Magic Markets #203: Year in Review – Alternatives at Westbrooke

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Introduction: This episode of the Magic Markets podcast is proudly brought to you by Westbrooke Alternative Asset Management. Established in 2004, Westbrooke is a multi-asset, multi-strategy manager and advisor of alternative investment funds and co-investment platforms. Westbrooke has a heritage as a shareholder and operator of assets and invests their own capital alongside investors in private debt, hybrid capital, real estate and private equity in South Africa, the UK and the USA. Westbrooke provides investors with a unique gateway to private market alternative investment opportunities which are traditionally difficult to access. Investors benefit from the depth of experience and quality of investment teams who apply the Westbrooke investment and risk philosophy and approach to everything they do. And for those seeking capital, Westbrook is able to structure unique hybrid capital solutions to help you meet your objectives anywhere on the capital stack. And of course, as much as we are proud to provide a platform to Westbrooke to discuss what they do on Magic Markets, you must always do your own research and speak to your financial advisor about whether any of these products are suitable for your needs.

 

The Finance Ghost: Welcome to Episode 203 of Magic Markets – Moe, that’s about the closest you and I get to any kind of endurance challenge as we’re on 203 episodes. Dino rode 200km on a bicycle this weekend, so it’s a bit of a race really – kilometres versus episodes. I like to think we’re doing okay here. I don’t think either of us is going to cycle 200km anytime soon, possibly cumulatively over five years. So well done Dino. All very impressed.

And if you don’t know who Dino is, then you obviously haven’t been listening to Magic Markets for too long because he’s been on a good few times before. That is Dino Zuccollo of Westbrooke, and if you don’t know who Moe is, then you must be very new here.

So Moe, always lovely to do this with you. Dino, it’s great to have you on as well. Let me hand over to Moe, who’s looking suitably dressed for a nice cold northern hemisphere while we bask in the sun here. And yeah, let’s do it. Let’s find out what Westbrooke’s been up to this year.

 

Mohammed Nalla: Ghost, I think that 200kms+ from Dino of cycling, that’s impressive. So again, well done Dino. But that’s not what we’re talking about here today. This is a show about markets and it’s been such an interesting time on the markets. We’ve just gone through a US election with lots of fireworks up in that jurisdiction. We know Westbrooke has a presence in the US, but guess what? Westbrooke also has a presence in the UK and the UK has been very different to the US. Economic growth in the US has been quite exceptional. It’s why the market’s kind of saying, can the Fed really cut a lot more aggressively? There are some inflation risks coming through in terms of the US. The UK, not quite the same story.

Like I say, we’re quite keen to hear from Dino in terms of some of the key differences that Westbrooke is seeing between the US and UK. But then lastly, South Africa, because South Africa has been kind of countercyclical to what’s happened internationally in many respects. Just last week we had another 25-basis point cut from the SARB. That’s going to be relevant to South Africans. I know a lot of people are disgruntled with the fact that the SARB could have maybe gone with 50 basis points, with inflation really ticking down quite significantly. But these global factors all play into one another. Global inflation seems to kind of flatlining, maybe a little bit of an uptick there. Oil prices, the low base effects are out. So all of this means that those three markets have very different interplays.

And that’s what we want to touch on with Dino from Westbrooke, just to understand some of the key differences, because that influences the opportunity set very differently in each of those geographies.

Well, that is a very long intro. Again, congratulations, Dino, on those 200kms on the bike.

 

The Finance Ghost: It was an endurance intro. Dino can cycle 200km faster, Moe, than you can introduce this episode. It’s unbelievable.

 

Mohammed Nalla: Actually, that’s true, Dino, welcome to Magic Markets.

 

Dino Zuccollo: Yeah. Hello, Ghost, Moe. It’s always a pleasure to be here. You guys have made me feel like I won the Tour de France on the weekend, which couldn’t be further from reality.

 

The Finance Ghost: Listen, by our standards, you basically did, so don’t worry.

 

Dino Zuccollo: For those of you listening, I think Ghost emailed me earlier to say that the amount I cycled on the weekend was longer than the two collective cycling distances for the year combined. I do appreciate the compliment from whence it comes. But for those of you listening, I did the Double Century down in Swellendam on the weekend, and judging by the attendees of the Double Century, which is half of the asset management and financial services industry in South Africa, most of you would have been there too, so I hope you all had a good ride. For those of you who didn’t, it was hot, it was hard, but it was a great time.

Moe, thank you first of all, for the intro. I think, look, what I’d like to do in this episode is spend a little bit of time, as you say, unpacking the year that we’ve had. It’s been, on the whole, another solid, strong year, but certainly a very interesting one.

If you look at Westbrooke, as you mentioned, we’ve got three geographies that we operate in – South Africa, the UK and the USA. We’ve had elections in all three of the geographies that we operate in during the year, at different stages as well. And so for me, a challenging year to price risk because when you are looking at dealmaking and you’re not entirely sure about what economic policy is going to look like going forward, what tax policy is going to look like going forward etc. it is difficult.

I think despite the fact that we’ve had record demand from investors who want to come into alternatives because of the diversification benefits, which have been specifically strong with institutions this year, which has been really cool for us to see, it has been a year where in certain instances, I think the best thing to do is nothing. Because we, fundamentally as a business, don’t see ourselves as asset gatherers. And that’s an important thing. Many asset managers are incentivised to raise as much money as they can, because the more money you raise, the more fees you earn. Whereas at Westbrooke, one of the things that I think is a key differentiator is that we’re generally the biggest investor in everything that we do. That changes things because we’re looking to invest our own capital principally as well as investors capital, and sometimes doing nothing is the best thing that you can do. So definitely an interesting year. Definitely a year where I think we’ve really, really had to focus on capital preservation as our key tenet as Westbrooke, and to really double down on our investment risk philosophy and approach.

But still strong. We’ve got R13 billion in AUM now, which is a really significant milestone for us. The teams continue to expand. In South Africa, we’ve got 23 people. In the UK, we’ve got 13 in the USA, we’ve now got 3 dedicated people on the ground. And Ghost from some of the conversations you and I have had, we also now looking at building out a presence in the Western Cape, which is quite cool.

 

The Finance Ghost: Yeah, absolutely. I mean, it makes sense. As someone who loves living in Cape Town, I can certainly support that decision from your side. It’s interesting that you say pricing risk. That is basically what you guys need to do as the investors generally, and of course, those who might be borrowing money will need to also think about that. They need to go engage the opportunity set. They need to decide whether or not it’s worth taking the risk, whether or not they can raise at the right sort of numbers.

South Africa’s definitely seen some improvement this year. The last show we did was all about whether or not you’ve actually seen that coming through on the ground in this post-GNU world. I’m just curious, you guys obviously have this helicopter view now because it’s the UK, it’s the US, it’s South Africa – a year or two ago, we would have not featured so well, I guess on that list in terms of certainty and how it’s all looking. Yes, there’s always opportunity, but then you have to price for it.

Would you say that that started to really change now? Are you able to price risk in South Africa in a way that’s a little bit more favourable to borrowers? It’s just looking less risky on the ground?

 

Dino Zuccollo: Yeah, look, South Africa’s been a crazy story, which everyone knows about. I mean, we went from probably one of our worst collective quarters as a country in Q1 this year and deal flow being mooted as a result, to suddenly GNU-phoria, optimism, people moving more and more into transacting.

And so I’d say you went from Q1, which was very negative, to Q2, which suddenly became very positive from an optimism and hope perspective, into Q3 where the optimism and hope then began to translate into deal flow. I think in South Africa, it’s been tough to be an entrepreneur for a long time and one of the key things that we do at Westbrooke is we support entrepreneurs with debt or equity funding solutions. In order for us to do that, you need entrepreneurs to do things, so I’d say the South African story for the last few months has been a very good one, which has benefited our private credit businesses.

The theme of South Africa, Ghost – we’ve spoken about this in a previous podcast – for a long time has been that we’ve had much more in the way of demand from investors wanting to invest with us than we’ve had deals available. And for the first time, I think in private credit, we’ve started to see that changing. In South Africa, the private credit and hybrid capital businesses have begun to transact again.

I think we still got a way to go before we see significant volumes coming through, but the GNU has definitely helped there, coupled with obviously declining interest rates now for the first time. I think we’ve seen two 25 basis point interest rate cuts, which also mean that not just is there renewed optimism, but the cost of debt becomes more affordable. And also, investors for the first time become comfortable to recycle money into equity and slightly riskier styles of capital. So that’s been a good story.

And then the other side of our business has been a theme which has been more prevalent for a while which is in the infrastructure, renewable energy space where probably over the course of the last 18 months I think we’ve raised about R350 million in equity capital and that’s allowed us to do 65 transactions over that space of time. This has also been an interesting one because a lot of what we were doing in the beginning was load shedding related. I read an article the other day that I couldn’t believe that I’m talking about – what Eskom will do with excess electricity that doesn’t get utilised! I mean it’s like how quickly the situation has shifted, but in our case our renewables business has much more become one around assisting corporates in a cheaper source of more predictable flow of electricity as opposed to batteries and load shedding solutions and the like.

 

Mohammed Nalla: I mean it’s absolutely remarkable how you’ve seen this massive turnaround in South Africa, not just on the sentiment but just in terms of the activity, interest rates – that’s the flywheel that you talk about. Whenever you see confidence, confidence then flows into investment and that kind of reinvigorates growth. Before we actually move off South Africa into some of those global markets that I do want to touch on, being the UK and the US, I want to ask you one specific question on South Africa. You’ve kind of pre-empted it a little bit when you mentioned the renewable energies perspective. In terms of Westbrooke and some of the activity you’re seeing, is more of that activity coming through from the secondary sector, manufacturing sector, or the consumer facing sectors? Where is that uptick coming from?

Because we’ve seen an uptick in terms of retail sales in South Africa, but you’re also seeing this uptick in terms of pent-up investment. I’m talking real investment in the manufacturing sector, certainly on some of the data prints that are out there. I want to try and marry what you’re seeing on the statistics that are being put out to the actual activity on the ground.

In terms of what you’ve seen, Dino, is that more consumer and consumption focused, is it services focused or are we actually seeing real investment going into the real economy and specifically, let’s call it that secondary sector, what does that look like?

 

Dino Zuccollo: Look, Moe, you got to take a step back and look at what we do. We’re a very focused business and we know exactly what we do and what we don’t do. In the lending space, we’ve got three niches that we look at.

The first is we love to lend to businesses that in and of themselves are lenders and they’re niche generally. We’ve got businesses that work in the legal fraternity that fund niche legal businesses. We’ve got general asset financiers etc.

The second is investment holdcos, businesses that in turn own underlying businesses, quite a few there in the financial services space.

Then a little bit of real estate, but real estate is tricky in South Africa.

So within those three niches, I think what we’ve seen is the asset finance businesses have continued to be strong and certainly call it the general asset finance businesses, an uptick, they’re performing better than what we’ve ever seen. And the underlyings there are all the way from your traditional PABX equipment, whatever it might be, to even things like solar. You’re seeing a lot of activity increasing there.

Investment holdcos are interesting because their levels of activity correlate quite strongly with their views around what’s going to happen into the future. Because oftentimes one looks for equity funding in order to fund follow-on acquisitions through an underlying business, whatever the case may be. I think we benefit indirectly there through a general improvement in the underlying economic conditions in the country.

On the renewable side, like I say, it’s been a total – call it a flip. The demand for load shedding solutions has obviously reduced quite substantially. What we’ve seen a lot of is corporates who are saying, look, NERSA are talking about a 30%, 40% increase in the tariffs and in addition to that, I live in Johannesburg and there’s no load shedding, but that doesn’t mean that the Sydenham power station doesn’t go down weekly, right?

In South Africa, you want certainty around cost escalations and then what you want is certainty of supply, because you can’t afford to be down because of crumbling infrastructure either. We’ve seen a lot of demand there and I don’t think that it’s going to go away anytime soon because the needs are not just around load shedding, the needs are around sustainability and cost as well.

 

The Finance Ghost: I think we have to talk about where we are in the interest rate cycle, just understanding your business as we do. And I would encourage anyone who wants to learn more about Westbrooke, go on to magic-markets.com, literally just search Westbrooke under all our free shows – there must be 10 or 12 shows there, I reckon, where we’ve run through everything that Westbrooke does over the past couple of years and it’s a really, really good primer if you enjoy alternative assets and that whole space, very yield-focused kind of stuff.

But what is interesting about Westbrooke is with your hybrid capital structures etc, you’ve always made a point of saying that you invest throughout the capital stack and alongside the owners of the business as required. You can do the mezzanine structuring. You can do all of that stuff, which is fantastic. So, just thinking out loud about the impact of interest rates on that, now we’re in a decreasing cycle. I think as rates were starting to head higher, it was very good times for your investors and for you at Westbrooke, because alternative lending works quite well in that space. You get quite strong returns. You can just lend out at good yields. Compared to equity markets that get hurt by rising interest rates, it really does look very good.

Obviously markets operate in cycles. I think anyone listening to this is well aware of that. I guess that’s where some of the flexibility comes in for Westbrooke, is you can then tweak your exposures depending on where you are in the cycle. You can do a bit more equity or a bit more mezz or a bit less traditional lending or whatever it is that you need to do in order to react to the macro. It would just be interesting to understand that decreasing interest rates impact on your business and how you react to it.

 

Dino Zuccollo: Yeah, look, it’s fundamental, right? What is interesting to me is that I’ve attended quite a few forums recently discussing these issues and it does seem Ghost like the conventional wisdom at the moment is that the trough of the interest rate cycle is going to be shallower than what was initially anticipated.

Certainly with Trump coming in and the discussion of tariffs on imports etc. that should be an inflationary economic policy. It will be interesting to see to what degree interest rates come down when they do bottom out. But they are coming down and they have started to come down.

And so what does that mean for us? There are a few things that we can do. So, if we move over to the UK for a moment, Westbrooke Yield Plus is our private credit fund in the UK. It’s our flagship product across the business because it is quite big and very widely invested. It’s got north of £200 million of assets, delivers somewhere between 7% and 9% net in sterling and has done so consistently for seven years.

That offering this year used to at the beginning of the year probably have, I’d hazard a guess, north of 85% or 90% of its underlying loans being floating rates in nature. What we’ve done there is we’ve moved approximately half of the portfolio into fixed rate debt in order to pre-empt the potential that interest rates continue to come down and to give investors an actual hedge, should that take place.

The first thing you can do there is you can get clever in the alts space with transaction structuring and that certainly proved to be very popular with clients. I think we’ve had a couple quarterly capital raises now of north of £20 million, which has been really great to see, the trajectory and traction there. But also when interest rates come down, it’s better for equity, right?

So we also, to your point, operate a hybrid capital business. What is hybrid capital? For us, debt is senior debt, generally where you’re playing the role of bank and you’re normally the sole lender. In hybrid capital, it’s generally a little bit more corporate cash flow lending, as opposed to real estate lending, which we do a lot of in the senior lending products.

We do a lot of preferred equity, stretch, senior, etc. so in our hybrid capital business, we might not be the sole lender or the senior lender, but the way our clients look at it is as follows – our senior lending products are very much for them, an alternative to traditional bonds, cash, fixed income, and hybrid capital is an alternative to equity, but in a more protected way because you’ve got the protections of debt, but you can still get some form of equity, upside kickers and participations.

I think with interest rates coming down, hybrid capital and the proposition around hybrid capital becomes much more interesting. Why? Because there you are getting the upside potential or some of the upside potential of equity, but with certain of the downside protections that still are inherent with being a lender, albeit maybe not senior lender.

I think we’ve got a very big journey to walk still in our hybrid capital business. The UK Fund One is delivering, call it just to give you a sense, about 16% in GBP, 15%/16% in GBP. The idea there would be to launch another one to our client base in January, February next year and hopefully in partnership with a senior lender so that we’ve got better control over the capital stack.

So in summary, Ghost, I think private debt remains interesting and will always remain interesting because people need higher yielding alternatives to the less-risky type investments. Hybrid capital becomes more interesting.

Then things like real estate in the US, which we haven’t invested into really for the last four years, becomes something that we are really seriously considering moving back into for the first time in a while. And in fact, it’s the intention of Westbrooke to bring for the first time in three/four years, another real estate equity investment product to our base early next year, most likely in the multi-family space.

 

Mohammed Nalla: Yeah, Dino, you’ve kind of pre-empted my question, because I wanted to move from the UK across to the US. Westbrooke’s presence there is slowly building out. It’s not as large as your presence in South Africa and the UK, but it has been one of the more interesting economies globally. The US has been growing quite strongly, certainly in the consumer side of things. Other sectors have been, as you’ve indicated – real estate for the last couple of years hasn’t been fantastic and maybe now you’re starting to see some of those opportunities start to come through.

Maybe just talk us through what you see that opportunity set looking like in the US, specifically in terms of the demarcation between your debt offerings and then the higher risk, mezzanine and the equity orientated offerings. What does that opportunity set look like?

And then also with the political changes that we’re seeing in the us, does that have any material bearing in terms of your outlook for that particular market and some of those sub-sectors we’ve just touched on?

 

Dino Zuccollo: Yeah. So, Moe, I think the US has historically been a region that we’ve invested quite heavily into real estate. We’ve got two areas of focus there. We’ve got a multi-family portfolio – for South Africans, think like Summercon or Balwin, except we own the entire block and we rent out those units. That’s multi-family, a multi-trillion dollar asset class in the US. We’ve got about a thousand units in that portfolio.

And then we also do manufactured housing in the US which is call it slightly lower LSM housing in America. which is done more like a prefabricated basis. A very tough operating business and obviously higher risk, but with the potential for much higher returns. What we’ve seen in multi-family, Moe, is that albeit that interest rates have been high and have been increasing for a while – and I think it’s pretty typical with real estate. What happens is interest rates go up, buyers adjust the expectation of pricing down, but sellers do not because they have a level of inertia in their minds around what they think their asset is worth. And there’s a level of not arrogance, but you know “this is what my property is worth, I’m not selling it for less. Sorry.”

And so what generally happens in when interest rates go up, in these asset classes you first see liquidity drying up. And that’s the world we’ve been in in the US for probably two, three years is we’ve not gotten there on pricing, but I don’t think much of the market has gotten there on pricing. So you haven’t seen the same level of transaction flow as what you’ve seen historically.

What we are now seeing for the first time is the other two factors having an impact. Sellers have gotten their heads around selling for a slightly lower price and interest rates potentially are coming down. Buyers are prepared to potentially pay a little bit more. So the first time we are starting to see transactions in the real estate space that we think make sense without a hope and a prayer needing to be modelled into your transaction modelling. I think there is an opportunity in America at the moment.

Then I think the other thing that we’re looking to do is build out – and we’ve already seeded it with group capital from Westbrooke – a real-estate-backed lending business in the US which will be very similar in style to what we do in the UK with Westbrooke Yield Plus, but of course with the US flavour – focused on the US and with returns we believe currently probably north of 10% in dollars.

So those for us as a business given our competency set and capabilities is very much where we are focusing, call it real estate equity and real estate debt. To give you a sense again of returns, we think real estate lending can be north of 10% and then in the multi-family space, which is in equity, but obviously very low-risk equity.

I think since 2017, our fund has delivered about 13% to 14% net in dollars. Those are the types of returns that you can expect with a really good manager who’s got the capability of doing these things. But I do think America is a big beast – there are 50 states in America, each one has their own dynamics. Referencing people is really difficult when you’ve come from the other side of the world. You’ve got to have an on-the-ground team. I really think it’s hard to invest in the United States unless you have people on the ground who are plugged into the markets that you operate in. Tax is complicated. So I think whilst being a very attractive investment jurisdiction, you’ve really got to as a potential investor back a manager who’s been there and who knows what they’re doing. The risks are not necessarily the ones that you see when you come into an investment. They’re often the ones that you don’t see which end up tripping you up.

 

The Finance Ghost: Dino, to bring the podcast to a close, because we are pretty much out of time – last question: your biggest surprise this year? Maybe not the obvious one of: hey, Eskom works and has excess electricity and how on earth did that happen? Anything else that maybe jumps to mind – maybe it is that, but anything else that jumps to mind? If you think back a year ago, coming into 2024, where you thought this year was headed versus what has ended up happening? Just curious to know what has really been a big difference for you versus what you thought?

 

Dino Zuccollo: Yeah, I think, Ghost, if you had said to me that South Africa was going to have a GNU and Trump would be president and there’d be all this optimism around the economic future going forward, that actually probably wasn’t the biggest surprise for me. The GNU to some degree was.

But what was a big surprise for me is how difficult it has been to price risk in that context. I think it is exceptionally – and we saw this in Covid, but I didn’t realise necessarily that this year would have the same kind of effect to the degree which it did have. In Covid, what we did is we didn’t know what the future was going to hold when things first unfolded. We didn’t know if the world was headed to a three-year lockdown and financial markets would never have been the same again, or the world would open up and things would go back to the status quo, which bizarrely seems to, by and large, been what’s happened.

So what do you do? You do nothing. And I think that’s maybe the message that I’ll leave the investors with, is that investing, when done right, can be a fantastic thing for your ability to preserve and compound your wealth, for your and your family’s futures prosperity. But the issue with investing is there are always conflicts all over the show. You invest with an asset manager who wants to earn a fee. Their incentives are to get bigger, yours are to make money, etc.

These are not necessarily conflicts that can always be avoided, but they certainly are conflicts that can be managed. Things like how much money does your asset manager invest alongside you? How long have they been doing this? What’s their track record like?

And in years like this, where a big surprise has been that it’s been really hard to quantify exactly what the future holds, and therefore, it’s really hard to work out how to price a deal, there are two ways you can respond to that. You can respond to that by saying, look, we’re under pressure to deploy and therefore we have to go and invest, even though we might get this decision wrong. Or you say no to a lot. And that’s frustrating for me and for my team because they look at a lot. Just to leave you with one stat, for example, just in one of our funds in the UK Hybrid Capital Fund, I think we’ve looked at 73 transactions this year for a combined value of about £1 billion. We’ve closed on one of them and we are working on six. And that’s something I’m actually damn proud of because we could have done more if we wanted to, but we chose not to. And in some instances, that’s exactly what you want from your asset manager.

 

Mohammed Nalla: Indeed. I think that’s a great place to actually leave it, because so often in investment, it’s about saying no. It’s about sitting on your hands. And I think what we’ve certainly found in this particular discussion with you is that Westbrooke is very mature in its approach to the deal flow, making sure you price the deals correctly. You’re not out there just chasing the pipeline. That discipline is very difficult. It’s actually a lot harder than a lot of people think, so kudos to you and the team on effectively turning down 70+ transactions when I’m sure it would have been very tempting to just put those on the book – asset gathering, as you referred to it earlier.

But that’s why I guess your investors are with you, is they know that it’s a team that is responsible, that’s going to deploy capital according to the rules and the parameters that you have set. So, again, congratulations on that.

Unfortunately, that’s where we’re going to leave the show this week. If you’re interested in learning more about this, reach out to Dino and the team at Westbrooke. Their website is in the link in the transcript. You can go and check that out. The team is very approachable if you have specific questions as an investor or as someone who’s actually looking to go and find funding for your next exciting adventure in South Africa, in the UK, in the US – reach out to Dino and the team at Westbrooke.

Dino, it’s been a pleasure having you on the show and we look forward to maybe speaking to you earlier next year when you deploy some of those new funds you’ve told us about. We certainly want to know a little bit more about that, but again, when you’re ready with that, we’ll definitely have you back on the show. Thanks so much for being on Magic Markets.

 

Dino Zuccollo: Thanks so much, Moe, Ghost. I’ll see you up Suikerbossie on the weekend.

 

The Finance Ghost: No, you definitely won’t. I can tell you for free. Not unless I’m driving something. If you see me on a bicycle, it’s because something terrible has happened to me and you should immediately stop and ask me what’s happened. Dino, Thanks. Keep hurting those legs, not your money or anyone else’s and we look forward to seeing our 2025 turns out. Ciao!

 

This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.