Significant changes in the peer-to-peer investment trust sector
A few weeks ago I wrote about the mixed fortunes of the peer-to-peer investment trusts with the poor performance of P2P Global Investments (LON:P2P), the largest fund in the sector, prompting the Board to initiate a review of its investment management arrangements.
The Board has now concluded its investigation and has announced that the investment manager, MW Eaglewood Europe, will merge with Pollen Street Capital, which runs the Honeycomb investment trust (LON:HONY) that operates in the same sector. Pollen Street will have overall control of the combined group.
Details of what this will mean for investors in P2P are still quite sketchy, although the Board has said that the fund will follow a “revised, more flexible investment strategy” and that the portfolio will be transitioned into “more attractive specialist assets”. The plan is also to have a greater proportion of the fund invested in sterling denominated loans and to reduce the number of peer-to-peer market place lending platforms that it is exposed to.
Pollen Street Capital was spun out of the RBS private equity team in November 2013. The firm has invested over £1.2bn across a range of businesses with the main focus since 2008 being financial services.
More competitive fee structure
P2P will keep its current annual management fee of 1% of net assets and the performance fee of 15% of NAV total returns, with no hurdle rate, will remain in place for 2017. The latter looks extremely uncompetitive, especially given the poor returns, and from the start of 2018 a performance hurdle of 5% of NAV total returns will be introduced.
A similar change has also been made at another fund in the sector, VPC Specialty Lending (LON:VPC). From 1st May the performance fee of 15% of NAV total returns will be conditional on achieving at least a 5% per annum total return for shareholders relative to a 30th April 2017 high water mark.
The Board of VPC has said that the new arrangement more closely aligns the manager with the interests of shareholders and that it is confident that the 5% p.a. threshold will be exceeded over the medium term.
The Board of VPC has said that the new arrangement more closely aligns the manager with the interests of shareholders.
Once these changes take effect, HONY, VPC and Ranger Direct Lending (LON:RDL) will all have annual management fees of 1% of gross assets, with P2P slightly cheaper at 1% of net assets. HONY and RDL both have performance fees of 10% of the NAV total return, with the former having a hurdle rate of 5%, although there is no such restriction on the latter. P2P and VPC both charge 15% with a 5% hurdle rate.
The best value fund in the sector is Funding Circle SME (LON:FCIF), which invests wholly in peer-to-peer loans that are originated on the Funding Circle platform. It charges no annual management or performance fees at the fund level.
Differing fortunes
P2P is the oldest and largest fund in the sector with total assets of £814m. It launched in May 2014 and invests in personal loans made through various peer-to-peer platforms with the aim of generating a 6% to 8% dividend yield on the original issue price. For its first 18 months or so the shares traded at a healthy premium, but the fund has failed to meet its return target and has slipped to an 11% discount despite having an active share buyback programme to prop up the price.
One of the problems had been the high exposure to US consumer loans, which had acted as a drag on returns, although the investment manager had already started to reduce the allocation to this part of the portfolio.
Honeycomb has been much more successful. It launched in December 2015 after raising £100m and has since grown its net assets to £198m through various secondary issues. HONY focuses on specialist lending to the UK consumer and small and medium sized enterprises (SMEs). It also provides structured debt facilities to specialist lenders that are secured on a portfolio of loans with the lender taking the first loss.
The fund initially had a target dividend yield of 8% per annum, but this was subsequently increased to 10% or more based on the issue price with effect from the third quarter of 2016. Its shares are currently trading on a 12% premium, with the last quarterly dividend of 24.5p giving them an annualised yield of 8.8%.
HONY has recently announced that it intends to raise a further £105m via a placing of 10m new shares at £10.50, having fully invested the capital from the previous fundraisings in May and December 2016. This shows the high degree of confidence that institutional investors have in the managers, which is further backed up by the concentrated nature of the share register with the majority of the investment trust being owned by Invesco and Old Mutual.
Lengthy transition period for P2P
The Board of P2P has said that the realigning of the portfolio and re-establishing performance at the target level of 6% to 8% per annum might take 18 months to achieve. It has also confirmed that it will maintain the existing share buyback policy, which should provide some support for the share price during this period.
The investment trust team at Numis expect the portfolio to look significantly different in 18-24 months’ time and believe that it will be important for the manager to maintain portfolio disclosures so that investors can understand their evolving exposure.
They think that the portfolio will eventually look more like that of the Honeycomb investment trust, although the changes are expected to be made gradually, as the existing portfolio returns capital through the natural amortisation of its loans, which runs at about 3% to 5% of assets a month.
The investment trust team at Numis expect the portfolio to look significantly different in 18-24 months’ time.
The US part of the exposure will be wound down, with the manager focusing on assets with lower gross returns and lower defaults than the existing portfolio. The specialist assets that it will transition into will be mainly sourced through Pollen Street’s direct relationships with originators.
Numis says that it will be interesting to see how similar the portfolios of P2P and HONY will become over time and they suggest that there could be the potential for a merger at some point in the future. Invesco is the biggest shareholder in both with 33% of the former and 46% of the latter, with Woodford Investment Management also having a joint stake.
Pollen Street has a good record in this area, but Honeycomb is still a relatively new fund and the performance will be tested over the next few months as its loans mature. The discount on P2P has narrowed significantly from more than 20% to 11%, although any further improvement would appear unlikely until investors start to see some of the benefits of the changes in the form of higher returns.
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