June 2024 - Market Commentary

The growing prevalence of credit or private credit within investor portfolios has materially contributed towards a better understanding of the asset class. As mentioned in our prior month's commentary, investors now appreciate that credit isn't homogenous but rather made up of differing risk-return subsectors. It has also led to investors being more skilled in asking the right questions of fund managers that operate in this space, which helps them discern who is swimming with their swimmers on and who is either blissfully unaware or neglecting to check (a reference to the Warrens Buffets quote ‘Only when the tide goes out do you discover who’s been swimming naked’).

Over our 8 years, we have suggested that investors scrutinise any potential credit fund manager by understanding, as a minimum, the following areas.

1. What does the credit fund actually invest in and am I comfortable with the risk profile of those assets? Are you financing an asset that in a variety of scenarios can be relied upon to repay the initial loan? This may involve lending to a good quality company which has predictable, stable, long-term revenue streams, a quality project that, even if it is not prima facie successful, has a residual value that can be realised or, in our case, a sufficiently robust pool of underlying loans which can be paid down to extinguish our investment amount. This assessment is the most important factor for investors, as it is the most influential factor driving potential investment outcomes.? ?

2. What fees is the fund manager charging and how much alignment does that create between fund manager and underlying investors? Notably, does the fund manager charge fees upfront which are not passed through to investors which we believe does not create alignment??We believe only through alignment, can investors get sufficient comfort that their money is in safe hands.? ?

3. What other incentives does the fund manager have? Are they exclusively incentivised based on the quality of the investor outcomes, or is investor capital boosting the value of the fund manager's equity in another company? With unlimited upside for equity holders, it's irrational to believe that those with the lending decisions will not be distracted at best or inappropriately incentivised at worst when they determine how that investor capital is used if they hold equity in the company receiving the funding.?

(Our response to the above would be 1, Manning invests in a range of asset-backed portfolios which we quantitatively and qualitative assess to determine their reliance and overall credit quality. We regard this as our core competence. Despite 8 years of various cycle dynamics, we have never had a negative return from credit. 2, All fees are charged at the Fund level i.e. we do not receive any upfront fees, with our fees including a small performance fee element. We believe this structure creates the greatest alignment with investors. 3. Manning has a strict Conflicts of Interest Policy and as a guiding principle, does not take equity positions in underlying lender businesses given the innate conflicts it creates.)

As a final point, we have been impressed by the sophistication of the Australian financial advice ecosystem. We regularly face very detailed and on-point questions about our strategies. Should an investor not be confident about the answers to any of the above questions for a fund in which they invest, then we urge those investors to reach out to their trusted adviser. Seeking advice can provide reassurance and ensure you invest with a fund manager who can perform when the tide is both in and out.

As the Australian credit markets continue to grow, investors will continue to become more discerning, which, in our view, will only enhance the attractiveness of the asset class and the quality of the fund managers who succeed in it.