Episode Transcript
The Finance Ghost: Welcome to episode 232 of Magic Markets. It's great to have you here and it's also great to have our guest on the show today. Moe, we haven't had this man in a while and that is Dino Zuccollo from Westbrooke. And we are very stoked to have you back, Dino, because it's always fun to talk to you about the world of alternative investments.
But before I say hello to you, let me at least say hello to Moe, up in a very warm Canada. He was boasting earlier about 35-degree weather outside, which I can tell you for sure we do not have in Cape Town. So Moe, I hope you are enjoying your northern hemisphere summer because I'm not loving the southern hemisphere winter.
Mohammed Nalla: Another truly global show brought to you by Magic Markets. I mean, I'm sitting in Canada, 35 degrees plus humidity. It's quite uncomfortable I must say. Ghost you're down in Cape Town, quite cold. Some cold fronts coming in there.
The Finance Ghost: Lots of humidity though. All the humidity, that I can tell you.
Mohammed Nalla: Well that helps a little bit.
The Finance Ghost: Falling out the sky!
Mohammed Nalla: Dino Zuccollo, you're also enjoying the northern hemisphere summer. At this point in time as we're speaking, you're sitting in London because you're actually very busy on the rollout of this new fund that we're talking to you about today. This week we're not going to wax lyrical on global, we're going to talk somewhat about the WDO UK Fund II. Westbrooke, you've gone on a fantastic capital raise and we want to unpack what's happening in the private asset space with all this volatility we've seen on the macro front. There's a lot of action in the hybrid space, in the alternative space. And Dino, that's why we've brought you in on this show is because we just love to share some of those insights of what actually happens when you hit the ground running. Dino, welcome back to Magic Markets. It's a pleasure having you on the show.
Dino Zuccollo: Thank you, guys. As always, it's an absolute pleasure to be here. I'm not entirely sure what everybody in the UK is moaning about from a heat perspective. I had a jacket on for the entirety of the day, but it is raining outside, so hopefully as the rest of the week goes by, it'll warm up. But it might also just be that we're conditioned for South Africa.
The Finance Ghost: Yeah, I think so. Those UK summers are a very relative term, of course. And I think we'll move on from the rainfall into how it's been raining in the markets because it has been a pretty wild year of stuff going on out there. It's quite weird because it feels like we've come out okay, but there was quite a roller coaster to get there. And obviously we've been talking about this a lot on Magic Markets, all of the geopolitical things that have happened, what's going on in the markets, etc. There's been a lot to look at.
And from our previous discussions with you, one of the highlights that you always reference in the world of alternatives is how they are just less volatile. Now, obviously, unlisted assets are not completely divorced from listed assets. They're just not marked-to-market every day. But they also don't get all the investor emotions that come through in the listed asset space.
So, I think let's start there and just, you know - we haven't spoken to you in a while. Let's just get a lay of the land of how this year has been in terms of, you know, your clients, your views on alternatives, and just whether or not it's lived up to the promise in what has been a very volatile time.
Dino Zuccollo: Yeah, Ghost. So many things to unpack in that question. Look, last year from a Westbrooke perspective was a very quiet year in terms of where we invested. We invested very much in the private credit space, so the least risky part of the capital structure. And investors certainly found refuge in the predictability of private credit.
This year has been different. We obviously started the year, I think, on quite a positive. We had interest rates which had been coming down. We had a Trump presidency which, at least initially, everyone thought was going to be very good for the market, and optimism resulted in the opportunity set both globally and locally in South Africa opening up.
In South Africa, I think by the beginning of this year, a little bit of the reality of GNU had set in, which was that there was a lot of, I suppose, optimism that then gave way to the realities of the fact that the South African market is still tough. And so things maybe in South Africa a bit slower, but certainly in our UK and US businesses, a lot more interest. And so as a consequence, what came from that has been a lot of deals. And, you know, in the strategy presentation every year when you plan your year out, you're going to give your clients a very smooth ride in terms of what you're going to offer them and when. And then the reality of life is that transactions come your way when they come your way. And at least in our instance, we had - I mean, I was just rattling off the list to you. I think three different offerings in the UK, two in the USA and one in SA, all came more or less consistently.
So I think the opening gambit, Ghost, is that it's been very active in the private market space, notwithstanding the fact that we've had wars and tariffs and all sorts of interesting things happening globally.
And maybe just the other point on that which is relevant to mention is that all of those things that I've just mentioned give rise to volatility, right? I mean, if you kind of look at traditional markets today, there are less listed companies today, significantly less than what there were 20, 30 years ago. So you've got more market cap in fewer businesses. And the bond equity correlation is now positive and strongly so, I think over 70%, 80%.
So you've got improving pipeline in alternatives and then also increasing demand on the part of the client base for something different, because they just are struggling to stomach the wild ride that is happening in highly correlated listed market portfolios in a volatile world.
Mohammed Nalla: Dino, I'm glad you touched on that stock-bond correlation point, because when we're talking to Westbrooke, you play throughout the entire capital stack. You've got stuff in the fixed income space, you've got stuff in the private equity space. What I want to get into is your hybrid offering that I've just mentioned, kind of the intro, but I just want to touch on briefly that point around the stock and bond correlation, because there are a couple of things at play there.
I think Westbrooke's benefit here is that you've got exposure, as you indicate, to the US. You then have exposure to the UK, Europe as well. And the economic cycles there are somewhat out of sync at this point in time. You know, lots of uncertainty in the US, so it is a little bit surprising you're seeing some deal flow come through from there as well, some question marks around US exceptionalism.
But the UK, Europe, that on a macro level has been looking as though there's a lot more activity coming through. So interested in some of those dynamics, but then also interested in terms of the fact that, as we indicate and I think you indicated this in the thought piece that you put out recently, when you've got global inflation around 2.5% and above, that's when you see the correlation between stocks and bonds actually increasing.
So, have you seen a difference between your US operations, what's happening there versus Europe? Because there's currently a little bit of a disconnect between what's happening on the European yield curve versus what's happening on the US yield curve. Just again, premised on the market has no idea what's going to happen with inflation, with the backdrop of this US trade tariff tantrum.
A couple of questions laid in there, but what's your view and what's your thinking on the market dynamics in that space? And does that correlation continue to increase or is it different based on geography?
Dino Zuccollo: Yeah, I mean, Moe it's such a nuanced answer that - in the space of two days last week, I had a client tell me that they will only do US dollars because they're really worried about the UK economy and what's going to happen here and the outlook for the pound. And then almost less than 24 hours later, a client tell me that under no circumstances will they invest in the US because they are so worried about the fortunes of the US and the dollar is overpriced relative to the pound.
And it depends on what President Trump says tomorrow morning, what the next outlook will be geopolitically. We've got a tariff deadline coming in. There is so much noise in the world. There are wars breaking out and ceasefires and then not - I think the world you live in today, taking macro views on things, is just a really complicated place to be. And that is why I like the world of alternatives in our positioning.
Because, you know, first of all, private markets, you can get much more clever by investing into niches where there's high levels of asymmetric return, so more return for the risk, but also in our positioning as Westbrooke, we're playing in lower middle markets. In South Africa, we're probably middle market. In the UK and the US, we’re lower-middle markets. So it's almost irrelevant what the macro is doing because we're in such small niches - we've done two private equity transactions in the UK this year. I mean, it's not even a number, for the world of private equity investing in the UK, let alone globally. But for us, that's £25 million of equity that we've used to buy two businesses worth, call it £60, £70 million collectively, that will generate really good returns for our clients, so the answer to your question is that there's a lot of volatility, no one really knows what the future holds. Private markets give you an element of lower correlation to all of that. And actually sometimes in our world, in tough markets, you can extract better returns than in good markets because there's less provision of capital.
But, and maybe this Moe, comes back to the hybrid fund. Where we have seen the biggest traction by and large in our business is in the world of hybrid capital. And that is because investors recognise the need for double-digit returns in hard currency, equity-like returns. But in the world that we're living today, it's much better to have better protection than to just be a naked equity investor in the business. And so if you can find the holy grail of investing, which is equity-like return with debt-like risk, that that is probably the place to be at the moment if you're a South African investor looking for hard currency, global exposure.
The Finance Ghost: Yeah. So I found that super interesting what you said about the currency earlier because it shows it's not such an obvious answer anymore where everyone was just diving into US assets at any price. What's going on in the world means that the US assets will have to compete for capital now just like everyone else. And I think that's quite an exciting opportunity for businesses outside of the US, like what you're doing in the UK for example, and certainly elsewhere in the world.
The term hybrid capital is something that Magic Markets listeners haven't heard in a while. So I think it's worth digging into what that is at the end of the day - and that's a really good opportunity to then also tell us more about this R3.8 billion fund that you've raised in the UK in partnership with RMB.
To your point, R3.8 billion is a lot of money, but in the UK market it's a handful of transactions of decent size and you can kind of - not skate under the radar necessarily, but you don't have to chase the big hype assets, you don't have to compete with the big private equity houses that need to do blockbuster deals. You can actually go and buy some really interesting stuff and use that hybrid capital expertise. So I'm going to open the floor to you there to just take us through some of the concepts of hybrid capital and also what this fund is all about.
Dino Zuccollo: Yeah, so let's start with hybrid capital, then we'll talk about the funds. So hybrid capital, I mean, maybe to take a step back at a typical capital stack of a business. So a business has got various levels of capital invested in it - generally senior debt, some businesses might then have junior debt, which ranks after a bank, but just in the secured debt piece of the cap stack. And then some businesses thereafter will have preferred equity and then vanilla equity. And there's different sort of combinations of that capital structure at play. Simple businesses will just have a lender and some equity and more complex capital structures could have a little bit of all of that.
In hybrid capital, what we do is we provide funding packages to borrowers who in the UK market, Ghost, are generally private equity sponsors and management teams, more often private equity sponsors these days than owners, but a combination of both, where those owners are looking for a funding package that does not simply play in the world of just senior debt and/or just play in the world of mezzanine debt. So what we did for many years historically was we would invest into, let's say, a second charge senior piece after a bank, right? And then you would have a combination of different lenders and equity holders in a single business.
Now that's fine and that's a very typical capital structure. However, what it does give is it gives rise to a lot of complexity. As an owner of a business, you've now got multiple parties that you need to deal with. And of course, in the event that something goes wrong, now there are a lot of different people at the table with competing agendas looking to work out what they would like and to protect their own interests.
And so what we've worked out over the years, Ghost, is that if you can come as a lender and give a borrower a single funding package that blends all the way from senior debt into second charge senior debt, and maybe even a little bit there beyond there, be it into mezzanine debt or preferred equity, but you can give that to a borrower in a single funding package at one rate that is blended across the different types of capital, that can make you really competitive. And it makes you really competitive because you take all of the friction out of a lending process and at the same time, you now have all the control in a single transaction.
So what we did this year in our second hybrid capital fund on the back of our first fund that did really well and continues to perform, we have partnered up with Rand Merchant Bank in South Africa where we've created a vehicle and that vehicle effectively is capitalized as a combination of equity investment from our clients and then some debt that RMB have put in. And in totality that vehicle's now got £155 million available to go into the UK market in the corporate lending space and do exactly what I've just mentioned, which is to provide sort of combination hybrid capital facilities to borrowers in and around the UK. The relationship with RMB is an amazing one, we think that they're a real top-tier organization. We obviously are very close with them.
And from our clients’ perspective, I think Ghost, it's given a huge amount of comfort that there are now two what they consider to be really smart parties at the table looking at transactions, be it both Westbrooke and RMB. And of course from the investor proposition perspective, that fund targets an overall return of 15% and above per annum in sterling, which incorporates a cash yield of 6% to 8% as well. I mean that's very much in the world of getting close to equity-like returns, but for debt-like risk.
Mohammed Nalla: Dino, you've almost pre-empted my next question. I was going to say, if you're playing in that mid-market segment, lower- to middle-market segment, what kind of returns are you targeting? I think you've answered that.
I want to maybe even just step back a little bit because if you're operating in that lower- to middle-market segment, does that fundamentally change the type of opportunities you're pursuing? I mean, obviously it comes with higher returns, arguably, targeted. But what does that do for your risk profile?
Because I think your business model is quite interesting, in that offering that one-stop-shop approach really takes the friction away from the small business owner. So maybe if you can answer the question around what does it do for your risk profile specifically?
And then also, I want to touch on a point because you've mentioned your initial fund that was very successful. We've got these targeted returns. What were the targeted returns there and what were the realised returns? Because that should also give investors some sort of line of sight. I mean, obviously you don't look to history and say it can be replicated, but it gives someone some line of sight in terms of the track record of delivery versus what you're aiming at.
Dino Zuccollo: Yeah. So I'll start on the second question first. So Fund I – Fund I had a different model. We only did the junior debt or the mezzanine debt piece alongside a bank. Fund I was launched two and a half years ago, Moe. It invested into seven transactions around the UK. It was smaller. It has to date returned 35% of our clients’ capital back to them in cash already, through a combination of the dividend yield that I spoke about earlier. And then we had two exits in the underlying fund and it is currently targeting a 15% return in pounds. So the same as what we're targeting on Fund II. And that incorporates, I think, an 8% to 9% cash yield that's being paid out there. So Fund I has done nicely. We think there might even be a little bit of conservatism in the valuations. And really it's been on the back of that that we've launched Fund II and have enjoyed the support from our clients.
Interestingly, Moe, what is Fund II targeting? Fund II is targeting businesses that deliver EBITDA of between £4 and probably £10 million, right? So that's R100 to R250 million EBITDA businesses which are generally trading on multiples of maybe six to eight, even ten times, in and around there, in the UK. So you can work it out. I mean, these are big businesses worth half a billion rand and more. And it's, it's an interesting thing, even when you look at the fundraise that we've just done, R3.8 billion, £155 million. You know, it's when you start to convert, these things get interesting.
So I'd say that the businesses we're lending to are of high quality and they are of material scale, but they have a long scope still to go and for growth. There is no doubt that if you look at the Westbrooke UK private lending ecosystem, the other fund that we have is a senior lending fund against real estate called Yield Plus, which you'll have heard about, no doubt, on podcasts gone by - that's delivering like 8%, but it's ungeared, it doesn't have the RMB relationship.
So corporate lending, Moe, I would say, is riskier than real estate lending, but on the other side, you are definitely compensated with a higher return. I think one of the things that we were very keen to do in Fund II, or two of the things, was firstly to create a portfolio for clients because, and this is interesting - we modelled it out, what happens if one - in our 15% base case Moe, we assume that two loans underperform and they just give us capital back. We don't make any returns on the loans. But then we said okay, well what happens if one - and we're talking eight to 12 transactions in the portfolio, so relatively concentrated in an 18 month drawdown period - what happens if one of those loans goes belly-up and gives us nothing back? Then your 15% moves to like 12.5% / 13% and if you have two total losses of capital in the portfolio, you're just over 10%.
And I think this for me is what becomes compelling is that when portfolio theory is allowed to take over, because in corporate lending you are being paid for taking the risk. Even if things don't go according to plan 100%, the assets that perform more than make up for the ones that underperform, such that on a portfolio basis you're probably okay.
I think where the risk comes in personally, is if you're doing these types of hybrid capital loans to single underlying borrowers on a syndicated basis, then it's probably fair to say that your risk-return is a little bit less skewed in the investor's favour.
Mohammed Nalla: Dino, I want to jump in again because again I think you've addressed some questions - I had a question around cash drag and you've indicated that you've got an 18-month drawdown period. So that addresses that point. A point you've mentioned - the point on your previous fund where you had the exit, so you had the greater than 30% return – partially capital, partially the dividend that came through. In terms of that, these funds are closed-ended funds. You effectively raise the capital, you then deploy it over a period of time.
What is the typical life cycle of the fund? You've obviously now closed the fund. You're going to deploy that capital over 18 months. How long before investors actually start seeing (a) cash flows, (b) exits, and then when do you actually wind the fund up?
Dino Zuccollo: I think it's important to say Moe that we will do a small second close. So we want to take that £155 million to more like £170/£175 million. So September/October this year we'll bring a little bit more money in, for any investors who are interested…
Mohammed Nalla: …because your pipeline is so strong! Because that was also a secondary question I had in the back of my mind is: what does the pipeline look like? Is 18 months just being conservative? How quickly can you actually deploy this?
Dino Zuccollo: Yeah, I think 18 months is the right number. If we need a bit more, 24, but we won't go, we typically don't like to go longer than that. Our clients prefer to have a slightly higher line of sight into when their money is going to be deployed. And they don't like having these long drawdown periods sort of hanging over their heads.
And then coming to your second point, Moe, so the way we've done this is that typically the loans that we structure are three to five year loans in duration. However, and this is really important - when you make a unitranche loan to a high-quality business that generates a lot of cash flow, which we always do, what you find, Moe, is that what was a loan initially that went through the senior into the stretch senior and was a slightly higher level of leverage - if you write a loan where the business traps the cash so they're not allowed to pull cash out, they quickly pay down the debt. And so what happens in a very short space of time, 18- to 24-months, often, is that businesses that had taken out what was appropriately priced debt from us at the time, are now paying quite expensive unitranche rates for debt that has amortised such that it's actually just senior debt. So the way we do that is we normally negotiate what we call an interest-make-whole period. If a borrower chooses to pay us back shorter than in 18 months or 24 months or whatever the time period is, there's a penalty involved. But when those periods come to an end, we are generally, especially when the businesses perform really well, paid back quite quickly by them thereafter. And so the way we structure the fund is that there's no reinvestment rights. When any of the capital comes back from the underlying loans, we can't take that money in the fund and redeploy it. We pay it back to our investors. And then the way we explain that to investors is that you then have the ability, if you want to recycle that money into Fund III when we're raising Fund III, which will be in 18 months’ time.
So there's a lot of capital that comes back by way of exits. And of course as soon as we've deployed, we will never do a transaction that is only accrued from an interest perspective. We want there to be some level of serviceability in the loan because ultimately cash flow is your best risk mitigant and so that dividend yield on the portion of clients capital that's been invested will begin to come through from day one.
The Finance Ghost: Dino, I just want to maybe, while we still have some time, touch on some of the underlying assets and the characteristics that you look for. Because you've got to find this really interesting combination of something that can absorb the debt-like protections, so that would typically mean stuff that's generating reliable cash flows, maybe it's got some fixed assets that you can hang your hat on. That naturally is why your previous Yield Plus efforts - well, that ongoing fund has had a lot of property exposure I would think. But if you're looking for the double-digit hard currency returns as you've talked about, and looking for equity upside where you can and the deals that really do well, then you've got to find stuff that can grow.
And Europe is not necessarily famous for growth, but of course there are pockets of it. And this whole thesis around the Europe industrial engine being switched on again is quite interesting and maybe there are some UK companies that benefit from that. So I think that's maybe a nice place to start to bring this to a close is just to the extent you can share some of the sectors where you're seeing really juicy activity, deals you've done and maybe just the characteristics of the kind of assets you're buying that make up this fund.
Dino Zuccollo: Yeah, Ghost, we've taken a lot of the principles from the way we invest in private equity. So this fund only does UK investments and there are some exclusions. So we won't do property, we don't generally do any primary agriculture, metals and mining, those kinds of things, and property developments. And then when we look at businesses Ghost, there's certain characteristics that as Westbrooke we look for, as opposed to boxing ourselves in, in terms of industries.
So that's generally a business, firstly that's run and operated by a highly qualified management team that we can reference really well - it's like the starting point for anything that Westbrooke does in terms of our Investment and Risk Philosophy and Approach is if you aren't dealing with competent and honest people, don't pass begin. And then we like businesses that are highly cash flow generative. So normally a ratio of sort of 70% and above of EBITDA converting into cash is something that's quite important to us.
We like businesses that are in niche sectors. So if you look at some of the transactions that we've done in Fund I, there's a business that manufactures fireproof doors that get sold into apartment blocks in the UK that benefits from a regulatory tailwind. Then there's two different education businesses in the fund as well that are training either young learners or nursery school teachers to operate in their respective industries. Those are both good examples of niche businesses that have regulatory tailwinds and that are what we would refer to as being structurally advantaged in the way that they’re set up. They're not that easy to find, but at a cadence in our view of one transaction a quarter, we're pretty comfortable in our ability to deploy the fund.
And that just, Moe to your earlier point, is the logic around the second close, which is we've got this pool of capital to the extent that the pipeline is strong and as strong as anticipated, then we'll do the second close and if not, then we won't. And it gives you that optionality on either side of fund size.
Mohammed Nalla: Dino, I think that's great colour. Unfortunately, we're running out of time. I do have one last pressing question which is just relevant, right? It's how do investors access this? Because we've touched on this in previous shows. But where can investors go for further information, you can refer them to your website or your socials. How accessible is this? What are your minimum sizes, lock in periods? What are the practicalities, the nuts and bolts of investing in this UK II fund?
Dino Zuccollo: So this fund firstly is marketed in South Africa under a CIPC-approved prospectus. So we've done all the regulatory bells and whistles that are necessary to take it to the market. It is a Jersey-domiciled fund which you invest hard currency into. There are two share classes, there's one where we draw the money from you over an 18 month period. There's another one where for the ease of admin, we take all the money up front and invest it in treasury management strategy and do the capital calls for you.
If a client wants to invest. I think the website is the best place to go. Follow the UK and then dynamic opportunities. You'll find a lot more information there. You can apply, you can ask us more questions, etc. If you are going to come in directly, the minimums are generally £250,000, so they are higher. But remember that this is a pool of let's say 10 underlying transactions. That actually equates to only £25,000 per deal over a 18-to 24-month period.
And if you would like a lower minimum, we would suggest that you get hold of your wealth advisor because generally in Westbrooke's ecosystem, wealth advisors we see as aggregators, they bring lots of clients and some of them might be smaller, but for us that's no problem. And so the minimums for wealth is generally £100,000, which provides a slightly lower access point. And of course you're welcome to get hold of me as well through the normal channels, either via the website or LinkedIn or X. I'm available on most of the platforms.
The Finance Ghost: Yeah, Dino, thanks. It's been really, really nice to have you back on the show. It's lovely to see what you guys have been up to at Westbrooke and to our listeners, there's so much stuff you can go and listen to from Westbrooke on the Magic Markets platform. So go on our website, just search Westbrooke, you'll find lots of examples. In the show notes, we'll link a couple of other relatively recent shows. Dino, good luck for deploying this money and getting this across the line. We look forward to some feedback later this year. We hope to have you back and hopefully see how it's all gone and watch you go from success to success. So thanks for coming back and telling us what's going on out there and as I say, good luck with navigating this market.
Dino Zuccollo: Yeah, it's a pleasure, guys. Thank you for having me. And next show we'll bring the Deal team on to talk about some of the transactions they've done in the fund.
The Finance Ghost: That'll be great, thank you.
Mohammed Nalla: Thank you to our listeners. Find us on X, it's @MagicMarketsPod, @FinanceGhost and @MohammedNalla, or go and find us on LinkedIn. Pop us a note on there. We hope you enjoyed this. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
