November 2017
In our series of fund manager profiles, we speak to Chris Andrews, La Trobe Financial’s Chief Investment Officer. Latrobe Financial provides specialist credit investment management capabilities. Chris is a regular and sought-after commentator on economics, investment and finance with a particular focus on the senior property debt asset class.
YR: Welcome Chris. Your credit fund offers investors the opportunity to generate an income return from credit exposure via loans secured by mortgages over real property including residential, commercial, rural, industrial, and construction and development projects across Australia. APRA’s focus on capping investment lending growth seems to some degree to have worked within the major Australian banks. Has this been a hindrance or an opportunity to non-bank lenders such as Latrobe Financial? Have you seen any change in either the level of demand or pricing?
LF: The Australian banks have a lot on their plate at the moment. Not only are they absorbing and implementing the regulatory changes arising from the international Basel III framework, but they are also being used actively as a policy tool by APRA via its macro-prudential regulatory powers. The net result for borrowers is that the banks are being forced to reject lots of high-quality credit applications and it can be difficult to know whether an application will be approved or rejected.
In this environment, we are finding that borrowers prize the flexibility and service-orientation of lenders like La Trobe Financial, as well as our stable credit policy. For us as investment managers, and for our investors, this is a significant plus, contributing to increased flows of high quality assets and supporting our targeted outcomes of capital stability and reliable monthly income.
While our credit policy remains unchanged – and has in fact tightened over recent years – we continue to experience the current environment as a favourable one, delivering attractive assets and excellent risk-adjusted yields.
YR: Explain to us how your High Yield Credit Portfolio works
LF: The High Yield Credit Portfolio has its roots in our burgeoning RMBS program. As investors in our Credit Fund learned of this program, we received significant levels of interest in participating. To respond to this interest, we created the fund, which invests in a portfolio of mezzanine notes in La Trobe Financial’s RMBS issuances. Because the notes are all in La Trobe Financial’s own program, investors know the expertise and discipline that has been brought to bear in assessing the underlying loan assets.
The fund is currently yielding 7.00% p.a. (it provides a variable rate of return) for a three year investment term. The minimum investment is $100,000.
YR: Your FUM has grown strongly over the last 12 months to $1.8 billion. Describe your investor profiles. e.g. direct vs platform, professional/institutional vs retail/SMSF. What’s the typical average investment size for professional vs retail investors? Has the growth and size of the fund impacted your investment universe or the way that you trade, execute or source your loans? Have you made any additions to your investment team as a result of this growth?
LF: Our 25,000 registered members are a very diverse group and range from classic “mum and dad” investors through to high net worths, platforms, family offices and other managers and approved deposit-taking institutions. We’re pleased to have seen solid growth in funds under management in recent years as investors increasingly look for alternatives in the capital-stable, income-generating space. In managing this growth, we have two key imperatives.
Firstly, we’re a high conviction manager with an investment philosophy and strategy that has been developed and refined over 65 years. While we will continue to look and drive for efficiencies in our operation, the fundamentals of our strategy are and will remain unchanged. Rigorous asset selection, credit assessment and loan management are the keys to a successful, resilient and repeatable program in this asset class.
Secondly, as an organisation inextricably committed to superior service, we have grown staffing levels across our organisation organically in line with the growth that we’ve experienced. It’s critical for us that our adviser and investor partners continue to experience consistently high quality personal service.
Behind that, we have a highly diverse group of investors. Our low minimum investment (just $1,000) means that we’re highly accessible for retail investors. At the other end of the spectrum, we work very closely and effectively with highly sophisticated investors, such as other fund managers and family offices. In our view, the breadth and diversity of our funding footprint gives a critical advantage in the market.
YR: Looking forward over the next 12 months. What is your view on the outlook for official cash rates? Do you see any increase(s) on the horizon. If so, what level and how quickly?
LF: We’re a very early advocate of the “lower for longer” thesis and, in fact, caused something of a stir when we came out four years ago and argued that interest rates would remain around current levels for a decade. We see nothing that would cause us to change our view on this. Reading between the lines, it seems clear that the Reserve Bank would prefer to move rates higher, but current trajectories of growth, inflation, exchange rates and household indebtedness will limit any upward movements significantly.
YR: Given that loan affordability is linked to the cost of borrowing, do you see any potential stress on the part of borrowers looking forward. What do you see happening with the level of arrears and defaults in both the commercial and construction lending space?
Given our view on interest rates, we don’t see interest rates causing material borrower stress in the forward period. Remember that we, like the Australian banks, test a borrower’s ability to service a loan based on interest rate settings that are assumed to be at least 2% higher than the prevailing rate at the time of loan settlement. This interest rate buffer is a very substantial mitigant against interest rate stress in portfolios and supports our view that significant increases from current low portfolio arrears levels are unlikely.
What’s your view on the commercial property market more generally? Do you see any pockets or locations where valuations are running ahead of the market?
LF: In terms of sectoral stresses, it is fair to say that a market as large and diverse as Australia’s $2.4 trillion mortgage loan market will always have pockets of underperformance. In recent years, mining-exposed economies have been hardest hit, with Perth down around 10% and Darwin down around 15% since mid-2014 peaks on ABS figures. Currently, we see the Brisbane apartment market in particular as in oversupply – Sydney and Melbourne significantly less so, on the back of continued population growth.
YR: The market appears to be somewhat complacent at the moment, what are some potential black swan events that markets may not have factored in over the next 12 months?
We certainly wouldn’t characterise the market as complacent. Investors and the financial media have actively – almost to excess in our view – been searching for risks in the lending space. Scarcely a week has gone by without a new angle published on the risks in house prices, demand/supply, credit assessment standards, household indebtedness and so on.
YR: Do you have a view on credit markets, and in particular the RMBS and CMBS market?
LF: Interestingly, in some ways, this intense focus on the risks of the sector has underpinned the strong performance of the RMBS space. Sophisticated investors have been able to take comprehensive stock of the issues, get comfortable with the market and execute their program.
YR: Inflation has been benign for some time. What is your outlook for inflation and how will you/have you positioned the portfolios for this?
LF: For the reasons I’ve mentioned, we believe that inflation and interest rates will remain low when measured against historical norms for a considerable period. On the other hand, we prefer to position our portfolios around variable rate loans to ensure that we are well-positioned to respond to any unexpected interest rate / economic shocks.
YR: We have seen a lot of media attention recently around peer-to-peer lending with a number of recent entrants in that space offering various types of investment opportunities ranging from first mortgage secured through to unsecured personal loans. Are there any particular areas that investors looking in that space should consider when assessing potential investment opportunities?
LF: La Trobe Financial has been in the peer-to-peer space for over twenty years and currently has around $400 million under management on a peer-to-peer or P2P basis. Our program utilises the same asset selection and credit assessment process as is applied to all of our lending and this presents investors with a range of targeted, individual investment opportunities. In this context, we have enormous conviction in the merits of the P2P sector. It provides a powerful and targeted alternative for yield-starved investors and is a terrific way to get direct access to a high-performing underlying asset class.
On the other hand, we also believe that much of the talk about P2P misses the point. We hear about ‘fintech hubs’, regulatory reform and cloud-based innovation. But P2P investors are not investing in technology companies. They’re investing in assets (however described) that are originated and managed by investment managers. Outcomes for P2P investors will depend on how well those assets perform – not by the bells and whistles of the manager’s IT platforms
So the first question for a prospective P2P investor is what are the assets being targeted? Frequently, managers in this space specialise in personal or business loans. These segments of the credit market offer higher yields, but also a higher risk profile.
Investors also need to be sure that they are comfortable with the manager’s individual strategy within that segment. As with any manager in any asset class, track record is critical here. Some of the hype around parts of the P2P sector has focussed on the returns that big banks have been able to generate in, for example, the personal credit space. However, there is no guarantee that a new entrant with substantially less management resources on which to draw will be able to replicate this performance.
YR: What do you see as the key elements in managing risk in these loans at either an investor level or operating a peer-to-peer platform?
LF: Ultimately, the performance of the assets of a P2P manager is likely to depend on two key issues – the rigour of the manager’s credit assessment and the manager’s strength in collecting outstanding loans. The discussion around P2P has generally covered credit assessment in a superficial way. Many of the P2P entrants have touted their ability to assess loan applications on the basis of an internal predictive algorithm or quasi-rating of an applicant.
The limitations of this discussion are obvious. Internal ratings and algorithms are untested and have no demonstrated predictive value. In the absence of an externally-validated track record, they are of little use to an investment decision by an external investor. If discussion of credit assessment has been superficial, discussion of collections capabilities amongst P2P managers has been non-existent.
YR: Typically what levels of arrears and default has been the experienced in your portfolio over the last 5 years?
LF: Where there are loans, there will be defaults on loans. Our own portfolio is currently running at 3.1% for 30 day+ arrears, which is broadly in line with the trend. The ability to ensure that those arrears result in low (or indeed zero) losses, is frequently a function of the manager’s collections capability. After all, anyone can lend money. It’s getting the money back that’s the challenge.
All of this discussion comes back to the fundamental drivers of investment returns. Can the manager originate quality assets and manage them appropriately? What processes and disciplines does the manager have in place to manage risk? And, most fundamentally, are investors being appropriately rewarded for the risks to which they are exposing themselves? Our track record tells us that investors will reward managers who get this balance right.
YR: Investors are constantly seeking new investment opportunities and the appetite for yield based investments is growing. Do you have plans to launch any new funds soon? If so, how would these funds be different to your current offerings?
LF: While we have a strong commitment to our core strengths as a manager, we’re equally committed to ensuring that our offerings continue to meet investors’ needs. In recent times, we’ve launched the three year offering through our High Yield Credit Portfolio that is currently delivering 7.00% p.a. and an investment product that assists parents to help their children onto the property ladder via our Parent-to-Child loan. Interestingly, we’re also getting a lot of very strong feedback about our La Trobe Direct platform, which lets investors manage their investments entirely online. We continue to add functionality progressively to this platform and this has been very well received in the market.