Confronted with an investment trust yielding 8.7% and trading at a 26% discount to net asset value (NAV), most experienced investors would assume that there was something wrong with it. Was the dividend about to be cut? Were the assets wrongly valued? Were the shares highly illiquid? Or maybe all three?
On being told that the investment return of the trust in question, which had unleveraged assets (ie, no borrowings) of £350m, was up 41% over one year, 89% over three years and 102% over five years, the same investor might mutter something about it being “too good to be true”.
Lending to early-stage firms
Yet VPC Specialty Lending Investments (LSE: VSL), run by Victory Park Capital, looks like a genuine anomaly. If there was a problem, the four brokers who rate the shares a “buy”, and its highly experienced board of non-executive directors, would have found it by now. Its assets, a portfolio of equities and loans, are unlisted but in such cases valuers and auditors veer towards caution. Investors cannot assess the portfolio themselves, but they can rely on those who have.
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VSL provides capital to vital segments of the economy that are under-served by the traditional banking industry, including small businesses, working capital products, consumer finance and real estate. The reason these businesses are unbackable is that VSL is lending to “high growth, early stage businesses that are investing heavily and so loss making”, according lead fund manager Gordon Watson.
Rather than lending directly, VSL lends through special purpose vehicles (SPVs), each connected to separate venture capital financiers. Typically, 80% of the capital of these SPVs is provided by VSL loans with an interest rate of around 11%, with 20% in equity capital provided by the financier. VSL’s loans are secured on the whole SPV so are only at risk if the equity capital is wiped out. In addition, VSL receives share options on the investments and sometimes invests in the equity.
“It’s not the easiest story to tell investors,” admits Watson. But the trust has had to wind down just four investments: it got its money back in full for three and expects to only lose around 10% on the fourth one. The pandemic was a worst-case scenario, but management reacted quickly, stopped lending and kept on top of its investments. It made no losses and 2020 returns were 12%.
At the end of September the portfolio held 25 debt investments, accounting for 72% of the total, and 42 equity investments, comprising 28%. The largest debt investment is 12% of the portfolio and the top ten account for 60%. The biggest equity position is only 4%. Most of the investments – 72% of the debt and 77% of the equity – are in the US.
Investments include four special purpose acquisition companies (Spacs) – listed shell companies with cash to acquire businesses that want investment and a listing. VSL is the sponsor of these Spacs, with deals lined up for all of them. Two of the deals have now been completed and the other two have been announced.
An excellent record
Victory Park Capital, founded in Chicago in 2007, has invested more than $6bn in over 100 transactions. It charges VSL the same as all the funds it manages: a 1% management fee plus a 15% performance fee. This is steep, which puts off many wealth managers and largely explains its discount, but investors should be primarily concerned about the returns, which have been excellent.
“Our market is growing,” says Watson. “We have three to five years of forward visibility on our returns, our portfolio is larger than ever and the deal flow is greater than ever before.” With loan interest covering the dividends and upside from the equity investments, VSL’s record looks sustainable, not the disaster waiting to happen that its rating implies.
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