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Private debt offers exceptional returns in hard currency for SA investors

20 February 2024 Westbrooke Alternative Asset Management
Dino Zuccollo

Dino Zuccollo

Over the past year, the JSE Top 40 lost roughly 10% of its value as measured in rands – and more in dollars. South African wealth is being eroded in global terms, creating a serious problem for local investors.

This makes offshore investment opportunities popular, with the caveat that markets like the Nasdaq are exceptionally volatile. Even for those with higher risk tolerance, a sensible approach to portfolio construction would include some lower risk assets that carry appealing yields.

In this environment of higher interest rates, attractive yields still exist. In 2023, Westbrooke Alternative Asset Management’s Yield Plus secured private debt fund enjoyed its strongest performance since inception, with a net investor return of 9.2% (in GBP, so the Rand return was even stronger). To achieve yields of this level in hard currency demonstrates the value of looking beyond equity and bond exposures and highlights the value of including alternatives in a well-diversified investment portfolio.

Why do equities underperform when rates move higher?

According to Dino Zuccollo, head of product development and distribution at Westbrooke Alternative Asset Management, “When rates move higher, debt costs go up, so more economic value flows to lenders in the way of higher interest costs. To make matters worse, higher rates are often due to elevated levels of inflation. This leads to enlarged balance sheets and a need to raise funding for these balance sheets, often from banks.

“A second factor is that higher rates mean that a higher rate of return is required when investing, which puts equity valuations under pressure. Companies with strong current cash flows are less severely impacted than growth stocks that are valued based on projected cash flows to be earned several years in the future. This drives substantial volatility in markets that have a heavy tilt towards growth stocks, like the US market.”

Do bonds make up for this?

In short, they don’t. Government bonds are the traditional source of diversification and yield in balanced portfolios. This doesn’t mean that capital values are safe – far from it. The only way a bond investor has reasonable certainty over returns is by holding a bond until maturity, which means locking in the capital for several years. If liquidity is needed before then, the investor is taking risk on the pricing of the bond.

To add to these challenges, government bonds pay a lower yield than well managed private debt funds. This is a function of risk (as the basic principle in a stable market is that the government is the lowest risk borrower around) as well as the ability of private debt investors to extract higher returns by operating in underserviced market niches. UK 10-year bond yields are currently sitting at just over 4%, which happens to be very similar to the yields on US 10-year bonds at the moment.

In contrast, the Westbrooke Yield Plus 2023 return was 9.2% and has now ticked up to in excess of 9.5% based on the most recent quarter’s performance. The fund targets a return of cash plus 5% to 7% per annum, with cash defined as the Bank of England Base Rate. In 2023, that base rate increased from 3.50% to 5.25%. This means a targeted return well in excess of what government bonds are offering.

Westbrooke Yield Plus is focused on capital preservation and the generation of a stable and predictable hard currency yield, by lending to a portfolio of UK private companies and real estate sponsors to achieve appealing risk-weighted returns. The fund currently has around 48 underlying loans with an average weighted loan term of 22 months. The weighted average loan-to-value of the security in the underlying portfolio is 56%. No individual loan exceeds 7.5% of the fund. In cases where loans do end up in default, private debt funds aim to have sufficient loan-to-value coverage and other protections to recover all or most of the loan.

Can the strong returns continue?

The latest US inflation data suggests that rates could be higher for longer. Coupled with a dealmaking environment that rewards information symmetry and the benefits of having professionals on the ground in the UK, 2023’s record year looks like a strong foundation for investors to be rewarded in 2024.

Westbrooke Yield Plus accepts new investments in terms of a CIPC registered prospectus. Investments are now open and close on 27 March 2024. The capital raise is strictly limited to GBP20 million and a GBP100,000 minimum investment amount applies.

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