Kapstream’s listed trust is trading on its neighbours’ problems

When a listed credit trust falls well below its asset backing, the market is sometimes saying something about the loans inside it. The Kapstream Investment Trust listed on the ASX in March at $2.00 a unit and now trades at around $1.63, yet its net asset value has barely moved, sitting at $2.01 per unit in late October.

Sector sentiment and recent competitor fund news explains much of the gap. Other prominent listed trusts were suspended from quotation on 30 September ahead of delayed audited accounts, and when they returned to trade they did so at significant discounts to provisional asset value.

Independent Investment Research reports that eight of the nine other listed credit trusts saw their discounts widen in September, with little change in the reported value of what they held. Kapstream’s trust has been sold alongside them.

Dylan Bourke of Kapstream believes the way the trust is built sets it apart from the rest of the sector.

“Some investors have been nervous about private credit, but not all private credit is equal. We chose to enter a sector that offers a small, highly diversified loan book with short duration. We believe it potentially offers an attractive return per unit of risk.”

A different book

The case for treating the discount as a temporary dislocation rests on how differently the trust is built. Property loans make up more than 50% of the listed trusts run by some of the peers. Whilst KIT tends to be underweight this segment, with only 2.6% exposed to construction loans on a weighted look-through basis, subordination and excess spread protect those facilities.

Additionally, the fund has more diversification than some peers. The average position size in some of their peers runs to between $10 million and $30 million, against less than $1 million across the 216 securities and 80 issuers in the Kapstream portfolio.

Close to half the look-through portfolio sits in warehouse facilities, where Kapstream lends not to a single developer but to non-bank lenders who then generally write hundreds or thousands of small loans of their own.

One borrower lends to doctors setting up their practices, with end loans in the order of $100,000. The pools are secured on residential mortgages, car loans and consumer receivables, carry average subordination of c18 per cent (the lender’s own capital that absorbs the first losses) and have recorded no note-level losses over the past 12 months.

Much of the remainder is public debt held through Kapstream’s longstanding cash plus funds, and a spread duration of 1.35 years means the whole book can mature quickly.

Simon Dawkins, Partner and Head of Capital Markets at Escala Partners, rates the trust highly against its listed credit peers.

“We see KIT as offering the best relative value in the ASX-listed, credit-based LIT space currently.”

Paid to wait

The trust pays a monthly distribution of around 1.3 cents per unit, set at the RBA cash rate plus 3.5 per cent on net asset value. If you can buy at $1.70, that equates to a running yield of about 9.2 per cent on a portfolio with an average BBB+ manager rating.

With 76 per cent of the book on floating rates, the distribution has risen alongside this year’s cash rate increases rather than the increases eroding it, and the portfolio’s yield to maturity has climbed from 6.79 per cent at listing to 9.45 per cent at the most recent monthly report.

If the trust trades back to $2 around the current net asset value within a year, investors buying at $1.70 may potentially generate a total return of around 27 per cent. All of this assumes of course that Kapstream can maintain the distribution levels, something they reaffirmed in their most recent monthly report.

Buy-back and selling pressure

The fund is also supporting the price directly. An on-market buy-back of up to 4.8 million units, about 5 per cent of units on issue, has run since 30 September and has accounted for roughly a quarter of daily on market traded volume, leaving more than 100 trading days of buying at the current pace. Every unit retired below asset value adds to the backing and potential cashflow of those that remain.

Much of the selling looks mechanical rather than considered. An estimated 15 per cent of the register has changed hands since listing as short-term holders from the float have exited, and with daily volumes of around 150,000 units, a small number of sellers can move the price a long way.

Kapstream’s Mark Bayley links the buy-back to the illiquidity premium that private credit offers.

“Private credit offers an illiquidity premium that investors harvest. The buy-back program is designed to assist in providing liquidity to investors where holding the investment changes due to investor circumstances. Every unit bought below NAV and cancelled lifts NAV per unit for the remaining investors. We hope that holders with a long-term view may be rewarded as volatility dissipates in credit markets.”

There is of course a counter argument to that logic. The warehouse facilities are privately valued, which is precisely the kind of opacity the market is now discounting across listed private credit, and in thinly traded trusts discounts have a habit of widening before they narrow.

For investors already holding units, perhaps the core question to ask is whether anything inside the trust has changed since March, and on the reported numbers very little has. A yield above 9 per cent on today’s price is a reasonable return for waiting while the market catches up with the loan book.