanting to see an overheated market, however hoping that this wealth effect may translate to increased discretionary spending, and a positive knock on impact to the economy.
SME Lending Market
The Australian SME lending market continued to grow and gain recognition in 2020. The Federal Government commenced the process to inject $2bn into the SME lending market through the Australian Business Securitisation Fund. We viewed this as a net positive for the market, as the government is supportive of the market, and focused on the growth of Australian SMEs.
The largest mover in the SME lending market was Judo Bank. Judo received their banking licence in April 2019 and subsequently raised $400m in equity, adding to the $140m Series A raised in August 2018. Judo announced $1bn in cumulative lending in January 2020. Prospa executed their IPO in June this year, raising $110m. These large public raises are examples of the sector as a whole scaling up, as the banks retreat from supporting Australian SMEs.
We continue to back our thesis that the market will continue to grow, and back end debt funding will be required to support the growth in this market.
Fund View
As outlined in the 2019 review, we came into the year with concerns around the domestic economy. We made a strategic decision to focus on increasing the percentage of senior exposures in the fund to counteract a soft market. We have originated new deals in line with this strategy throughout 2019. We saw 30 day plus arrears levels remain below our modelled tolerances throughout the year, which is our key lead indicator of potential weakness in the underlying loan pools. This strategy was focused on capital protection, which is our first order concern within our strategy.
Returns for the fund were strong throughout 2019, with 9.87%* delivered to investors for the year, 27.43%* since the August 2017 inception of the fund. The reduction in the cash rate had some impact on the returns for the year, as did the return impact of the skew towards more senior exposures. Diversification of the portfolio increased significantly over the year, with the number of loans almost doubling, and another loan originator added.
The fund maintained the Very Strong rating from Australia Ratings throughout 2019, which was a positive external appraisal of the fund.
2020 Outlook
We remain cautious on the Australian economy, however, are more positive than this time last year. We are focused on the impact the Macro environment will have on various sectors in the Australian small business market. We will be focused on working with loan originators we are funding, discussing adjustments to their underwriting, and assessing the adequacy of provisioning. We will be seeking new opportunities in the sector that meet our internal assessment standards.
We are still seeing the strong risk adjusted returns in the non-bank lending space, and expect the sector to grow strongly in 2020. Care must be taken in assessing the opportunities.
*Past performance is not an indication of future performance
Disclosure
This report is provided to you for information purposes only by Aura Funds Management Pty Ltd (Aura) (ACN 607 158 814, Authorised Representative 1233893 of Aura Capital Pty Ltd AFSL 366 230). Aura Funds Management Pty Ltd is the Trustee of the Fund and a subsidiary of Aura Group Pty Ltd.
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