I think its great news that M&G have managed to get their proposed Direct Lending fund over the finishing line – it is called M&G Credit Income and is now trading on the premium segment under the ticker MGCI. The fund manager is Jeremy Richards and the fund has a management fee of 0.7% per annum, falling to 0.5% pa until the end of next year.
The company will target dividends of LIBOR plus 4%, with 2.55% over LIBOR until the end of next year. This target of around 5% seems to me to be a realistic one via a portfolio of public and private credit opportunities. According to Numis, “the portfolio is expected to have over 100 holdings (minimum 50) and at least 70% will be invested in investment grade assets (at least BBB- or comparable internal rating), with up to 30% of gross assets able to be invested in sub-investment grade debt. The portfolio will invest across a broad range of assets including, commercial mortgages, leveraged loans and direct lending, public liquid and illiquid bonds, private placements, structured credit, and infrastructure debt. Gearing can be up to 30% of net assets, but is not typically expected to exceed 20% of NAV.”
So, why am I so enthusiastic? The first point to make is that M&G are big and respected players in the private credit and direct lending markets. Up until now, the listed private credit markets have tended to feature more middle-ranking players such as Pollen, VPC and SQN. These all have their virtues, but they aren’t huge institutional players who can bring real ‘heft’ to this nascent, fast growing asset class. My own sense is that private credit is a valuable diversifier in a fixed income portfolio but requires real expertise which means that the managers have to have both fixed income and direct lending skill sets. M&G can bring both and thus will help broaden liquidity in the asset class.
The next positive for me is that target yield – and the management fee. To hit that sub 5% rate, M&G won’t have to creep too far up the risk curve especially across a diversified portfolio, as evidenced by the relatively high credit gratings of most of the proposed investments. The long-term target for fees of around 0.7% also isn’t unreasonable although personally, I’d prefer that rate to be closer to the interim 0.5% fee proposed.
Lastly, there is a possibility that these private credit markets will provide some income protection in a rising rates environment and could also have lower correlations with traditional equities or corporate bonds. That lower correlation is likely to be in part driven by the underlying lack of liquidity of the investments. Thus, prices might hold up if we face a ‘normal’ uptick in volatility and subsequent recession. If we face a financial crisis and equities plunge over 40%, correlations may jump as investors savagely mark down illiquid investments. So some hope of diversification benefits but no absolute guarantee.
One last parting note on social housing. I see that Civitas is reporting that one of its relationship housing associations, Trinity, is non compliant based on terms set by the Regulator of Social Housing. Apparently, the provider is working with the regulator to resolve the position, which seems to be focused around lease terms and health and safety obligations – Civitas exposure is around 6.9% of rental income in portfolio terms. It sounds like there is a good chance that the housing association will work through its issues and the issues don’t seem to have impacted the rent roll. But after the issues with First Priority earlier this year, this is a slightly unfortunate echo of the challenges facing the housing association sector. In my humble opinion, rather like pension funds, there are too many sub scale providers who struggle to hit all the tough rules set by the regulators. I also worry about the growing commercial diversification by these associations and I have real concerns about the top-level corporate governance at board level for many outfits. My concerns are amplified in the assisted living sector where many of the providers are sub scale – and grappling with increased costs and tougher regulations. I suggested looking again at Civitas shares when its share traded at a big discount and its nice to see them ticking back up at a premium. But I remain concerned about the underlying viability of many providers in the social housing sector and I’d be a great deal happier if funds such as Civitas traded closer to book value.