Other than fixed income, what other options are available for advisers to consider in order to deliver a steady and consistent level of income within client portfolios? James Robson and Pietro Nicholls of RM Funds talk to Sue Whitbread about how secured lending can provide appropriate opportunities
SW: RM Funds may be a new name to some readers so can you give us some background to the business?
James Robson: “RM Funds is the alternative credit business from RM Capital. RM Capital was established in 2010 and has been involved in fixed income and capital markets advisory activity since then. To put it into context, we’ve arranged or advised on over £1.5billion in transactions through our advisory team. RM set up a fund management business in 2015 to focus on alternative credit fund management. Alternative credit as an asset class is relatively new and the focus is around assets which exhibit stable and consistent cash flows as a substitute for traditional fixed income investments. Looking at the regular fixed income space – like government and corporate bonds –there’s a dearth of yield, however within the alternative credit space there are opportunities with attractive yields with stable and visible cashflows. That’s where RM operates and with more than 120 years of experience between us in the team, we have established ourselves as a specialist alternative asset management firm focused on credit products & secured lending.
SW: For those who are not that familiar with secured direct lending, Pietro, can you highlight what’s involved and what are your key areas of operation?
JR: “Within the alternative credit space there are a number of sub sectors ranging from Aircraft Leasing to Specialist Real Estate and one of these sub sectors is direct lending. In essence, it’s nothing new, it’s just lending. The fund lends money to corporates – as opposed to them raising finance from the banks. The types of businesses that we lend to are typically SMEs or mid-market corporates. These are not micro businesses of course, they can be fairly large – generating £50m in revenue for example. The kind of business we back are in areas which have suffered since the banks have retrenched from lending to anything other than their blue chip client bases. We help those firms which have good assets, good business models, strong management teams and we provide the financing to support their growth and development. We go through a rigorous credit process of course, which I’ll explain now as it’s important to understand.
“It all starts at stage 1, when someone reaches out to us with a requirement for funding or we see an opportunity to invest in a debt instrument. By stage 2 we proceed to the due diligence process – where we understand exactly what the business does – digging down to see where the risks are, what kind of shape the management team is in etc. This is an involved process which costs the borrowers money so they need to be committed to it. Our credit function then sits over the top of these areas, to make sure we’re taking the right kind of risks and that we’re generating the right kind of returns for that level of risk. The next phase is execution where we actually document the transaction or purchase a Loan. Thereafter, it goes into M&C – monitoring and control – where we monitor the investment throughout its life. It’s important when we invest that we have effective sets of reporting requirements, covenants etc. in place that the borrowers agree to. The fifth box is one we’d hope not to have to step into, which is in a case where something has gone wrong. Depending on what that is, will determine what action we take. In the worst case scenario, we would seize the assets of the business to the value of the loan to protect our investment. Of course, it’s something we’d rather not have to activate but it’s an important part of the process to have in place.”
SW: James, can you talk us through the investment products you have available– and which you think are of interest for advisers, planners and paraplanners?
JR: “In 2016, the first product we launched was RM Secured Direct Lending. This is an investment trust, listed on the London Stock Exchange and is a product which aims to give a steady, secure and consistent income stream along with the preservation of capital. Currently, the market cap is just under £90m and our target is to pay a 6.5% dividend. We feel it’s a product of interest to all investors as, let’s face it, everyone at this stage of the economic cycle is looking for income whether they are private clients, wealth managers or institutional investors. Looking at our shareholder register, we have a huge number of investors. Our largest investor in the investment trust is the Church Commissioners (CCLA) as well as other institutional investors, plus there are around 4,000 retail investors. Being a closed end fund investors can buy or sell shares through their stockbroker as well as some platforms, as it is listed on the LSE. During March, we’re undertaking a “C” share issue to raise additional capital which should take the capitalisation of the trust to over £100m.”
SW: Given that a key investment objective for RMDL is to deliver income, is that 6.5% level of income sustainable for investors in the trust? Can they expect to receive it consistently over the longer term? What about the value of capital?
Pietro Nicholls explains. “We have a simple objective that this is a yield product with preservation of capital. In the first year we targeted a 4% yield (we exceeded it at 4.2p) with 6.5% being the target yield thereafter. This is the yield net of running costs, managers’ fees etc. and so the shareholder should expect to receive a consistent income return of 6.5% per annum.
We believe a key differentiator for RMDL is that it has a fixed income portfolio positioned for growth in a rising interest rate environment. This is quite unusual as bond prices usually fall in a rising rate environment, however a significant number of our investments have a floating or index-linked coupon rates. At present, as interest rates start to rise, this should mean that this increased coupon should flow through to the bottom line and dividends could then increase. Of the remainder of the portfolio holdings which have fixed rate coupons, we tend to keep the maturity dates relatively short on these investments so that we do not have significant exposure to any interest rate movements.
“The investment trust has traded well since inception in 2015. We see the main reason behind this is that we provide a lot of transparency about the investments themselves – including the names of the businesses we lend to and invest in – something which isn’t always the case within our peer group. Also our management fees are fairly low – we don’t levy any performance fee – in addition we take 50% of our management fee and invest this into shares in the trust every quarter. As well as the fact that we invested into the fund ourselves on day one, this provides real alignment of interest as we have “skin in the game” and demonstrates that we back ourselves.”
SW: Pietro, advisers and paraplanners will be keen to hear where you think the main risks lie for investors in this sector and how do you and the team work to minimize them?
PN: “The main risks lie in a borrower defaulting on a Loan. This is a clear risk and mitigated by RM in several ways:
- Invest in sectors with stable and visible assets and income stream such as student accommodation, healthcare and energy projects.
- Focus on non-cyclical sectors – these areas are less likely to suffer in a prolonged downturn
- All investments are secure Loans which give downside protection via robust covenant packages to ensure if things go wrong there is a good chance of recovering the investment
- Ensure rigorous due diligence is done on all investments and there is robust monitoring and control,
“As an example, one of the largest investments in the portfolio provides debt to an asset finance business that has a portfolio of nearly 1,000 physical assets such as diggers and tractors.
“This investment is secured over the whole portfolio and has a very granular structure with lots of security. Another investment is to a large healthcare business with a senior secured charge over their business cashflows and their real estate portfolio. As I previously mentioned, these are the types of businesses we favour with stable and visible earnings and tangible security.”
SW: Pietro, where does the business go from here? Do you have plans to expand?
“Yes, indeed we do. Our next fund going through the FCA process at the moment is the RM Alternative Income fund. It’s a fascinating product and one which we are very keen to tell advisers and paraplanners about as we think it is well positioned for their needs. We have constructed the portfolio to offer maximum diversification across the alternative credit space within one UCITS product. When we consider where it will invest, there is a broad range of sectors in areas like infrastructure, specialist real estate which would encompass distribution centers and GP surgeries, private credit, aircraft leasing, asset based lending, P2P lending, structured credit etc. This new fund looks to make the right kind of investment across these areas in one investment, offering true diversification against traditional investments like equities and bonds. The concept that it will invest across such a broad area really plays to our team’s strengths. We’ve got direct experience of operating in these areas which need the specialist knowledge that we have within the team. Through this new fund, we can offer investors and their advisers this diversification strategy in one place at a competitive rate – our intention is to cap all fund charges at 0.85%.
“The income target for the fund will be 5% net to investors after costs, but with these costs capped. We’ll be paying the income quarterly too. We don’t see another product on the market like it. It will be an open-ended fund with daily liquidity and the investments RM make will typically be in listed equites and bonds. This is important, both in allowing a speedy deployment of capital to minimise cash drag and also to facilitate any investor redemptions.
“Of course, we have to wait for FCA decision but we are hoping that the fund might be available early in April 2018 as we enter the new tax year. We believe that it the fund will be highly attractive to advisers who are seeking an investment which can deliver an attractive and consistent level of income for clients. It’s an exciting time for us and we’re really looking forward to engaging with professional advisers and building working relationships with them for the future.”
James Robson is Chief
Investment Officer and Principal, RM Funds
He is the Co-Manager of RMDL and has C.20 years of experience in the Capital Markets, Credit Products (including CDS, and Structured Products), Risk Management and Corporate Credit. James founded RM Capital Markets in 2010 and currently heads the Alternative Credit Management business. Prior to this, James was a Credit Trader for RBS and Dresdner Bank and was former head of the European corporate credit trading business at HSBC. He is a member of the RM Capital Markets Board, and an Investment Committee member. He is also a shareholder in RM Capital Markets Limited, and RM Secured Direct Lending PLC.
Pietro Nicholls is
Principal, RM Funds
He is the Co-Manager of RMDL and has C.12 years of experience in Investment Banking, Capital Markets, Corporate Lending and Project Finance. Pietro has extensive experience advising publicly listed, unlisted and government related entities on investment, financing, M&A and liability management solutions. He joined RM in 2013 to setup the Capital Markets & Advisory business, a business which over three years advised on, sourced, structured and or arranged over €2bn of debt finance transactions located within W. Europe. In 2015, alongside James Robson, Pietro set-up the credit management business and subsequently launched RM Secured Direct Lending PLC. He played an active role in the development of the UK Retail Bond market, a now established form of funding for corporates. Like James, Pietro is also a shareholder in RM Capital Markets Limited and RM Secured Direct Lending PLC.