News and Insights

The Fund delivered +0.77% in October, 9.34% over 12 months and 6.73% annualised since inception (April 2016), continuing to deliver over 5% net return above the RBA cash rate.

We are pleased to report the Fund’s portfolio of assets continues to perform strongly, and we believe, is well-positioned to continue delivering strong income returns with capital stability. Despite the Fund’s higher expected returns, our approach to risk management remains unchanged. Manning has recently completed our quarterly Macroeconomic Assessment, aimed at gauging the influence of present and forecasted economic trends on our portfolio for both the immediate future and the long term. This thorough analysis is part of our commitment to understand the broader economic landscape and its potential effect on portfolio performance, particularly with regard to credit risk.

As we observe the macroeconomic backdrop, including issues around inflation, geopolitical conflict, productivity headwinds, and structural labour force changes, we are assessing what the implications are for Australia’s economy and our investment strategies. As readers will be aware, the bedrock of our investment strategy has always been to find and invest in investments that we believe will perform through the cycle, so moving through the various phases in the economic cycle shouldn’t necessarily require significant changes to our portfolio positioning. Given the RBA’s continued determination to tame inflation and slow the economy, it is key to consider how that contraction might impact the various components of the portfolio, and in turn how that might inform our investment decisions in the immediate future as well as medium term.

In determining credit quality, we assess a transaction via a bottom-up approach rather than top-down via a credit rating. While the assessment is an extensive process, two simplified examples of distinct elements that we consider illustrate how we aim to protect investor capital in times of stress.

Having made a detailed assessment of each of the Lenders we work with, we examine individual assets originated by a Lender by reviewing source information (loan application forms, credit files, and alike) that provides a rich insight into borrower quality. A testament to the value of this approach is looking back at the Global Financial Crisis, which was at least in part caused by loans to poor quality borrowers being bundled up into an often complex and opaque structure, and sold as relatively low risk, until eventually and unsurprisingly, many of those borrowers couldn’t make repayments.

We consider not only if borrowers can make their ongoing payments but also, if their circumstances change, what is the quality and extent of asset security is available to us to protect the portfolio from any credit loss. We believe this approach provides a vital sense of portfolio quality, which, in turn, informs our assessment of overall credit quality.

Another example would be understanding the alignment of incentives. Manning assesses the extent to which a Lender (and the principles behind it) has ‘skin in the game’. Which means what is the risk capital that the Lender itself is prepared to offer to support the performance of the assets they are generating? This is known as the amount of ‘risk retention’ that Manning and other market participants require from the sellers.

Given Australia’s position in the economic cycle and the clear intent of the RBA, management of credit quality remains a key focus. We advocate for investors to either do their own granular due diligence to assess the credit quality of their investments, or alternatively invest with those who have a proven track record in being able to do so.

Is diversification really the only free lunch in investing?

While diversification is often termed ‘the only free lunch in investing’ I am not necessarily a believer. Diversification for diversification sake can mean investors invest in substandard assets that drag portfolio returns lower. We do subscribe to the view that sensible diversification that pays homage to the 80/20 rule (80% of the value from diversification can be achieved by implementing 20% of the possible diversification strategies) can add significant intrinsic value particularly when interwoven into ones asset allocation and asset selection process and, therefore, is a worthwhile pursuit.

How much and by what means diversification is achieved depends on an investor’s goals and highlights the value of good quality advice via an accredited financial advisor, broker or planner. While we have shown the table below since 2016, we cannot emphasise enough observing the asset allocations of some of the most sophisticated investors, such as the Future Fund can assist as a yardstick for investors to assess their own portfolio.

When to diversify

Since establishing the firm 8 years ago, we have spoken with hundreds of investors who, broadly, believe their portfolios require greater diversification. Many confess an overweight position in property and Australian shares, with the former being difficult and expensive to rebalance and, therefore, the latter being of primary interest. So, do investors diversify and if not, why not?

Everyone loves a stock story, with Australia home to many great emerging and emerged companies. On a spectrum, we can broadly think about them from being relatively stable, typically more mature companies that pay strong dividends (so called blue chip) to the more speculative which are targeting growth over profits without a dividend. In conversations with investors who hold an overweight position in these blue chips, we commonly find that while they equally recognise the need for diversification within their portfolio, they feel familiar with these stocks being household names that they have held for many years. Therefore, the thought of selling these shares to move into another asset class to achieve greater diversification is perceived as taking greater risk as it’s a move from the familiar to often something less familiar even though, rationally, the move is designed to lower portfolio risk.

If we consider the other end of the spectrum, the more emerging pre-profit companies have recently been heavily sold off and, in some cases, trading at a fraction of their prior highs. While their current valuation may be supported by the changes to fundamentals (high cash rate and therefore discount rate, in part justifying the lower price), we commonly hear that ‘we think it’s at its lows’ and therefore do not want to sell. In this regard, the fear of missing out on the upside dominates decision-making rather than an unbiased observation of the outlook.

So, when do investors typically diversify? In our experience, when we are in an equity market environment similar to what we are today, characterised by a broadly softening index and overall share prices. We have found that in these times, the rational thought process doesn’t play second fiddle to the fallacy of familiarity nor fear of missing out.

It is unrealistic to believe investor psychology, including fear of missing out or the fallacy of familiarity, does not influence investment decisions. Being aware of such biases and balancing them appropriately alongside objective investor rationale will enhance one’s investment credentials and likely portfolio outcomes.

A deep dive on credit as a diversifier

While we can’t speak to the other asset classes that the Future Fund invests in including Infrastructure, Timberland and broad Alternatives, we can provide a perspective on why more Australians are investing in Credit which in the Future Fund portfolio, occupies a larger share of the portfolio than both Australian Shares and Property, in stark contrast to many other investor portfolios. As outlined above, some are increasing their allocation due to overweight positions in other assets class. Another driver observed is the demographic shift with the so called baby boomers, who in general, are moving from a wealth accumulation to a wealth preservation mindset and thus, are drawn to fixed income/credit investments that prioritise capital preservation, are less influenced by the risk on/risk off cycles of equity markets and can deliver a ‘real’ rate of return, in particular shorter duration strategies where returns typically lift alongside inflation and higher global cash rates. This move towards fixed income and credit has seen an influx in new managers and investment opportunities in this space, we remind investors not all managers are of the same pedigree and for an asset class designed to preserve capital, investing with those that have a track record and the right incentives remains paramount.

Join CIO Adrian Bentley and Head of Investment Solutions Juliet Shirbin, as they discuss the role of macroeconomic analysis in managing a through-the-cycle portfolio. The Manning Monthly Income Fund is designed to perform in all market conditions and maintain its return target of RBA cash rate + 5% net of fees.

Podcast:

https://open.spotify.com/show/3wUHgMkL5dFn9ZNywdLURK

The Fund delivered +0.76% in September, 9.26% over 12 months and 6.70% annualised since inception, continuing to deliver over 5% net return above the RBA cash rate.

We are continuing the theme of explaining a key element of how the fund works in each monthly performance update so clients and advisers can further understand both the investment strategy and attributes of the product.

The Manning Monthly Income fund operates as a fully distributing trust, which means that all income received by the Fund during each period, after deducting fees and expenses, is obligated to be distributed to investors monthly. This structure holds significant advantages for investors seeking both capital stability and a dependable income stream, especially when compared to other asset classes such as equities, where dividends/distributions are often discretionary in terms of the amount and timing of payouts, if any are made at all. Moreover, the monthly frequency of distribution, as opposed to the more typical half-yearly approach, adds an extra layer of consistency for our valued investors.

Manning focuses its investments on assets that yield a monthly income-based return, allowing us to efficiently pass on the returns received by the Fund to our investors in a timely manner. For our investors, this translates into the ability to receive their monthly returns as cash distributions, reducing the need for regular redemptions to meet their income requirements.

Investors will note the distribution rates from fixed income have increased significantly of late due to the higher RBA cash rate. By way of example, the Fund’s annualised current distribution yield is 9.15% versus the ASX 200’s indicative dividend yield (including franking credits) of circa 6.10%.

The Fund delivered +0.75% in August, 9.10% over 12 months and 6.67% annualised since inception, continuing to deliver over 5% net return above the RBA cash rate.

Since May 2022 when the RBA started increasing Australia’s cash rate to slow the economy and its uncomfortably high inflation, there has been little evidence of that higher cash rate’s impact. For example, retail sales remained robust, growing each month throughout 2022. We are now witnessing the lagged impact of that policy, which is reassuring as it indicates the RBA cash rate may be high enough and no more pressure needs to be added to household or corporate balance sheets by way of further cash rate increases. While reassuring, it’s also important to note from a relative perspective, a 4% increase since May 2022 in the RBA cash rate is substantial, and it could even be argued, more impactful given its prior low 0.1% base that it came off.

From a fixed income investor perspective, we are watching for signs of stress both in the economy (i.e. changes in the unemployment rate, corporate insolvencies, house prices and alike) and in fixed income assets. Currently, the most vulnerable assets where we believe stress will be seen first are those with meagre protections, such as business loans not secured by a hard asset such as a property or vehicle or, large loans compared to the size of the borrower. Large loans for a variety of reasons have proven to be more problematic and it is why, bankers globally watch loans size carefully.  Large loans can be even more problematic when they are not supported by a borrower that has regular annuity style income streams to meet regular repayments. For example, a large loan that capitalises interest throughout the term and relies upon a future intended event to pay the loan off. These transactions contain significant ‘event risk’ and make it difficult to detect a deterioration in credit quality before the final repayment is due.

As we assess the outlook for Australian fixed income and credit markets, we are keenly watching lenders who allow large loans, particularly where borrowers have limited regular business revenues to make regular repayments. Such a dynamic is commonplace within construction finance, where you are lending to a developer who often has large net cash outgoings during the construction phase and primarily relies upon the project going according to plan, the apartments or properties selling in a short period and selling at a high enough price to recover the full loan amount. Such an asset has material inherit risk, which is why the Manning Monthly Income Fund has no construction finance assets. It should also be noted, that large loans are also more impactful to an investor. For example, a loan defaulting in a portfolio of 20 loans can have a 10 times larger impact than a portfolio of 200, and so on.

Therefore, assessing the number of loans and the largest loan of one’s portfolio is a good barometer of risk and why Manning Asset Management prioritises avoiding large loans and investing in a diversified fashion.

In the face of an unpredictable economic environment, skilfully managed fixed income investments can provide attractive risk-adjusted returns. Like all asset classes, risks remain that, when poorly managed, can lead to unfavourable outcomes for investors. Join Portfolio Manager Josh Manning, Chief Investment Officer Adrian Bentley, and Investment Committee Member Paul Edwards as they discuss how Manning Asset Management leverages the team’s 100+ years of experience through credit market cycles to create an essential foundation for managing the firms’ portfolios.

The webinar will cover:

• Lessons from 100 years of investing in Australian fixed income
• Asset structuring
• What the investment management team are watching and how we are positioning the portfolio over the quarter

The webinar will be presented by:

Josh Manning – Portfolio Manager and Founder

Adrian Bentley – Chief Investment Officer

Paul Edwards – Investment Committee Member and Executive Director

Juliet Shirbin – Head of Investment Solutions & Investor Relations

Disclaimer:

This video may not be copied without the prior consent of the issuer Manning Asset Management Pty Ltd AFSL 509 561, ACN 608 352 576. This podcast is intended for use only by persons who are ‘wholesale clients’ within the meaning of the Corporations Act. It is intended to provide general information only and has been prepared without taking into account any particular person’s or entity’s objectives or needs. Investors should, before acting on this information, consider the appropriateness of this information having regard to their own situation. While due care has been taken in the preparation of this podcast, no warranty is given as to the accuracy of the information. Except where statutory liability cannot be excluded, no liability will be accepted by Manning Asset Management for any error or omission or for any loss caused to any person or entity acting on the information contained in this webinar. We do not guarantee the performance or success of an investment and you may lose some or all of the capital invested. Past performance is not a reliable indicator of future performance.

The Fund delivered +0.78% in July, 8.97% over 12 months and 6.64% annualised since inception, continuing to deliver over 5% net return above the RBA cash rate.

With the rise of interest in fixed income investments, we have seen an accompanying increase in fixed income fund managers. Investors, therefore, look to understand how our Fund differs from these newer offerings.

In 2015 when establishing Manning Asset Management, we looked at the very best fund managers globally to understand what differentiates a good from a great fund manager, with two themes emerging. First, they do something and do it very well, or in other words, they ‘stick to their knitting’. Secondly and most importantly, they emphasise and ensure alignment of interest in every facet of their business. These two principles have been the foundations of Manning Asset Management.

We demonstrate our close alignment with investors by ensuring all fees, interest, and other related benefits flow to investors. We do not believe the practice of keeping establishment or upfront fees or other such monies paid when investing in a new transaction is fair to investors.  For example, a manager that retains the upfront fees and only passes on the interest payments to investors is incentivised to negotiate higher upfront fees and lower interest rates with borrowers which conflicts with the interests of our clients, who’s capital is ultimately being invested.  A fund manager should be incentivised to invest in transactions that best fit the fund’s risk-return profile, maximising returns and minimising risk. Removing this conflict as we do, removes any bias and allows a clearer perspective on safeguarding investor interests.

We prefer a fee structure that pays an amount for running the strategy and an approximately equal amount if we deliver on our investment objective of achieving the RBA cash rate +5% net of fees (circa 1% per annum in aggregate). This simple fee structure where we are not pocketing other fees along the way has been a vital element in not only ensuring we are best placed to safely manage investor capital through uncertain times but, importantly, has also been a source of additional investor returns and why we have outperformed several peers.

By prioritising specialisation and removing fee conflicts, we have been able to safeguard investor interests and maximise returns. As a result, the Manning Monthly Income Fund has consistently delivered upon its target return of RBA cash rate +5% net of fees since its 2016 inception.

Beneath the yield fixed income investors receive, there are often overlooked avenues of transaction income many investors are missing out on.

The decade high RBA cash rate has been a boon for investors, seeing fixed income expected returns soar. While most investors focus on yield (often termed ‘running yield’), they overlook there are often additional sources of income available from the transaction.

When a new fixed income asset is originated, it should be little surprise that not all investors have the same access or negotiating power. Therefore, terms between investors shall vary. Generally, the larger the investment, the better the economics that can be achieved on a given transaction. As a wholesale capital provider, fund managers like Manning see three important ways to generate returns for their investors.

Firstly and most importantly, fixed income investments typically have a consistent yield paid to the providers of that capital. This rate may be fixed or floating, pegged to the RBA cash rate or bank bill swap rate. In our experience, 80-90% of investor returns come from this source, although the actual percentage can be higher or lower depending on the asset class.

When a new transaction is issued, larger investors can often charge an establishment fee (or upfront fee) of up to 2% (or higher in certain situations), which can be quite material depending on the yield and maturity date of the investment.

Lastly, while uncommon, larger investors may negotiate options or warrants in the issuer themselves in certain circumstances, such as for a newer originator. The rationale being if a manager like Manning can invest a material amount in the new fixed income issuance, that is commercially very attractive to them as opposed to having to court many underlying investors taking time and money, and therefore, there should be some share in the commercial upside. Where this does occur, it is more likely to be in our higher returning strategies (Manning Credit Opportunities Fund) and these can materially boost returns, albeit over a longer timeframe than the above.

How different managers treat these sources of return matters

Across the Australian market, we see a wide range of practices in how these sources of investor returns are shared between fund managers and their investors. In some cases, managers will retain a portion of the yield (e.g. an investment pays 9%, and the manager passes on 8% to the investor, retaining 1% in fees). We also see some managers pass on 100% of the yield and charge a fee for managing the fund overall.

We also see a variety of practices around how the establishment fee is shared with investors. This is a crucial element for investors to consider. The rationale being an issuer of a security is indifferent to paying a 2% establishment fee and 7% yield or a 9% yield assuming a 12 month investment. Therefore, if a manager keeps these establishment fees, that manager is incentivised to trade off investor returns for higher establishment fees in which they keep. This same principle can also be applied to options or warrants when they are not given to the investors whose capital is being used to invest.

Understanding the attribution of your return is key

Investor attraction to fixed income is timely, given the higher expected returns from the elevated RBA cash rate. To maximise investor returns, investors should understand what level of returns are being taken by the manager, and what is being passed on. To do so, an investor needs to understand if the manager is retaining a portion of the running yield, if establishment fees are passed on and if not, how much these fees are and lastly, the treatment of other benefits such as warrants. We believe that providing a manager is transparent and discloses these facts, it’s simply around evaluating how much a manager is paid in total vs the value they deliver to investors and whether the fee structure delivers an alignment of interest that favours investors. If this transparency is not forthcoming, investors should exercise caution, seek further clarification, and consider other investment options if not satisfied.

We urge all investors to understand this equation and ensure the fund manager you are using is genuinely maximising your returns.

(For transparency, I have included how Manning treats such profits

• Percentage reduction in running yield = 0% (i.e. 100% goes to our investors)
• Percentage of establishment fee kept by Manning = 0%
• Percentage of options kept by Manning = 0%
• Manning charges a fee at the Fund level that on average, equates to circa 1% per annum)

The Fund delivered +0.72% in June, 8.88% over 12 months and 6.60% annualised since inception, continuing to deliver over 5% net return above the RBA cash rate.

The Fund delivered 0.72% in June being in line with its monthly return target. Investors will note that returns move monthly as investment maturities occur and new investments come online, impacting cash held by the Fund. During the period, we have identified several opportunities in the late stages of due diligence, although settlement has been delayed seeing the Fund hold additional cash. We are comfortable holding this cash given the attractiveness of the transactions underway.

Throughout the month, we have engaged with multiple advisory and institutional clients who share a common interest in our views on the economic outlook and how we manage risk accordingly. A key pillar of our investment process is picking the right assets to perform through the economic cycle and structuring them correctly.

Structuring refers to the contractual obligations we put in place to control risk, and if those risk limits exceed our tolerance, they give rise to certain rights. By way of a simplified example, Manning will determine what level of arrears we are willing to tolerate when investing in a pool of underlying assets. The counterparty seeking finance must ensure those arrears levels are not exceeded. If these set levels are breached due to counterparty-specific or industry-wide issues, Manning would typically have a right to require that counterparty to repurchase some or all of those assets in arrears, or the facility would need to be closed and paid down. As closing the facility would be detrimental to that counterparty, they are highly incentivised to ensure those limits are not breached initially and, if they are, are quickly resolved before we exercise such contractual rights.

Given this approach, when structuring transactions upfront, we consider how that facility would be paid down should that counterparty not adhere to our pre-agreed risk limits. Importantly, we focus on ‘asset-backed’ transactions in that our financing is secured against assets that are of value and can be recovered to repay some or all of our capital. Therefore, a request to have our facility repaid can either occur through being refinanced or allowing those underlying assets, which are being regularly repaid, to repay our financed amount.

We have had counterparties who have breached our risk limits, and we have had to exercise our rights which has always led to 100% of capital being returned due to the sensible, legally enforceable contractual obligations within our agreement. This approach has ensured the Fund has never had a negative month from credit losses in its 7+ year track record while investing through a variety of market cycles and economic conditions.

We remain vigilant of the outlook and are pleased to say all counterparties are operating within risk limits, and we do not see an elevated risk profile in the portfolio.