Asset Backed Investing
Why we enjoy it (By Travis Miller, 15th October 2019)
The iPartners portfolio is becoming increasingly weighted towards Asset Backed Funds ("ABS"). This is primarily being driven by the attractive risk/return dynamics that can be achieved and to assist investors looking for diversification away from the more typical assets.
According to Investopedia "An asset-backed security (ABS) is a financial security such as a bond or note which is collateralized (secured) by a pool of assets such as loans, leases, credit card debt, royalties, or receivables"
In simple terms this means you as an investor are not exposed to a single underlying asset, you are typically exposed to a diversified portfolio of assets, with the main benefit to an investor is that you are largely minimising idiosyncratic risk.
As an example;
- If you invest in a corporate loan to Company A and Company A goes into default, 100% of your investment is exposed to the recovery on Company A.
- If you invest in an ABS transaction and Company A is in the portfolio only a portion of your investment would be exposed to Company A (if at all, dependant on structural protections).
To answer the question from the start, Why we enjoy it?
Primarily due to the simplicity of the underlying business, the control achieved through portfolio lending criteria and the direct benefits of a first ranking charge over the lending vehicle and the portfolio of assets.
If you make a corporate loan to an operating business, amongst other things you care about their EBITDA, revenue, competitors, industry etc.... there are a lot of moving parts at the operating entity level that you ideally need to understand and monitor.
If you make a loan to a special purpose company ("SPC') that holds a portfolio of loans the business model is simplified, you lend money to the SPC it then uses your loan to make lots of smaller loans within predetermined guidelines, thats about it.
- The SPC must earn more money on the lots of small loans than what it costs the SPC to pay you interest. (The difference is called the Net Interest Margin ("NIM'))
- The SPC Servicer (the business that originates / administers the loans on behalf of the SPC) must ensure it gets repaid on most of the small loans to maintain the NIM and ensure its ongoing viability.
- Hold enough equity (subordination) in the SPC to absorb losses on the small loans before you start to lose money as a lender.
There are other factors involved although if points 1-3 above are balanced correctly investors should expect a good outcome.
Not every SPC pool of assets is exactly the same and together with the subordination it will drive return/yield on the asset.
iPartners targets for our investors private pools of assets sourcing an attractive risk / return than otherwise obtained through the more public / larger securitised assets.
An example of a current offer can be viewed by clicking here.