[Update 3/25/2019: The SEC has now filed suit against Direct Lending Investments charging the firm “with a multi-year fraud that resulted in approximately $11 million in over-charges of management and performance fees to its private funds, as well as the inflation of the private funds’ returns.” Bloomberg has more on the story here.]
Direct Lending Investments is one of the largest fund managers in the alternative lending space. I was an early investor in their first fund and over the years I documented my returns and experience on Lend Academy.
Earlier this month Brendan Ross, the CEO of Direct Lending Investments, Inc., sent a letter to investors notifying them that they have suspended withdrawals and redemptions effective February 8, 2019. Lend Academy was able to obtain a copy of this investor letter, dated February 11, that provides some color into what happened. The reason given was the delinquency of a large holding, VOIP Guardian, a telecom receivables factoring company.
The total assets in the fund as of November 30, 2018 was $758 million and the principal balance with VOIP Guardian was $192 million or 25% of the total. What has happened apparently is the telecom companies that do business with VOIP Guardian have failed to pay their obligations. From the investor letter:
VOIP Guardian’s amounts due from these delinquent obligors is now $160 million, with the result that VOIP Guardian in turn remains unable to make its payments due to the Funds. We now suspect that the cessation of payments is the likely result of misconduct (although we have not yet determined by whom) and that a substantial portion of the $160 million may not be recoverable.
A recent Bloomberg article quoted the CEO of VOIP Guardian saying that some long time clients stopped paying their bills and that his company has done nothing wrong. We don’t know why these companies have stopped paying their bills and that matter is currently being investigated.
Now, I should point out that I was an investor in the Direct Lending Investments fund but I was redeemed from the fund as of June 30, 2017. I did not initiate this redemption, it was a mutually agreed upon decision because DLI did not want me sharing my returns from the fund publicly. At the time I was disappointed because it had been my best performing lending investment for many years.
Many existing investors have reached out to me asking for my opinion and what can be done. Unfortunately, investors have little choice but to ride this out. Again, here is what Brendan says in the investor letter:
The General Partner and the Board took this action because they determined in good faith that such a suspension is advisable to protect the Funds, including because it would be inappropriate to use the Funds’ liquid assets to redeem some investors ahead of other investors. The General Partner and the Board currently expect that the suspension will be in effect for an extended period of time. The Funds may make distributions and payments during this period if they determine that it is appropriate and if the Funds’ liquidity so permits.
During the suspension they will not collect performance fees or any management fees on the portion of the fund attributable to VOIP Guardian. But how much principal is returned to investors is dependent upon how much of the $192 million is recovered.
My first reaction when I heard this news was disappointment. I have been a fan of the pioneering work Brendan has done in this industry and I know how hard he has worked to build up this fund. This must a bitter blow for him personally because he has put his heart and soul, not to mention his own assets, into his company.
Now, to have 25% of the fund in one holding seems high to me and in hindsight was clearly not a good move. But when a high yield holding performs well for many years you can understand the reasoning to increase the allocation. When I went back and looked at my 2015 annual report from the fund VOIP Guardian was just under $33 million or 8% of the fund at that time (the investment began in October 2015). A year later that amount had grown to almost $99 million.
I know Brendan will do everything he can to recover the money that is owed. But it seems highly likely that investors will suffer some kind of principal loss. It is a tough reminder that higher yielding investments usually means a higher level of risk. I have had conversations with a few of the investors in the fund over the past couple of weeks and most have been resigned to the fact they will lose some principal.
I will be following this story and will share more when there are new developments.