In this week’s video insight Roger identifies how credit income funds work and why most equity investors invest for the growth provided by growing businesses, and they also invest in cash, bonds or hybrids, looking for monthly income and returns that are uncorrelated with their equities and other assets.

Transcript

Roger Montgomery: Equity markets are hyper-volatile at the moment. And September was a particularly challenging month, the S&P/ASX200 declined 7.5 per cent, the S&P500 fell 9.34 per cent and the tech-laden NASDAQ gave up 10.5 per cent. Even government bond investors were unable to escape the sell-off; the S&P/ASX Australian Government Bond Index lost 1.74 per cent and the S&P U.S. Aggregate Bond Index declined almost 4 per cent.

It might seem everyone lost money in September. But they didn’t. Investors in credit income funds, like the Aura High Yield SME Fund (wholesale clients only), which is available through Montgomery, generated positive monthly income and enjoyed a stable unit price.

The reason for the very different returns is the fund doesn’t invest in equities or bonds.  Instead, it undertakes an activity that’s been conducted for thousands of years. Aura High Yield SME Fund investors lend relatively small amounts of money for short periods of time to Australian SME’s. And they do this through a carefully selected panel of lenders or originators – they’re the businesses assessing the applications and providing the financing. 

Now, if you are even remotely conservative, like me, you might recoil at the concept of lending to small and medium businesses (mind you, you probably also recoiled at September’s equity and bond market returns) – it just sounds risky, doesn’t it. But keep in mind lending to SMEs is what banks have been doing with your money for eons. More recently however, the banks have pulled out because it has become too capital and labour intensive for them.

But small and medium businesses still want to grow and still need financing, and so a structural opportunity has emerged for non-bank lenders to fill the gap.

So, what kind of small and medium businesses borrow from the lenders selected by Brett Craig and his team at Aura Credit Holdings?

Think of a farmer with a large crop of wheat or canola or sorghum to get off. Unfortunately, the header has broken down and they need $100,000 to fix it, and quickly. Because the crop will soon be harvested, the farmer might only need the money for a month or two. If he or she went to a bank however, it might take six weeks, and a mountain of paperwork to obtain the financing. With non-bank lenders, the funding can be provided in a couple of days. And the farmer doesn’t mind paying a higher rate of interest because the borrowing is only for a short period and the crop is worth much, much more. For example, if they borrow $100,000 to fix the header at 12 per cent per annum, and they only borrow for three months, the interest cost is just $3,000. Meanwhile, the lender mitigates risk by taking security over the header, the crop and the farm.

The famous 1926 book, The Richest Man in Babylon, about frugality and enterprise – a book that continues to inspire people to become better financial managers today, contains sound advice for lending:

Let me quote; The safest loans…are to those whose possessions are of more value than the one they desire…and elsewhere the book advises…before you lend, assure yourself of the borrower’s ability to pay and their reputation for doing so.

With security over the farm, the header and the crop, the value of which is far greater than the loan, and with revenue from the crop only a few weeks away, the lender is assured of our hypothetical farmers ability to pay and of the value of the possessions being higher than the cost to fix the header.

Nothing is guaranteed of course and there are always risks. Importantly, Brett Craig has been assessing those risks carefully for more than five years, producing monthly income, a return of more than 9.5 per cent per annum and no negative months to investors. And the lenders selected by Brett and his team have their own capital on the line, ensuring any losses from defaults are first borne by their returns. If defaults grow and their returns are completely eroded, it is then their capital on the line next, and before investors in the Aura High Yield SME Fund are exposed. 

With Brett, we have just completed a round of dinners through the major capital cities speaking to investors about his management of the Aura High Yield SME Fund, explaining the structure and risks and inviting investors to consider whether the opportunity is right for them and to speak to their adviser. We don’t have the results for September just yet, but August generated income of 0.67 per cent, and for the year to the end of August the income return was 8.32 per cent. The September numbers should be out soon, so keep an eye out here on the blog for those September return update.

Most equity investors invest for the growth provided by growing businesses, and they also invest in cash, bonds or hybrids, looking for monthly income and returns that are uncorrelated with their equities and other assets. The Aura High Yield SME Fund is for wholesale and sophisticated investors only and the Aura Core Income Fund is for retail investors with $25,000 or more to invest. If you would like to find out more, or would like to invest, remember it is essential you speak with your adviser and seek personal professional advice about whether the Aura High Yield SME Fund or the Aura Core Income Fund is right for you.

If you would like to learn more about the Aura Core Income Fund, please visit the fund’s web page to learn more:  Aura Core Income Fund

If you would like to learn more about the Aura High Yield SME Fund (wholesale clients only), please visit the fund’s web page to learn more: Aura High Yield SME Fund

You should read the relevant Product Disclosure Statement (PDS) or Information Memorandum (IM) before deciding to acquire any investment products.

Past performance is not an indicator of future performance. Returns are not guaranteed and so the value of an investment may rise or fall.

This information is provided by Montgomery Investment Management Pty Ltd (ACN 139 161 701 | AFSL 354564) (Montgomery) as authorised distributor of the Aura Core Income Fund (ARSN 658 462 652) (Fund). As authorised distributor, Montgomery is entitled to earn distribution fees paid by the investment manager and, subject to certain conditions being met, may be issued equity in the investment manager or entities associated with the investment manager.

The Aura Core Income Fund (ARSN 658 462 652)(Fund) is issued by One Managed Investment Funds Limited (ACN 117 400 987 | AFSL 297042) (OMIFL) as responsible entity for the Fund. Aura Credit Holdings Pty Ltd (ACN 656 261 200) (ACH) is the investment manager of the Fund and operates as a Corporate Authorised Representative (CAR 1297296) of Aura Capital Pty Ltd (ACN 143 700 887 | AFSL 366230).  

The Aura High Yield SME Fund is an unregistered managed investment scheme for wholesale clients only and is issued under an Information Memorandum by Aura Funds Management Pty Ltd (ABN 96 607 158 814, Authorised Representative No. 1233893 of Aura Capital Pty Ltd AFSL No. 366 230, ABN 48 143 700 887).

Any financial product advice given is of a general nature only. The information has been provided without taking into account the investment objectives, financial situation or needs of any particular investor. Therefore, before acting on the information contained in this report you should seek professional advice and consider whether the information is appropriate in light of your objectives, financial situation and needs.  

You should obtain and carefully consider the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the Aura Core Income Fund before making any decision about whether to acquire or continue to hold an interest in the Fund. Applications for units in the Fund can only be made through a valid paper or online application form accompanying the PDS. The PDS, TMD, continuous disclosure notices and relevant application form may be obtained from www.oneinvestment.com.au/auracoreincomefund or from Montgomery.

Montgomery, ACH and OMIFL do not guarantee the performance of the Fund, the repayment of any capital or any rate of return. Investing in any financial product is subject to investment risk including possible loss. Past performance is not a reliable indicator of future performance. Information in this report may be based on information provided by third parties that may not have been verified.