A fund for retirees

This week’s fund manager interview is with Ashley Burtenshaw who’s one of the founders of Gryphon Capital Investments and he and his partners are launching a new retail investment trust that’s targeting 3.5% over the RBA cash rate, which is 5% at the moment, after fees. The plan is to invest in residential mortgage-backed securities mostly and pay the yield or the income monthly and there’s only one other of those sort of funds investing in residential mortgage-backed securities or any other kind of fixed income securities that pay a monthly income. 

It’s a good investment potentially for retirees who are interested in getting a variable interest rate on their investments and in this case, 5% at the moment, obviously it will go up as the RBA cash rate rises, whenever it does, which could be some time into the future. But at least you’re protected, you’re not just stuck on the same interest rate on your income as a retiree. You get some protection for when interest rates rise and so it’s definitely worth looking at and that’s why we’re talking to Ashley Burtenshaw who’s one of the founders of Gryphon Capital Investments.

Here's Ashley Burtenshaw, Partner at Gryphon Capital Investments.

Okay so Ashley, the Gryphon Capital Income Trust is a bond fund.  I suppose the question that springs to mind is why would an investor get you to do that rather than buy their own portfolio of fixed interest bonds, so they don’t have to pay you 72 basis points, which is your fee.  What are you going to do that investors themselves can’t do?

What we’re looking to do is to be able to deliver a predictable monthly income stream and by doing that if you actually look around the market, it’s very difficult to hold bonds and not a lot of them are listed, so there’s only a few that are listed and so therefore being able to list a fund which is – or an LIT, a listed investment trust on the stock exchange, gives those investors the opportunity to get access to predictable monthly income streams and also the key thing being, getting diversity.  Being able to assemble a portfolio of fixed income bonds which is RMBS to give them the diversity and take that stock selection away and give it to a specialised investor to give them the best chance of preserving their capital, because when investing in bonds it’s all about getting the return of your capital.

I didn’t realise it’s going to be a listed trust that pays a monthly income?

Correct, Alan.

I’ve never heard of that before.  Are there many of those around?

Yes, there is one other that I’m aware of, yes.

Right, okay.

Do you want the name?  I don’t know if I should be giving you the name, but…

Go ahead, tell me.

There is a competitor out there. 

What is it?

Yeah, it’s a corporate loan fund called Metrics Credit.

Right, well that’s good to know, thank you.  But let’s talk about your fund.  Now how do you go about to provide a monthly income stream?  Presumably the interest payment payable on your bonds that your loan will be six monthly.

No the bonds that we invest in Alan, they actually pay monthly because they’re underpinned by residential mortgages and all borrowers pay monthly if they are paying principal and interest, it’s all monthly and so we just pass through the principal and interest from the ultimate mortgagors through to our investments and then ultimately through to the investors in the listed investment trust.

The targeted yield on it is 3.5% on top of the RBA cash rate.

Correct.

How firm is that?  Is that a floor or a cap or just a target or what?

It’s just a target but given we’re not charging any performance fees, whatever the return on the listed investment trust is they will earn, the ultimate beneficiaries, the unitholders, will earn the performance of the assets less the fixed fees of running the listed investment trust.  Anything above that will also be paid to the unitholder.

Are residential mortgage-backed securities at the moment, the RBA cash rate plus 3.5% plus your fees, your fee being 72 basis points and then there are some other fees as well on top of that.

Yes.

I mean is that what it is at the moment?

Yes, you can definitely earn – the returns that we’re talking about are available in the market and we will not be using capital to pay the distributions for the unitholders, it will all be paid out of interest generated on the investments that we invest in.

Presumably the interest obviously is taxable in the hands of the investor?

Yeah, it will be a trust, correct, no franking.

Trust, so there’s no franking, full pass through. 

Correct.

Are you only investing in residential mortgage-backed securities?

Residential mortgage-backed securities are approximately about 85% of the asset-backed universe and there are 15% available in other asset classes, be it autos, small ticket commercial and credit cards and some equipment but it typically is represented by 85% residential mortgage-backed securities.

Is that going to be your portfolio allocation, 85% RMBS and 15% other things?

Yeah, it’s roughly that, we’re modelling on a model portfolio, we’re sort of indicating anything around 85-90% being residential mortgage-backed and 10-15% being asset-backed.

Are you going to invest in things that retail investors would not have access to?

Correct, it’s purely at this stage just an institutional market and obviously being such a big market, around about $114 billion, which is tradable globally around the world by a whole range of different investors, we’re looking to bring the institutional product to the retail investor.

Tell us about what happens if you get a run on – people start to sell if there’s a bit of a decline and people are kind of concerned and they sell your listed trust units, what do you do then?  I mean, I’m just wondering what the risks might be for investors in your trust? 

Alan, if you think about that, the first thing we’ve got to do is be true to label and make sure that we’re passing through the cash rate, plus 3.5%, after fees and that is being paid every month and so if the fund is starting to get impacted by oversell of selling then those units will trade at a discount to the NAV.  But given that we’re still paying the cash, plus 3.5%, then ultimately the unitholders will be able to actually get a higher return. 

In terms of the fixed income market, it’s a very, very well-understood tradable market in the institutional landscape and given that all these bonds get marked daily by third parties providers, there’s a lot of transparency in terms of where those markets for those bonds trade.  Therefore, we would argue that there would be good support if the discount from the units got away too far from the NAV of the assets. 

As you say, that would drive up the yield and at some point the yield would tap out?

Yeah, then the institutional investors would be starting to look to buy those types of assets in the units because it’s trading at a discount to where they’re tradable in the market.

Have you back-tested the relationship between the RMBS yield and the RBA cash rate and over time through the cycle is it around about 3.5%, plus your fees?  I suppose that makes it around about 4.5% or 4.4%.

5.5%, Alan.

That’s right, so 5.5%, is that what it is through the cycle?

Pre to the crisis, these bonds were trading roughly on average around about BBSW, plus 25 basis points.  Then post the crisis the yield has widened given that there’s been a couple of events that have happened, which has made these bonds through what we would refer to as changes in rating agencies methodology, which has now been in play for some time I would say and these returns have been available and we’ve got at least three years track record producing these types of returns that we’re looking to offer to the retail investors.

I suppose another risk is that you start to get delinquencies on the bonds, on the mortgages behind the bonds.  What sort of default rate or bad and doubtful debt rate are you assuming?

The way that we stress it, is we look to the APRA 100 & 200 year event, and what that entails is basically shocking house prices down by up to 30-40% and this methodology has been publicised back in 2013 for the lender’s mortgage insurance.  And by doing that, shocking, it actually assigns a probability default across each of the LTV buckets and a loss given default to come up with an expected loss.  We underwrite for that scenario and unless a bond passes that scenario you can’t go into the portfolio.

What sort of downturn in the property market and what sort of default rate on bank mortgages would there have to be for your trust to be in trouble?

It would have to be a massive, massive multiple.  If you think about it, Alan, in history in Australian mortgages the default rate has been anywhere between sort of – let’s call it 10 basis points.  Therefore, for us, for the investments that we invest in, it would have to take a massive multiple of that of history before we would be impacted.

Right, okay, got that.

A very, very serious multiple.  And it’s because in history of the Australian residential mortgage market no bondholder has ever taken a loss in the RMBS market, so it’s got very, very, very good performance.

Tell us a bit about Gryphon Capital Management.  How old is it and who’s behind it apart from yourself?

It was incepted back in May 2014 where the investment team for Columbia Threadneedle ABS spun out and was setup with their full support where we were managing the same clients and mandates at Columbia Threadneedle, we were entering into a sub-advisory agreement through the spin out into Gryphon Capital.  Those clients, most of them are still with us today and we still manage some money on behalf of Columbia Threadneedle which is now four years in the making and we have support from institutional investors, be it Australian insurance companies and super funds.

What’s Columbia Threadneedle?

It’s a big European/US fund manager which is owned by Ameriprise.  They manage roughly about $480 billion dollars’ worth of funds.  The owners are myself, Steven Fleming, which are based in Australia, and we have one equity partner, Henry Cooke who is based in the UK.

What sort of funds do you have apart from this new one?  Are they all fixed interest or do you have equity funds as well?

No, this is all we do, Alan.  We’re a specialist and this is the only sub-asset class we invest in which is RMBS and ABS.  That’s the only asset class we invest in.

This new fund is basically a retail version of what you’ve been doing for four years?

That’s right.

What sort of returns, yields have you been producing since inception?

The two that we’re talking about here, one of the strategies has been producing 5.31% annualised, post fees.  The other strategy has been producing close to just under 7% annualised after fees.  One of the strategies has been running for just on 18 months and the other strategy with just under 7%, after fees, has been running for three years.  

That just under 7% one, is that more volatile than the 5.31% one?

Yeah, so what we do is we’re a low volatility manager, Alan, and what we try to seek is high information over returns and that requires our annualised capital volatility to be very low.  That 7% style return typically comes with only about a 1.5-2% annualised cap vol and you’re correct, the other strategy which is entirely investment grade, it as an annualised volatility given it’s only been running for 18 months, but still it’s got an annualised volatility of less than 1% for those returns.

With the new fund that you’re launching for retail investors, what sort of volatility do you expect?

We would expect it not to exceed the upper band of what I was just talking about in terms of the secured ops, no more than sort of 1.5-2%.

I suppose the advantage is, as interest rates rise so will the yield on these units? 

That’s right.  But also, it’s going to be a bumpy road out from the quantitative easing.  We’ve been on and so therefore we are mindful that we are moving into a more volatile time as we get the transition away from quantitative easing to quantitative tightening.

I presume the new trust will only invest in Australian residential mortgage-backed securities?

That’s right.  Correct, Alan.

And what’s your view about interest rate, the RBA cash rate, that it’s where it is for a while?

Yes.  Our analysis would indicate that we see the cash rate being unchanged for an extended period.

What, like another 12 months?

We don’t time interest rates but we see there’s a lot of capacity.  Contrary to the unemployment numbers, we see capacity in the labour markets and therefore we don’t see any evidence of wage inflation coming at this point, so we believe they’re on hold for a while yet.

What sort of skills do you bring to bear on it?  Do you bring to bear the idea of what states the mortgages are in or what do you do that’s unique and expresses your experience?  What are people buying for the 72 basis points?

[Laughs] It’s the access to the market, but also being able to get a specialised investor to invest in this product which requires a lot of resources and a lot of systems capabilities.  For every investment that we make, we receive the underlying loan data and therefore, for our portfolios that we manage on behalf of institutional clients, our loan database is in excess of 115,000 loans, of which we receive dynamic data – well, we call it dynamic data – which is how those borrowers behave after they’ve originated the loan.  We map their arrears, we map how fast they are paying, the amount that they’re pre-paying. 

That data gives us a very good lend into the borrower’s behaviour and also where those borrowers are located.  We collect the postcodes and lots of other different information about the borrower which gives us the best ability to extract the best risk adjusted returns.  It’s all about the database and collecting the data and then being able to stratify the data, as well as run the stress test across each loan in the portfolio.