Mini Bond – Max Risk?
Chief Investment Officer James Robson explains that RM Funds uses two separate, regulated structures, to deliver liquidity and disclosure in its investments in the alternatives space
The last article I penned for Focus on Funds concentrated my thoughts on some of the key risks surrounding investments within the alternatives space.
The first two items on the ‘risk list’ were liquidity and disclosure:
Liquidity; ‘unless you are a pension fund or a significant institution why would you not want to be in a regulated or liquid structure’
Disclosure; ‘a lack of liquidity usually comes with a lack of disclosure. ….Investors need to know where exactly their investment is and what the ownership structure or security is, particularly when it comes to investments via platforms or mini bonds. Here the devil is in the detail.’
One month later and London Capital & Finance has collapsed resulting in expected significant losses for holders of their mini bonds.
In RM Secured Direct Lending’s annual report last month, I wrote: ‘The key risks for the alternative finance peer group lie in the more loosely regulated areas of the market where there has been a significant mispricing of risk in recent years.’ If RM Funds can see these risks then why can the FCA not? What do we need to do as an industry to effect change?
Firstly, we can highlight the risks investors are taking in mini bond investments and what pitfalls to look out for – secondly, we can suggest other structures whereby investors can get access to other alternative income strategies which are regulated thus offering enhanced investor protections.
In my opinion what are the key risks for investors in mini bonds? Put simply the biggest risk is that the business fails and you lose your money. The key to avoiding this is due diligence ‘DD’; what legal entity are you investing into?; what is the strength of the company’s balance sheet; where does your investment sits within its corporate structure; and re-examine any current and previous disclosures- are they adequate for you to really understand this investment?
RM offer two separate, regulated structures, with different strategies and return objectives investing within the Alternatives space; crucially these structures will allow investors to receive both the liquidity and disclosure unavailable in a typical mini bond.
Investors can then accurately decide whether they like the strategy or not – RM cannot guarantee returns but we can provide all the information required so potential investors can make an informed investment decision in conjunction with their financial adviser.
The first RM strategy is an Investment Trust (a closed ended structure) listed on the London Stock Exchange called RM Secured Direct Lending Plc ‘RMDL’, which invests in a portfolio of secured debt instruments.
‘RMDL aims to generate attractive and regular dividends, targeting circa 6.5%’
RMDL aims to generate attractive and regular dividends, targeting circa 6.5% through loans sourced or originated by the Investment Manager with a degree of inflation and interest rate protection through index-linked or Libor linked returns where appropriate.
Loans in which the Company invests are predominantly secured against assets such as real estate, plant and machinery and/or income streams such as account receivables.
As at 28th February RMDL had a diversified portfolio of 36 loans spread across a broad range of businesses giving a broad spread of risk for any investor.
Monthly factsheets outline the portfolio characteristics which are clearly labelled, a non-executive Board represents shareholders and a separate independent valuation agent assesses the companies’ loans independently of the Investment Manager.
There is limited leverage (maximum 20%) so a shareholder owns the proportion of the business represented through a shareholding. The Board are committed to provide a clean structure with excellent investor disclosure and monthly Net Asset Value ‘NAV’ reporting and the availability to trade daily via a stockbroker.
The second strategy offered by RM is called the VT RM Alternative Income ‘RMAI’. The legal structure of this is a UCITS product (an open ended structure).
The Undertakings for the Collective Investment in Transferable Securities (UCITS) is a regulatory framework which creates a harmonised regime. When you invest in a UCITS you know as an investor there are certain protections required by the regulator:
- A UCITS may not invest more than 20% of its assets in one fund
- Concentration limits such that no investment is more than 10% in transferable securities and that the sum of investments in excess of 5% is less than 40% – the so called 5/10/40 rule
- Rules as to what kind of assets they are allowed to invest in (eligible assets) which is found in the investment policy section of the specific Fund prospectus.
- A depository which monitors cash flows and ensures cash is booked in segregated accounts
- An Authorised Corporate Director (‘ACD’) regulated by the FCA which oversees the Fund.
For example, with RMAI you have NatWest as a depository, RBC as a custodian, Valu Trac as ACD and RM Funds making the Investment Management decisions.
‘investors can elect to have an Income or Accumulation share class, there is daily pricing and dealing and the target income return is 5%’
RMAI invests within the debt or listed equity of companies active within the infrastructure, alternative credit and specialist real estate sectors (such as GPs surgeries and Care Home businesses).
With circa 50 holdings this fund is well diversified and has a capped fund Ongoing Charges (‘OCF’) at 0.85%; investors can elect to have an Income or Accumulation share class, there is daily pricing and dealing and the target income return is 5% from the initial income share launch price.
Comparing these regulated and unregulated structures we believe the risks that are inherent within the mini bond are an inability of the investor to be able to carry out adequate DD on the investment structure itself, the investments behind the structure and the manager. It is also the case that these are often new companies with no track record that can be verified.
Within both RM strategies outlined earlier there is significant information available for investors to do their DD on the fund strategies and the manager.
In addition, the investment managers at RM themselves focus heavily on diligencing the underlying investments and adhere to a strict evaluation process. For example, during the DD phase for RMDL investments the RM team will typically commission legal advisors, technical advisors (such as insurance, architecture, lighting, heritage, planning and surveys), commercial advisors and property or asset valuers.
These sector experts work on behalf of RMDL, and produce detailed reports on all specialist aspects of a prospective investment. The objectives of these reports is to provide our investment team with a detailed and insightful picture of the business, the market in which it operates and/or assets of the company. Thus, we are aware of key technical or legal risks which could have a material impact on our investment or present an undue risk for investors.
At every step along this process the due diligence informs the teams thinking about the all the risks from investment specific risks to technical factors; if the combined level of risk is not acceptable then the investment does not progress.
RM Funds cannot offer an investor recourse if investments go down in value as returns cannot be guaranteed. However, the structure is a heavily regulated one and the investor benefits from full disclosure as required by financial services legislation and liquidity.
Using the relevant fund disclosures investors can review these investments to ascertain if they match an acceptable level of risk and return for their portfolios. All of the factsheets are displayed and can be accessed via the RM Funds website. These factsheets are clear on valuations and the portfolio as no one, including us, like surprises.