Volta Finance Ltd (LON:VTA) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: You recently published on Volta Finance, but sat it behind a disclaimer. What is that about?
A1: Volta Finance is not a simple business, and the disclaimer simply says, “THIS DOCUMENT IS NOT AVAILABLE TO ‘U.S. PERSONS’, NOR TO PARTIES WHO ARE NOT CONSIDERED ‘RELEVANT PERSONS’ IN THE UNITED KINGDOM, NOR SHOULD IT BE TAKEN, TRANSMITTED OR DISTRIBUTED, DIRECTLY OR INDIRECTLY, TO EITHER OF THESE CATEGORIES.” The full disclaimer is on the second page but, for the man on the Clapham omnibus, it just means it is an investment only for sophisticated, professional investors.
Q2: OK that is clear. What was your note about?
A2: In this note, we reminded investors of Volta’s attractions and risks, focused on how Volta generates the cash to pay the dividend, and looked at some of the issues from the latest Report and Accounts. The core to paying the dividend, and its long-term sustainability, is generating cash from the underlying 700 borrowers, a broad diversification by counter-party, geography and economic sector. Currently, a near-record level of income yield is being generated. While recent months have seen both forex and sentiment volatility, with a range of positive and negative capital movements, the long-term performance will be driven by cash generation. The discount appears anomalous, given Volta’s track record.
Q3: What are the key attractions and risks?
A3: The key attraction is a model that has delivered long-term returns above peers and benchmarks. Ongoing risks are well controlled, and they have that ideal, bell-shaped distribution of monthly NAV returns. Importantly, returns have been earned from predictable sources, like interest and coupons from loans and bonds, not volatile capital gains, and these stable income sources more than cover the high (9.5%) dividend yield. Volta has a flexible mandate to optimise returns, depending on market conditions, part of which comes from leveraging AXA IM’s (the investment manager’s) competitive advantages. It is currently trading at a discount of 15% to NAV, a level above peers and historical levels.
The potential risks in investing in Volta are a market deterioration in credit. To mitigate this, Volta has a hugely diversified portfolio by individual borrowers (700+ in total, top-five holdings representing just 2.3% of portfolio), by sector, by geography, and by macroeconomic sensitivity. Another risk is that sentiment can create volatility. Changes in sentiment can have a dramatic effect on Volta’s assets (and so NAV), but also on the discount. Finally, favourable conditions in underlying markets make reinvestment challenging.
Q4: You called your report ‘Follow the money’, so how does Volta generate the cash to pay the big dividend?
A4: The basic flow of cash is very simple. CLOs (Collateralised Loan Obligations) generate income from a large portfolio of loans; this income is then used to pay the interest on a broad range of issued debt, with any residual cash (after expenses) being available for the equity holders. Volta’s flexible mandate means it can invest across the whole capital structure of CLOs and similar vehicles to take advantage of the best opportunity. In recent years, it has increased the expected ongoing cashflow by increasing its exposure to equity elements of CLOs and also US dollar, rather than European, assets. It increases its returns with a modest amount of gearing and, in recent years, it has benefited from lower-than-average default rates. In its 2019 financial year, the cash return was 13.8% and, in the past six months, this has increased further. The key business message, though, is that the cash to pay Volta’s dividend ultimately comes from over 700 corporate borrowers with a huge spread by sector, geography and economic risk.
Q5: You clearly did a deep dive into Volta Finance’s Report and Accounts. What did you learn from that?
A5: Mainly, we were reassured that Volta’s conservative approach continues. It makes high returns by using skill to identify opportunities, exploiting Axa’s market presence and knowledge and having a flexible mandate to exploit market opportunities. It is not about excessive risk. In the Investment Manager’s Report section, there was also a detailed explanation of why Volta has increased CLO equity exposure at this stage of the cycle. To some, that may appear counter-intuitive, but the positioning comes from a detailed analysis of likely cash and sentiment effects, and balancing risk and reward. CLO equity positions are much cheaper and give higher ongoing cashflows than lower-quality debt exposure, and the likely impact in a downturn on the prices of both from here is not materially different.