Buy-side Awards 2016
On the face of it, difficulties in property development, state funding, social care, and stresses in the inflation swaps market might seem unlikely to find a common solution. But Cheyne Capital thinks such a solution exists, and the London-based hedge fund manager has put together a fund to invest £610 million ($759.9 million) pursuing that idea.
Cheyne's Social Property Impact Fund – for which first-round fundraising completed in May – will buy or build properties suitable for disadvantaged groups or the elderly, and lease them to councils or care providers at inflation-linked rates.
It's an initiative that has carried the London-based fund manager into the orbit of politics – presenting at a recent parliamentary conference on alternative finance, for example. But the motivation is more than simply doing good – or being seen to do so.
The "opportunity set" is at least £60 billion estimates Stuart Fiertz, Cheyne's co-founder, president and director of research.
"We see this as an integral and differentiated leg of what we do. Our real estate debt business today is about $2.5 billion in assets under management. Our credit business is about $1.5 billion. The near-term objective is to get the social housing to be about a $2 billion business."
Cheyne's fund is aiming to tap frustrated institutional demand for inflation-linked cashflows – a post-crisis dislocation it hopes to benefit from and contribute towards fixing.
"We've watched how well infrastructure companies such as HICL Infrastructure have been trading. Every time they look to raise more money, the market accepts it," Fiertz says. "That tells you there is huge demand for inflation-linked assets."
Cheyne sees that demand intensifying, partly owing to new margining rules related to swaps coming into effect between now and September 2020, which will force pension funds to post variation margin against long-term swaps.
"That's an additional cost if you are getting your inflation through swaps," Fiertz says. At the same time, some pension funds feel less at ease post-crisis facing bank counterparties on derivatives contracts lasting 30 or 40 years.
"The alternative – the way to get inflation without the counterparty risk and without the need to put up collateral – is to buy inflation linked assets," Fiertz says. "But UK linkers are strongly bid today and they became even more strongly bid after the UK referendum vote. You look at the real yield on linkers and it is negative 1.5% on a 20-year bond.
"In our view, the next phase for the market is to buy inflation embedded in either a security or an asset."
If only half of the social housing demand is met through new building, we are talking about 600,000 housing units. That gives you a £60 billion investment opportunity
Stuart Fiertz, Cheyne Capital
That's what Cheyne's fund offers. Terms on the leases underlying the fund will typically be linked to consumer price index inflation – making for current yields in excess of 4% on costs. "It's a 600 basis point pickup over gilts and we think that is generous giving the credit quality of our tenants," Fiertz says.
The fund is two-thirds leveraged to boost both returns and its inflation sensitivity, making the latter above 100%.
Cheyne is targeting a levered 10% to 12% return net of fees for the fund.
For investors, the numbers behind the strategy are compelling. UK home supply is trailing demand, with 1.2 million families in the queue for social housing, according to the UK's Department of Communities and Local Government. Building rates – at 30,000 units a year – are well below yearly demand growth of about 80,000 units.
An annual £3 billion government grant to housing associations, against which they would borrow about the same again, was cut to around £500 million by the coalition government in June 2012 and has stayed there since.
Meanwhile, social care providers face rising calls for assisted-living, nursing and care home places as the population ages. The over-60s and over-75s are the fastest growing segment of the national demographic, Fiertz points out.
So far, the fund has built 80 one- and two-bedroom flats in Luton, is building 200 affordable homes in Sheffield, and has completed a strategic partnership – with developer Kier, Lloyds Banking Group and the UK Homes and Communities Agency – to build a further £1 billion of housing for councils over the coming five years.
About half the investors are pension funds, the remainder mainly insurers and sovereign wealth funds. Half are based in the UK and the rest in Europe, North America and Australia.
"If only half of the social housing demand is met through new building, we are talking about 600,000 housing units," Fiertz says. "That gives you a £60 billion investment opportunity." That's not accounting for social care-related development.
Cheyne plans to launch a second fund, and says it has interest already from institutions in Japan and the Middle East.
The firm also intends in future to issue inflation-linked notes itself. "If we borrow on a nominal basis, we generate a leveraged inflation exposure but pay slightly more for that leverage." As an alternative, the firm can secure cheaper leverage by issuing inflation-linked bonds. That way, the fund would pass through "one turn" of inflation to bondholders but retain exposure to at least one times inflation while generating a higher real yield.
It's been a solid year for Cheyne. Fiertz says he is pleased with performance in the firm's credit funds over the past 12 months, given spreads have moved little and rates have risen recently. And, in the real estate markets, the firm believes it has navigated post-Brexit vote turbulence successfully, he says.
"We'd been cautious in avoiding cyclical parts of the market, such as offices and high-end residential properties, and had focused on sectors driven by secular trends," he says. "And we've been well positioned to take advantage of the further retraction of bank lending after the referendum."
Cheyne's total Return Credit Fund is up more than 25% for the year to September. Its Real Estate Credit Holdings Fund is up close to 11%.