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Can asset-backed debt funds provide a port in the storm?

Of all the long-term consequences of the financial crisis of 2008, one of the most serious is the partial withdrawal of the banks from some of their traditional lending activities.

Tougher capital adequacy requirements have made it more expensive for them to provide loans, which has left key areas of the economy short of funding and created a lucrative gap in the market.

Part of the shortfall has been met by the launch of a series of asset-backed debt funds. These specialist investment trusts lend to a variety of different sectors and typically aim to generate secure dividend yields in excess of 6% per annum for income investors.

Loans to small firms

Arguably the worst affected area is small and medium sized enterprises (SMEs). Many of these businesses need to borrow in order to grow and are willing and able to pay in the region of 10% per annum for a loan that is secured on the firm’s assets.

RM Secured Lending (RMDL) raised just over £50m when it launched in December and plans to lend the money to businesses with a good visibility over cash flow and earnings.

The loans will typically pay 8% to 12% per annum with each being in the £2m to £10m bracket and lasting for three to 15 years. RMDL aims to pay a 4% dividend yield in 2017 as it invests its capital with the figure rising to 6.5% in 2018 with quarterly distributions.

James Robson, chief investment officer of RM Capital, which manages RMDL, says that they have a large pipeline of opportunities to lend into the targeted space.

‘Our loans are typically project finance style loans where as a lender we take enhanced security rather than traditional SME balance sheet lending, which would be the more typical solution from the general corporate banking market. These loans are secured and should anything go wrong we have a number of credit enhancements to ensure we are likely to be repaid.’

It is similar to Hadrian’s Wall Secured Investments (HWSL), which raised £80m when it floated last June. By the end of December the company had made secured loans of £22m with an average interest rate of 8.4% over a four year term. It had also signed commitment letters on behalf of another £40m. If executed these would be sufficient for it to achieve its target annual dividend yield of 6% with quarterly distributions.

Other asset-backed debt options

Another option worth considering are the mortgage-backed debt funds such as the TOC Property Backed Lending Trust (PBLT) that recently raised £17.3m. It is managed by the direct lending specialist Tier One capital, which plans to concentrate on regional housebuilding across the UK, as well as small serviced offices and hotel developments.

The fixed rate loans will mainly be secured on land or property and the intention is to grow the fund to £150m over the next 12 months. It is targeting a 7% dividend yield with quarterly distributions.

UK Mortgages (UKML) was created in July 2015 and aims to provide shareholders with stable income returns via a portfolio of loans secured against UK residential property. It is targeting a net total return of 7% to 10% per annum and has an historic yield of over 6% with quarterly dividends.

Rob Ford, founding partner and portfolio manager, says the strategy behind the fund is to buy a number of UK mortgage portfolios and then take advantage of the securitisation markets to issue AAA-rated paper that will provide around seven times gearing.

‘We buy mortgages from many different organisations including the high street banks and building societies and also have an agreement with The Mortgage Lender to originate mortgages for us on an ongoing basis.’

The more established £450m TwentyFour Income Fund (TFIF) invests in European asset-backed securities including collateralised loan obligations. It is managed by TwentyFour Asset Management, which also runs the UK Mortgages fund, and is one of Winterflood’s investment trust recommendations for 2017.

‘It targets a net total return of 6% to 9% per annum and aims to pay quarterly dividends of at least 6p per annum. Based on the fund’s current share price this equates to a prospective dividend yield of at least 5.3%,’ explains Innes Urquhart, a member of the investment trust research team at Winterflood.

Nice view before the Thunderstorm.

Floating rate exposure 

Secured debt funds with a short duration or exposure to floating interest rates should do well when interest rates finally start to go up. A prime example is the £990m NB Global Floating Rate Income fund (NBLS).

NBLS provides a diversified exposure to US senior secured loans with a bias towards higher quality issuers. These debt securities rank at the top of the capital structure with any further increases in US three-month LIBOR likely to feed through into higher returns.

‘We believe that NB Floating Rate Income is an attractive way to gain a diversified exposure to the US loan market. The dividend yield is 4.5% and has scope to grow as US interest rates rise,’ says Ewan Lovett-Turner, director, investment companies research at Numis Securities.

He also likes the £225m CVC Credit Partners European Opportunities (CCPG) fund that invests in European senior secured loans. This is yielding 4.8% and has recently switched to quarterly distributions.

Before buying any of these funds it is important that you are comfortable with the areas where it invests, the security of the loans and the level of gearing. It is also essential to check that it is not trading at an excessive premium to net asset value.

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