Volta Finance Ltd (LON:VTA) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report sits behind a disclaimer, what can you tell us about that?
A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries, like the US, where the report should not be read. In the UK, because CLOs are not a simple asset class, the report should be looked at only by professional/qualified investors.
Q2: You called your recent piece ‘FY’24: another year of outperformance’, what can you tell us about it?
A2: Volta Finance’s monthly factsheet to its full year end of July reported an NAV total return of 19.7%, while annualised cash receipts were 22% of the July NAV, consistent with levels seen since mid’22. For 16 consecutive months, it had generated positive NAV returns.
In this note, we detail the different elements that have driven this performance. We note both positive markets and incremental value added by the manager. The discount appears anomalous with such a performance.
The latest monthly factsheet to August continues these themes, making it 17 consecutive months delivering positive returns, annualised cash returns rising slightly to 23%. The 2024 year to date return, at +10.9%, is nearly double US and Euro High Yield indices, which returned +6.3% and 5.6%, respectively.
Q3: Your note identified two drivers to the performance; positive markets and the value added by the manager. Taking markets first, what can you tell us about them?
A3: CLO markets are often seen as complex or highly technical with a myriad of market-specific terminologies. We believe investors should, as always, just follow the cash. For the CLO market, at heart, cashflows are very simple. CLO structures invest in a portfolio of loans from which the cash in is driven by corporate borrowers’ payments. The CLO funds this portfolio with equity and a mix of debt, most of which is better rated than the loan portfolio because of the diversification benefits of the structure.
So, looking at why current markets are favourable, cash receipts into CLO structures have been strong, with low default rates driven by good corporate profitability and cashflow, and many borrowers passing on inflation to customers. Additionally, most loans were floating rate. In addition to interest rates, cash leaving CLO structures reflects refinancing and resetting opportunities, which have also been favourable, as we have detailed in previous notes.
So, good dynamics for both cash in and out.
Q4: And the value added by AXA IM, the manager?
A4: AXA IM adds value with its scale, bringing i) specialist expertise to identify mis-priced opportunities and manage risk, ii) a broad network with informational advantages, and iii) business introduction and pricing opportunities. We also highlight its portfolio construction/asset selection.
We refer investors to our note ‘The benefits of having AXA IM as the manager’, published on 7 December 2023, for a more detailed review of the benefits that AXA IM brings.
Q5: What about the risk?
A5: CLO structures have multiple risk-enhancement features. Cash is retained in SPV/used to repay investment-grade debt if the level of collateral or interest cover falls below set levels.
AXA IM, Volta Finance’s manager skill in picking good managers was shown early in the pandemic, when circa 20% of US CLOs saw cash diversion, and Volta had none. There are multiple income, risk and concentration tests that maintain that an ongoing risk profile of SPV is within known parameters. There is less of a maturity mismatch, with interest and principal repayments from assets matching CLO liabilities. Assets are backed by good-quality security.
The end result is shown by the absence of any CLO investment-grade defaults between 2012 and 2021, and losses under the Fed stress-test scenario were just 1/35th the level of corporate loans.
