That is concentration risk. If too much of a fund is exposed to one loan, borrower or sector, a problem there can have an outsized effect on the wider portfolio.
So how do you tell whether a fund is well spread? Counting its loans is a start, but it does not tell you how large they are or what they have in common.
More loans alone do not tell the whole story
A portfolio could hold many loans and still depend heavily on a few large borrowers. Or it could lend to different businesses that would all feel the effects of the same downturn.
That is why a new loan has to make sense in two ways: on its own terms and as part of the portfolio it joins. When Merx considers a loan for the Merx Private Credit Fund, it looks at its size, the security behind it, the borrower’s sector and how much similar lending the Fund already holds.
A loan might meet the Fund’s lending criteria and still leave the portfolio more exposed to one part of the market than Merx wants it to be.
How Merx manages concentration
Lending is spread across unrelated business owners and property professionals in different sectors. But Merx also needs to consider how much of the portfolio is tied to each borrower.
Under the Fund’s policy, an individual loan or borrower exposure cannot exceed 15% of the total loan portfolio. Sometimes a lending opportunity may have attractive characteristics but be too large for the Fund to take on in full. In that case, Merx may co-invest alongside other lenders.
And it is not a question that gets answered once. Loans are made and repaid, so the balance of the portfolio changes. Merx needs to keep looking at where the Fund’s lending is concentrated as that happens.
What this means for investors
When you invest in the Merx Private Credit Fund, you’re investing in the portfolio of loans it holds. A problem affecting one borrower, or a group of borrowers, may have a limited effect or a much larger one, depending on how the lending is spread.
That is why portfolio balance matters. It tells you something the number of loans alone cannot: how much the Fund relies on particular borrowers, sectors or parts of the market.
Diversification does not remove investment risk, nor does a concentration limit prevent an individual loan from underperforming. But knowing how the lending is spread helps you understand what the Fund depends on. Whether you’re considering an investment or already invested, useful questions to ask include:
- How is lending spread across borrowers and sectors?
- Do limits apply to individual exposures?
- How are new opportunities assessed in the context of the existing portfolio?
Concentration risk is one of several risks associated with investments in private credit, alongside credit and liquidity risk. Understanding how each is identified and managed provides important context when considering the Fund and the returns it seeks to generate.
To discuss how concentration risk is managed in the Merx Private Credit Fund, contact fundgrowth@merx.co.nz.
Investors should carefully review the Information Memorandum and seek professional advice where appropriate before making any investment decision. Investments in private credit involve risk, including the potential loss of capital, and returns are not guaranteed. Investors must qualify as “wholesale investors” as defined in Schedule 1 of the Financial Markets Conduct Act 2013. The Fund is not suitable for retail investors.