Invesco Enhanced Income (formerly Invesco Perpetual Enhanced Income) (IPE) predominantly invests in high yielding corporate and government bonds. The company has this morning reported interim results to 31 March 2020. IPE delivered a total NAV return of (13.4%), which compares to 3 month LIBOR of +0.4%. The share price premium decreased from 1.3% to a discount of (9.2%). Since the end of the reporting period, the company has returned to a premium and has recommenced issuance of shares. In the view of IPE, this reflects not only the improving market environment but also the company’s strong performance relative to both its peers and 3 month LIBOR. We also note that borrowing at the period end was 19% gross and 14% net of cash balances.
Dividend policy unchanged
In her outlook statement, IPE’s chair, Kate Bolsover, noted: “During this extremely challenging time, there has been no material change in portfolio strategy. The company’s closed ended structure means the Manager does not have to realise investments in these volatile markets to meet redemptions. It enables the Manager to utilise borrowings to take advantage of opportunities to purchase bonds at attractive prices and enhance income as and when they present themselves. The company has material revenue reserves available to support the payment of the quarterly dividend. The company’s dividend policy remains unchanged and, whilst the board is closely monitoring developments throughout the covid-19 crisis, it remains confident that the portfolio is in good hands.”
Review from managers Paul Read, Paul Causer and Rhys Davies – rising defaults inevitable under the recessionary backdrop
“The performance of the high yield bond market over the six months to the 31 March 2020 was dominated by the market’s reaction to the impact of covid-19 in late February and March 2020. The deterioration in sentiment was further compounded by a collapse in the oil price. This had a significant impact on the US high yield market, which has a high number of energy companies.
By end of March, most countries across the world had, in response to the virus, introduced some form of lockdown. Economic activity has been significantly curtailed and many companies shuttered.
The world’s central banks have responded to these shocks with unprecedented stimulus, slashing interest rates and restarting Quantitative Easing programmes. In the US, the Federal Reserve has committed to direct support of the corporate bond market including the unprecedented step of announcing it will purchase high yield bonds under certain conditions. After a very sharp market correction from late February, these announcements sparked the biggest rally in high yield bonds since the global financial crisis in 2008.
Large fiscal policy stimulus programmes have also been a part of the response of many governments. This has included loans and support for companies. Nonetheless, the period has been extremely difficult for many companies, in particular those in leisure, travel and parts of the retail sector. For many companies the impact of this crisis will be felt for some time.
The banking sector has also come under pressure and many banks have announced that they are stopping dividends, in-line with recommendations from both the European Central Bank and the Bank of England. The payment of interest on bank capital bonds, including additional tier 1 (AT1) bonds, is not affected.
Unsurprisingly, this difficult environment for companies has led the rating agencies to revise their predictions of default rates higher. The market has also aggressively repriced the risk of default with large moves in credit spreads (the premium over government bonds that companies need to pay to borrow). By 31 March 2020 European high yield spreads had increased to 854 basis points (bps). This compares to a level of 405 bps at the 30 September 2019 and a low of 316 in mid-January 2020.
With a recessionary backdrop it is inevitable that default rates will rise, and indeed we have already observed several high yield issuers appoint financial advisors with a view to restructuring their debt.”
Portfolio strategy – subordinated financials the largest allocation and banking sector much stronger than in 2008
“The company entered the crisis on a relatively strong footing. The portfolio was cautiously positioned by the end of 2019, which was a natural response to yields having fallen so much and our sober view on valuations. At the very early stages of the virus outbreak we raised cash in the portfolio significantly. This defensive stance, combined with the closed-ended structure, meant that we were well positioned to take advantage of the re-pricing that occurred. Slowly and cautiously credit risk was added.
The focus of these purchases was on companies that we think have the balance sheet and business profile to survive the economic shock. Names added included Ziggo, Pinewood, IHO Schaeffler and Teva. The financial sector also provided some very attractive opportunities during March. Both Senior and AT1 bonds were added across multiple issuers with a focus on large European banks.
Following these purchases, subordinated financials remain the fund’s largest sectoral allocation. Despite European banks having been asked to halt dividends and share buy-backs, the current situation is very different to the 2008 crisis. Then, banks and other financial institutions were the problem. This is a real economy shock and banks have come into it with much stronger liquidity and higher capital levels and asset quality. The announcement to halt shareholder payments has no bearing on banks’ intentions to pay AT1 coupons and we believe they will continue to do so. Outside of subordinated financials, the three largest sectors in the portfolio are telecoms, food and utilities.
Over the period under review, the Company’s NAV fell from 74.2p to 62.1p. The NAV total return was –13.4%. The portfolio maintained gross borrowing of 19%.”
Outlook
“High yield bond markets have repriced to reflect the severe economic shock that the crisis is inflicting. A lack of market liquidity at the start of the crisis exacerbated price moves and created some very attractive opportunities for the company. We were able to add positions to the portfolio, buying bonds from companies that we believe have a balance sheet and business profile that can survive.
Looking ahead, although markets have rallied from the lows of 23 March 2020, credit spreads still offer some of the best value we have seen for many years. That said, there are undoubtedly challenging times ahead for many companies and default rates are likely to increase. A thorough and comprehensive analysis of each issuer and maintaining a diversified portfolio remain a crucial part of our approach, as we seek to add exposure and lock in value for when markets do recover.”
IPE: Invesco Enhanced Income looks for balance between credit spread opportunities and likelihood of rise in defaults