TwentyFour Select Monthly Income’s 5.2% year-end NAV return led by banking and insurance sectors – Over the year ended 30 September 2019 TwentyFour Select Monthly Income (SMIF) says it performed in line with expectations, generating an NAV total return of 5.16% for the year. As a comparison the Euro high yield index generated a total return of 5.22% over the period, the Sterling high yield 6.25% and Dollar high yield indices 6.30%. The best performing sectors for the fund were banking and insurance while negative performance came from European high yield corporates and North American high yield
Extract from the chair’s statement
SMIF’s chair, Claire Whittet, had this to say: “The financial year started with challenging conditions for investors with largely weaker corporate earnings, slower global growth expectations from the International Monetary Fund (“IMF”) and a very hawkish October 2018 commentary from the Federal Reserve (“Fed”). Sentiment was impacted when Fed Chair, Powell raised the possibility of Fed Funds being tightened beyond the perceived neutral rate, creating fears of a policy error. As a result global stock markets had the worst month in 6 years and the benchmark 10 year US Treasury yield breached the 3.25% resistance level. Geopolitical fears and comments from President Trump reiterating his disapproval of Powell and the Fed’s tightening bias added further to volatility.
Over the reporting period sentiment was pulled in different directions by trade talks between USA and China and the emergence of tensions between the EU and USA over EU state subsidies added to concerns over the economic outlook in Europe. Narratives relating to these tensions continue to impact sentiment, volatility and the economic outlook and these remain unresolved.
Volatility in European assets remained relatively high driven by a difficult political backdrop and poor economic performance. Germany is especially sensitive to a fall in global trade and to the ongoing trade disputes and falling factory orders were an area of concern for investors and policy makers. Reflecting this Mario Draghi struck a dovish note, stating that the European Central Bank (“ECB”) saw risks tilted to the downside and ‘they stood ready to adjust all instruments if necessary’. Draghi delivered on this in September 2019, announcing a further cut in the ECB refinancing rate to -50bps, further quantitative easing (“QE”) from 1 November 2019 and tiering for bank reserve deposits held at the ECB. It remains to be seen if this policy will succeed in the ‘real economy’ but markets responded favourably.
The portfolio managers recognised that the weaker sentiment and heightened volatility in Q4 2018 was an intra-cycle dip, rather than the start of an end-of-cycle period, and took the opportunity, to selectively add favoured credits at the shorter end of the credit curve. However, a lack of new issuance volume impaired secondary market flows limiting the availability of suitable assets. Despite demand for tap issues the portfolio managers declined a number of requests for new share issuance and only £3m of new shares were issued over the year.
Despite considerable economic uncertainty, geopolitical volatility and a very challenging period for markets in Q4 2018, the fund generated a respectable return over the financial year. The total return based on reinvestment of dividends for the year was 5.16% (NAV per Share). Reflecting the difficult backdrop the 3 months to 31 December 2018 produced a negative return of 2.92% but the last 9 months generated a strong 7.94% return.
Once again the key outperforming sector for the year was Banking, where the portfolio managers continue to be very selective. The net contribution from the banking sector was 2.92%, or 57% of the total return for the Fund, despite representing only 35% of the average allocation during the period. Insurance was another key performing sector generating a net contribution of 0.99%. The allocation to asset backed securities (“ABS”) averaged 28% through the year but contributed a net 1.17% of the return, as the bonds were slow to recover from the sharp sell-off in late 2018. The portfolio managers still consider the sector to represent relative value and maintain the exposure. The only sectors where there were negative returns for the year were in European high yield corporates (net contribution -0.17%) and North American high yield corporates (net contribution -0.54%). These were primarily due to the underperformance in the French paper and pulp company, Lecta and US energy producer, EP Energy.
This economic and credit cycle is now extended and whilst defaults and recover rates remain attractive an expectation that this will not remain so forever is not unreasonable. Although the manager does not currently anticipate a significant change to existing conditions, we must be mindful that the quality of the general credit universe has fallen over the past decade. Favourable issuance terms have led to relaxed covenants and lower yields enabling weaker companies to refinance, often with extended maturities.
As a credit fund we are exposed to a deterioration in the credit environment and the higher yield we generate is a reward of illiquidity and credit risks. The focus of the Manager is very bottom up and is built on a strong understanding of each security held and the specific drivers of credit. This centres on only buying securities that satisfy strict criteria and then closely monitoring these, thus helping mitigate many risks more top down strategies incur.
The closed ended structure for this fund was chosen to enable the manager to exploit the illiquidity premium on certain types of fixed income security. This dramatically reduces any mismatch between the liquidity of the fund and that of the underlying assets held, making this the most prudent way to hold such assets.
However, recent comments by Powell and Carney, Head of the Bank of England, about potential illiquidity in fixed income markets is a warning that the cost and availability of liquidity is not constant. High demand for fixed income products coupled with low yields and spreads has ensured robust issuance activity reducing the cost to deploy funds but secondary market liquidity can be problematic due to changes in the market eco-system including regulatory reforms.
The current economic expansion is the longest in modern history and hence investor sentiment is becoming more fragile. Geopolitical risks remain elevated and with global growth declining and economic risk growing the portfolio managers anticipate more frequent periods of volatility as the end of this cycle approaches. They intend to utilise any heightened volatility to source suitable new assets and maintain the relatively attractive yield without taking increased risks. As such the portfolio managers are confident that the company’s income will continue to be sufficient to maintain the 0.5p dividend per month for the year ahead.”
SMIF: TwentyFour Select Monthly Income’s 5.2% year-end NAV return led by banking and insurance sectors