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[TOP STORY] Alternative assets as an interesting class

Dino Zuccollo of Westbrooke Alternative Asset Management explores the world of private debt, where clients get exposure to a diversified pool of private loans in and around the UK.

SIMON BROWN: I’m chatting now with Dino Zuccollo: he is from Westbrooke Alternative Asset Management. Dino, I appreciate the time, as always. Let’s just touch broadly on alternative assets as a class. I was having a look at some charts earlier this morning. Equities, almost anything that you would traditionally invest in that gives you a daily price update, [are] having a ‘red year’ to date. One of the benefits of alternative assets is that lack of liquidity, the lock-and-process to it, and just the structure part. You are probably not having as painful a year from your alternative investments?

DINO ZUCCOLLO: Morning Simon, and thanks for having me on the show, and good morning to everyone listening. Yes, you’re right. I think it’s quite a pivotal moment in the progression of alternative assets as an industry here in South Africa at the moment. What we’re seeing going on in the markets is there is quite a bit of pain across the board. Alternatives – I suppose the thesis has always been that they are illiquid, they’re unlisted.

What is an alternative in simple terms?

Simon, it’s basically a direct investment, as opposed to making an investment through some form of a listed exchange or listed instrument. I always make the example that, if you buy a Reit stock on the JSE, an alternative is a direct property acquisition, as an example. It’s something that we’re all very familiar with, given that many of us have invested in a house.

Now, to your point, because an alternative is illiquid and unlisted, we’re not subject to the same volatility and these rapid price movements that we see happening in our investments.

There’s a consequence of things that might not have any relation to the actual value of the instrument that you’ve invested into. So we’re seeing record flows from clients at the moment.

SIMON BROWN: I was just chatting to Wayne McCurrie about the Mr Price [annual] results: good results and the market pushed it down. If you are a shareholder, you are scratching your head. One of the benefits of this listed space is I want to call it the ‘nicheness’. I think I’m making up words there, but you get the sense of that niche – you’ve got one of them. One that you’re looking at is essentially investing into unlisted properties in the UK – well not investing into them, they are loans, but it gives you a fairly decent cash yield. We’ll come to the details in a moment. Some folks might look at [that] and think, ‘oh, I can do better with my tech stocks’ – but of course not in 2022.

Tell us a bit about it. This is essentially short-term funding. Am I correct around that?

DINO ZUCCOLLO: Yes, correct. The asset class you’re talking about, Simon, is called private debt. Effectively what one does in private debt can be defined as where someone other than a bank makes a loan to a company. So we as Westbrooke, as an example, are a non-bank lender.

Now it certainly isn’t the world’s sexiest asset class, but I think in times like this, you don’t want sexy, do you? You want stable, you want consistent, you want de-risked.

So where we’ve been investing a lot recently is in this world of private debt. It’s achieved through funds and in a structure where clients get exposure to a diversified pool of private loans in and around the UK. I think the advantage there, Simon, is that if you are investing, for example, in a two-year fixed deposit, you’re going to be earning in sterling somewhere between 1% and 2% per annum. A private-debt investment can give you – at least with us – north of 6% per annum without in my opinion necessarily needing to take more risk.

Now, in the world that we find ourselves in, where equities have been falling for a long time, inflation is incredibly high and bonds are incredibly volatile, the question is where you would place your money without getting poorer in real terms. I think private debt is potentially a solution that can help clients in that regard.

SIMON BROWN: I want to come to the ‘potentially’ in a moment but, before we do, folks are going to say, non-bank debt is almost loansharking in a sense …It’s not, it’s just [that] sometimes banks are just not perhaps the right structure for the borrower, and that’s where you can step in with good old-fashioned due diligence as well?

DINO ZUCCOLLO: Yes. The big change in the market, Simon, was Basel in 2008. What that did is it put a whole host of regulatory requirements on banks that made their ability to extend credit incredibly difficult. They’re not allowed to lend against certain types of assets. It takes them an incredibly long time to get loans approved through their credit committees and generally as a result of the costs involved, there’s a minimum ticket size below which they just won’t play.

Now, at least what we found in the UK market is that there’s a very, very large what we call small- and middle-market segment of really quality businesses looking for debt funding and generally, at least in our case, that’s against real estate. So you’re actually secured against a property in central London, which we think is an attractive investment.

Now, many of these guys can’t get debt from a bank – at least short-dated debt – and that’s where we are playing. So I would argue that actually it’s the furthest thing from loansharking.

It’s very much what you would find at a bank, except quicker, better, faster, to use the cliché.

SIMON BROWN: Some of the key metrics, things such as loan to value, you can manage that. If the building is worth, I don’t know, £1 million; perhaps you would only lend £600 000 against it so that you’ve got that security. Nothing’s perfect, but it gives you some sense of security in case of a default.

DINO ZUCCOLLO: Yes. So what do you want in debt? You want a quality lend, with a significant equity buffer. So, in our case, the average loan of value, or for every million pounds of property that we’re secured against there is about £570 000/£580 000 of debt. But you want more than that. You want to make sure that you’re lending to a high-quality individual.

A very, very important tenet for us as a business is that you can make the best lend to someone who’s dishonest, and you’ll probably lose money. If you make a lend to someone who’s honest, even if it isn’t the best lend, that individual is likely to repay you. So it’s a factor of the security; it’s a factor of whom you’re lending to; it’s a factor of the credit metrics. And then from an investor perspective, we like to say – this is very important – there’s no upside in debt. It’s not an equity investment where, if your lend shoots the light out, you’re going to earn more.

So what do you want? You want diversification. Currently we are running a portfolio of 45 underlying loans; no loan is more than 5% of the portfolio. That ensures for a client, when you go through something like Covid, if you do have loans that don’t perform – we had them too, everyone has them – what’s important is to make sure that a single loan that goes bad isn’t going to bring down the entire investment, and isn’t going to have too material an impact on returns.

SIMON BROWN: We mentioned that this is not the go-go stocks. This is going to give you a nice stable, predictable return in sterling, which is an attractive point. It fits into – and we’ve talked around this before – that sort of alternative investment part of your portfolio which is never an all-in type of investment whatsoever. It’s a couple of percentage points, maybe as much as 10 or 15 at the sort of tail end of the portfolio.

DINO ZUCCOLLO: It’s interesting. I was looking at the stats yesterday – I’ve actually got the stats in front of me, and you’ll probably find them interesting – in the first world allocations to alternatives by institutions [were] 22% of average; by family offices, 35% on average; the Yale University endowment 75%. So it’s certainly something that’s becoming more and more interesting.

To your point private debt, Simon, I see as an alternative to fixed-income or some kind of cash or bond investment. It’s not the overall of your portfolio; it’s not necessarily the biggest allocation, because the trade-off is that you’re locked in.

You’re not in this world of daily priced and liquid, like you are going to find in the traditional market.

So the upside is you’re getting a significantly higher return [and] you’re getting some tax efficiency, which is quite nice. The downside is that you’re locked in for a period of time.

Where I see private debt playing a very valuable role is in a well-diversified portfolio. So you’ve got your high risk, you’ve got your low risk. And then within your low-risk bucket you kind of get a split between the daily priced and liquid investments that you can find in the bond markets.

Then there’s an element of the portfolio that wants a stable cash yield that’s not volatile, that’s going to tick along nicely, that’s not going to move around too much when things like Ukraine happen. That’s really what we’ve got on offer for clients here.

SIMON BROWN: Those numbers are staggering – 22%, 35% and 75%. I need to readjust my view. But I think your point , Dino, is well taken in that the alternative asset space is growing. I want to dig into this more – perhaps the sort of fastest-growing sector within the investment world.

Dino Zuccollo of Westbrooke Alternative Asset Management, I appreciate the early morning.

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