By Daniel Lanyon on Monday 27 June 2016
The manager of the Polar Capital Income Opportunities fund owns P2P and marketplace lending exposure instead of regular credit as he thinks it could stand up better in a prolonged period of down market conditions.
A significant downturn in the global economy should see P2P/marketplace lending funds outperform regular credit markets, according to Polar Capital’s Nick Brind.
The fund manager heads up the £122.9m Polar Capital Income Opportunities fund, a portfolio mainly consisting of a blend of credit and equities in the financials space.
He has exposure to alternative credit in the form of the first two P2P/marketplace lending investment trusts to launch onto the UK market. These are the £871m P2P Global Investments trust and the £391m VPC Specialty Lending trust. Brind bought both funds at launch, in July 2014 and March 2015 respectively, and has been adding recently due to their move to wide discounts in the last year shown below.
P2P GI's Premium/Discount
P2P/marketplace loans are a relatively new type of fixed income exposure for professional investors and fund managers with the scale and liquidity not easily suitable for open-ended funds such as Brind’s which have to be able to swiftly deal with daily redemptions and inflows without experiencing ‘cash drag’.
However, many of the UK’s top fund managers have been attracted to the high target yields on offer in a world where yield compression in both equity and fixed income has been occurring for many years, thanks to the emergence of a cadre of closed-ended funds operating in the space.
Gaining exposure in the form of an investment trust structure is a big attraction, says Brind, as you don’t have the issuees of liquidity and so forth. However, the manager is mostly attracted to the space as he believes in a significant downturn in global markets it is likely to outperform the broader credit market.
“There is no data yet to prove it but I suspect that in a downturn you're going to see spreads widen on a fixed income portfolio on expectations of defaults and in specific credits you will see some sharp falls because of those worries. I suspect it will perform slightly differently in a down period. In theory the trusts could be buying back their shares to manage the discounts. Also they are shorter duration because they are also consumer loans.”
“When you are looking at risk-adjusted returns from SME lending and consumer finance and you look at investment grade, high yield and leveraged loans the risk adjusted returns are more attractive and the dispersion of returns is less. To me it just another form of credit within consumer finance or small business lending. It goes into that box along with your normal corporate bond and other fixed income securities. However, because they are structured as an investment trust, you have some equity type risk there from the discounts.”
Indeed, the initial surge in demand for the P2P Global Investments and VPC Specialty Lending trusts saw both move to hefty premiums. Today in contrast they are now on hefty double digit discounts.
"Because they are sitting on discounts it makes it harder for new funds to come along. Some of the wealth managers haven't bought into it. [However] it is another diversifier, a different asset class,” Brind said.
“There has been this big compression in yields and it is different types of risk but the attraction to me of buying P2P GI or one of the others is that in theory you are getting good risk adjusted returns. Lots of granularity. If you buy a subordinated loan you have a lot more specific risk.”
“You are going to lose money on some of those loans but thinking through the cycle it should deliver reasonable returns. That is the attraction, especially if you don’t want to take a lot of risk on the downside. None of these vehicles are going to have massive amounts of leverage. It is mostly capped around 1.5 times.”
Performance of fund vs Lari index
Source: AltFi Data
Brind has been adding to both P2P GI and VPC Specialty Lending in recent weeks as he says there move to discounts has made them more attractive, although he doesn’t believe they will replace the banking industry as some investment commentators have claim.
“Most of the money is coming from institutions. It is not Mrs. Miggins from her pie shop doing a bit of online P2P lending in the evening when she shuts up shop. Also, it hasn't been properly tested through a credit cycle albeit some have been around in 2008/9 in a small way. It has also not been tested for higher interest rates.”
He also says funds in the space could do more to better communicate investors, particular by giving more frequent updates to the net asset value [NAV] of the portfolios which currently are updated on a monthly basis.
“Transparency is improving but it is not great for all of them. partly some of the discounts are related to that,” Brind said.