Aotea Asset Management CEO Will Carnachan. Photo / Dean Purcell.
When Will Carnachan came back to New Zealand from Hong Kong at the end of 2015, he noticed a gap in the local capital markets.
The former BNZ banker had seen the rise of private
credit funds in the US and European markets, but here the main source of debt for businesses was still the banks.
Bigger companies were able to turn to the stock exchange to issue bonds, but mid-sized businesses were too small to make that a viable option.
“New Zealand’s capital markets are very thin,” says Carnachan. “You have got common equity – you either get that from private individuals or the stock market. Your other prominent form of capital is debt, and that had largely come from the banks.
“There were really no other viable options [for larger companies] outside that.”
While property businesses have typically been able to find people to help fund development projects, there wasn’t an established alternative lending base in New Zealand, Carnachan says.
In 2018 he left the bank and joined an Australian credit fund to begin establishing a market in New Zealand, getting both investors on board and lining up businesses to lend to.
But it was a connection back to his BNZ days that resulted in Carnachan and three other former bankers coming together to launch Aotea Asset Management.
Raynor McMahon, Craig McManaway and Nicholas Whitwell had also decided there needed to be a New Zealand credit provider and had approached a major institutional investor with the idea of setting it up. But with no experience in running a fund, the institution pointed them towards Carnachan.
“This investor was aware of what I was doing and they said Will has some practical hands-on experience, you should talk to him. It just happened to be that I knew these guys. It was quite serendipitous.”
Carnachan was keen but didn’t want to take the leap without financial backing. In July last year the four former bankers launched their first credit fund with the institutional investor coming on board with a cornerstone stake of $150 million.
He won’t name that investor but the Herald understands it is the Accident Compensation Corporation.
Aotea made loans to three corporates before Christmas and is now close to finalising another couple of deals.
A second fund targeting another $75m to $100m is in the process of being raised from wholesale investors – with KiwiSaver funds being eyed as a potential source of investment.
“We are focused on well-established businesses in pretty defensive industries – we tend to look at funding against really strong, reliable cashflows,” says Carnachan. “The businesses we have provided loans to are in healthcare, education, consumer staples, the most recent one is transport and logistics.”
The loans are typically $15m to $25m to businesses whose earnings before interest, tax, depreciation and amortisation are in the $5m to $15m range.
They are not start-ups.
“They are certainly not small companies by any stretch, but they are too small to go to public capital markets to raise debt; bond issues are uneconomic at the size they are operating at.
“It represents a big part of the New Zealand market. We think it’s a great opportunity because those businesses make up a big chunk of our GDP and they are really good businesses a lot of them – well run, being owned by the founders, people who are experts in their field.”
For wholesale investors in the credit funds, Carnachan says it is aiming to deliver investors a reliable income in an investment class that is typically harder to access.
He says the fund is lending alongside other lenders – including banks in some cases. In those cases its loan interest rates are similar to the banks, but typically its interest rates are 1 to 2 percentage points higher. Loans are made on interest-only terms, typically for a period of three to five years.
“What we are trying to offer is a more commercial, flexible funding structure which really enables the business owners, whether shareholders or management founders, to execute on their own strategic or growth plans.”
Banks have pulled back on business lending in recent years as they have focused on home lending.
“Banks in New Zealand, if you compare them to commercial banks offshore or even Australia, have been really supportive of their business customers. I think the reality is with all the regulatory impost capital charges coming down the pipe, they are just not going to be able to continue to fund credit growth for their clients.
“We have sized the business lending market – it’s about $110 billion – that’s right across the spectrum. We are only focused on a relatively small portion of that but it still amounts to a pretty significant number. We are there to deliver a solution at the margins where it is maybe getting harder for the banks to do it or banks can work with us to deliver an outcome for their customers.”
While Aotea lends to a range of businesses, there is one area it has explicitly ruled out: property lending.
“It’s a very well served market currently – we are not property finance experts. We wanted to focus on a part of the market that was under-served.
“The other thing is, property is a cyclical industry exposure. We are conscious of that in terms of our approach to lending. We are trying to look at industries less exposed to those cyclical movements.”
Many of its loans come through funding private equity deals.
“If you look at the largest user of our product, it is really private equity firms – they use us to facilitate their positions and the reason they like dealing with us is we understand what they are looking to achieve. It’s typically they want to push a fairly strong growth agenda and to do that you generally need to reinvest your cashflows into growth.
“Traditional financing often requires the borrower to pay back a lot of the debt. Whereas we say we have done our homework, we are happy with the business, you can reinvest that free cashflow into growth and achieve your own strategic aims – that is part of the thesis.”
Aotea is hoping to attract KiwiSaver schemes as investors.
“We think KiwiSaver is the largest latent opportunity. Really, for that opportunity to be properly unlocked, KiwiSaver providers have to become more comfortable with illiquidity across a portion of their portfolio.
“There are some that are certainly more progressive in that space than others. We are having good conversations with those parties; we do see them as being partners or investors of ours going forward.”
KiwiSaver schemes are still new to investing in “non-vanilla” asset classes, preferring to put their money into long-established areas such as shares and fixed interest. Only some invest in private equity, while others have picked up some alternative investment such as cyptocurrency.
Carnachan points to Australia, where superannuation funds now allocate up to 20 per cent of their portfolio to alternative investments.
“Our product is viewed over there as a fixed income alternative. There is still work to be done by some of the KiwiSaver providers here and some of the wealth platforms to get their heads around that. But we are confident they will, because it provides a nice diversifier – it has extremely low volatility because we are a floating rate product – our instruments don’t get revalued based on market interest rate movements.
“We do a lot of due diligence on borrowers – we review their performance regularly. We get quarterly and monthly reporting from borrowers.”
Carnachan says while Aotea is the first New Zealand credit fund, he expects others to come and says there is room for two or three players locally.
“There is going to be more domestic competition over time. I’m aware of another group that is getting established in this field. We think there is probably room for two to three domestic players. But the market is tiny here.
“Our goal is to become the pre-eminent alternative lending service. The one people want to go to first. We will continue to focus on those segments where we think we have an advantage.”
For now, they are running a team of seven people in an office on Auckland’s Queen St. Carnachan says it can easily manage $300m to $400m worth of investments at that size but would need to expand its analyst pool beyond that.
“The standard investment process is typically three months. But in the current market environment it is taking longer because we are typically involved when there is a sale.
“Vendor and purchase expectations are starting to move and that means things are taking longer.”
But he is confident private credit investment will eventually take off here as it has done in other countries.
“We are playing the long game. We have complete belief in what we are doing.
“Being the first party in the market has its benefits, but you really have to drag people along on the journey. We think what we can offer is pretty unique and certainly has a place in well-balanced portfolios. But what we have learned is, it is just going to take time.”