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Market Jitters

By David Stevenson on 8th January 2016

Happy new year!

 

Not!

 

It has been the worst start to the year for Chinese equities for two decades and the week isn’t even over yet. The latest twist in the plot has been Chinese regulators deciding to dispense with their new circuit breaker system. Inevitably Western stockmarkets have reacted with panic – indices throughout the Western world have been showing oceans of red ink as investor’s headed for the exits (although it is worth observing that trading volumes are actually fairly low).

 

Given this appalling start to the year, it’s worth investigating how the growing number of alternative finance and lending funds have performed in the market malaise. Let’s start to answer that question by looking at the first table below which looks at one month returns to January 7th (we’ve also included one year returns). We’ve featured two very broad stock market benchmarks – the UK based FTSE All Share index and the US S&P 500 index. Alongside these two bellwether indices we show returns for two interesting US specialist indices which track funds.

 

 The first is for what are called MLP or master limited partnerships – tax efficient structures that invest in energy infrastructure such as pipelines and storage tanks. Next to that we’ve included another US index which tracks the nearest equivalent to marketplace lending funds in the US market – BDCs or business development companies (subject of next months FundWatch).

 

These peculiarly US structures lend to a large variety of small businesses in a very tax efficient structure. Lastly we’ve used two sets of measures by the investment trust researchers at Numis – one which tracks all the alternative finance funds on the London market plus another that tracks a similar bunch of funds which track asset backed funds (which also lend to businesses).

 

The bottom line is that over the last month stockmarkets have tanked with MLP energy infrastructure funds falling even faster – notching up a more than 4% loss in just four weeks. BDCs by contrast have actually INCREASED in value by over 1.5%.

 

Back in the UK direct lending and alternative finance funds have recorded small losses of just 0.6% - asset backed funds have notched up even smaller losses at -0.35%. We think this is a pretty good set of returns all things considered and they show that lending funds should be able to withstand the first wave of volatility as markets wobble and wilt.

 

Whether these lending funds will prove to be quite as uncorrelated if wider stockmarkets started notching up 10% or even 20% losses is quite another matter but from this limited evidence we’d suggest that lending funds have done remarkably well.

 

Lending Funds

The next table below looks at the state of play on January 7th for the alternative lending funds on the UK market. The numbers are distorted by events at GLI Finance, whose shares have tumbled in value and currently trade at a 25% discount to book value. Once one excludes GLIF, discounts by and large haven’t widened out and more than a few funds trade at a premium.

 

For us the most notable anomaly is pricing for Victory Park Capital’s C class share issue. These are selling at around 92p against book value per share of close to 99.7p. Obviously this class of shares isn’t fully invested in loans yet (cash is at 45p in the £) but if the fund does get fully invested in the next six to nine months, buying in at 92p on the £1 with a targeted dividend of 8p could give you a net yield of closer to 9% which probably isn’t bad value for a very diversified global fund. 

 

More on Honeycomb

Just before the New Year we ran an article on a new fund that hit the London market called Honeycomb. It’s not strictly an alternative finance fund as such but it does engage in direct consumer lending and has many of the same characteristics as the Altfi funds we normally follow on this website.

 

We suspect there’s a good chance that because the article appeared over the festive break, few of you will have read the note. So here it is again.

 

Honeycomb started trading on the Specialist Fund Market of the London Stock Exchange after raising £100m for a new UK domiciled investment trust. Once fully invested, and leveraged, the fund will target a yield of 8% pa on the issue price via quarterly dividends through investing in loans to consumers and small businesses.

 

Direct or alternative lenders may look and feel like alternative finance platforms but there’s a crucial distinction – they tend not to use marketplace platforms to do the lending, usually working through existing originators. This fund works through a separate business called Honeycomb Finance or other third parties. At the moment this roster of partners includes: Freedom Finance (the UK largest personal loan broker); entu (financing on its consumer energy efficiency products); Pay4Later (point of sale consumer credit); and Shawbrook (UK challenger bank).  Loans may include everything from wholesale finance, secured against granular portfolios of loan receivables through to portfolios of credit assets acquired from third parties. No single consumer credit asset will exceed 0.15% of gross asset, with no single SME loan exceeding 5% of gross assets.

 

The majority of the portfolio is expected to be in unsecured loans to consumers (interest rates ranging from 6-15% and an approximate size of up to £100,000) as well as lending to small businesses, although it may also invest in secured loans. Crucially as much as 10% of the funds gross assets can be invested in the equity of companies originating and broking consumer or small business loans and in companies processing and analysing data relating to lending to consumers/SMEs.

 

According to investment trust analysts at Numis “Honeycomb will be managed by Pollen Street Capital which has invested over £1.2bn across a range of businesses. It was formed in November 2013 from the spin-out of the RBS private equity team. The team has focused on financial services since 2008 and has founded or invested in a number of financial services businesses including Shawbrook, Arrow Global (consumer debt purchases from banks), Target (outsourced software solutions to the loans, savings and insurance markets) and Freedom Finance”.

 

Pollen Street’s managing partner is Lindsey McMurray who has more than 19 years’ experience and has the team managing the RBS Special Opportunities fund since 2005.

 

Fees on the fund are 1.0% p.a. of gross assets with no fee on cash until 80% of net proceeds are invested. In addition, there is a performance fee of 10% of NAV growth each year over a 5%pa compound hurdle from the NAV at admission. The initial NAV is £9.82 per share. The manager has also agreed to pay an affiliate of Liberum, the broker, 20% of the management and performance fee. As for gearing the fund is targeting borrowing of 50-75% of net assets, with a limit of 100%. Borrowing may be at the company level or via SPVs. Key shareholders include familiar names from the registers of P2P Global and VPC – Invesco and Old Mutual who between them will own over 75% of the shares.

 

Honeycomb is part of a much broader alternative lending scene that is fast emerging in the Us and the UK. These new players tend to focus on traditional loan structures – consumer loans – but effectively operate rather like shadow banks, directly lending to borrowers, frequently using internal leverage to amplify returns. These direct or alternative lenders – ranger is another example – sometimes cross over into alternative finance by using market place lending platforms but for the large part they tend to prefer working with more traditional orignators of loans.

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