Henderson Diversified Income outlines new investment objective and policy – Henderson Diversified Income (HDIV) has released its full year results for the year to 30 April 2021, which includes details on its proposed new investment objective and policy, initiated by the regulatory requirement to transition away from LIBOR to alternative reference rates by the end of 2021. The new proposals are subject to shareholder approval at the upcoming AGM in September.
Although not part of the investment objective and policy, the board is also proposing to change HDIV’s benchmark, effective from the date shareholders approve the new investment objective and policy. The replacement benchmark (which is hedged back to sterling) will be as follows:
- 60% Global High Yield Credit (ICE Bank of America Global High Yield Constrained Index)
- 25% Global Investment Grade Corporate Credit (ICE Bank of America Global BBB Corporate Bond Index)
- 15% European Loans (Credit Suisse Western European Leveraged Loan Index)
Investment objective
The current investment objective is to “seek income and capital growth such that the total return on the net asset value of the company exceeds the average return on a rolling annual basis of three month sterling LIBOR + 2%”. The board proposes to change this to “seek a sustainable level of annual income and capital gains consistent with seeking to reduce the risk of capital losses, by investing in a diversified portfolio of global fixed income and floating rate asset classes”.
The board has also put into place assurances that investments, activities and the activities of service providers are consistent with wider social responsibilities which it believes are a growing priority for stakeholders. It said ESG issues can present both opportunities and threats to long-term investment performance and that constructive engagement with management can be the most effective way of driving meaningful positive change in the behaviour of investee company management. However, as HDIV is largely invested in debt securities, engagement may be lighter touch than in an equity company and so the board is continuing to examine the benefits and risks of including a more explicit ESG objective for the investment portfolio.
Investment policy
The current investment policy aims to deliver its objective by investing in a diversified portfolio of global fixed and floating rate income asset classes including secured loans, government bonds, high yield (sub-investment grade) corporate bonds, unrated corporate bonds, investment grade corporate bonds and asset backed securities. The company may also invest in high yielding equities and derivatives, using a dynamic approach to portfolio allocation across asset classes and is permitted to invest in a single asset class if required. The company seeks a sensible spread of risk at all times and can invest in assets of any size, sector, currency or issued from any country.
The board proposes to deliver its new objective using a dynamic approach to portfolio allocation across asset classes and the managers are permitted to invest in a single asset class if required. The company seeks a sensible spread of risk at all times and can invest in assets of any size, sector, currency or issued from any country.
Results
Meanwhile, HDIV enjoyed a good year of performance with a NAV total return of 13.5% and share price return of 10.7%, both ahead of its current benchmark return of 2.2%. This is however slightly behind the new proposed benchmark, which is up 15.5% during the period under review.
A third interim dividend of 1.10p per share was paid on 31 March 2021 and a fourth interim dividend of 1.10p per share was paid on 30 June 2021 making a total of 4.40p per share for the year, in line with expectations.
Extract from the managers’ report:
Macro Background
In many ways the period under review was fairly easy to navigate. The global COVID fiscal and monetary stimulus continued supporting markets fantastically well. The period was entirely about credit repair, recovery and reflation. The war on COVID led to extraordinary support which was hugely beneficial to the corporate bonds we hold in this Company. In fact, given that COVID was not anybody’s fault it is arguably unlikely we will ever see such widespread support for corporate bonds ever again. In early April 2020 (before the start of this financial year), the Fed crossed the Rubicon and announced they would start buying corporate bonds and ETFs. This was the ultimate signal to “not fight the Fed.”
In reality they only bought a tiny $14bn of corporate bonds as market participants, knowing they had an explicit backstop support, wanted to front run them. Unlike previous crises we have endured this essentially meant that the investment grade and high yield markets were open for business – open at a price, but open.
Many large investment grade businesses tapped the markets for precautionary reasons to bullet proof their balance sheets. 2020 was a period of record issuance and record spread levels and volatility. US investment grade spreads peaked at a scary 4% over Treasury yields in late March 2020 and rallied with frightening speed to only 0.9% – reassuringly expensive, again at 30 April 2021. The snap back in spreads was the fastest on record and was further compounded in the Autumn of 2020 by the exceptionally positive vaccine news and then the market friendly US election result. As mentioned last year we increased gearing where possible to lock in some of these scarily wide corporate bond yields. As the markets matured we then saw more desperate high yield issuers tap the markets – Carnival Cruises has in some ways become the poster child in this crisis for rescue bridging finance – indeed they have raised loans, secured bonds, unsecured bonds, convertible and ordinary equity many times in the last year. Other distressed issues followed suit in names such as AMC Cinemas and Six Flags.
The EU and UK Government’s demonstrated extraordinary levels of state support to vital sectors such as autos, airlines, travel companies etc. These businesses were considered too big to fail. There was of course unprecedented support to employees on furlough type schemes. Governments were desperate to avoid a depression and by using enormous transfer payments they kept money moving around the economy. Life was of course much tougher for smaller businesses who do not have access to financing so easily. Unlike “normal” recessions we have not seen a dramatic fall in incomes nor a rise in unemployment. In addition, we have seen significant demand for physical goods for the home offset by the collapse in demand for services. The COVID crisis has widened inequality between large cap and small businesses but also between wealthy and employed and those less fortunate. The wealthy and retired have been forced savers whilst low income groups have had to borrow to survive. US high yield default rates have been surprisingly low – they peaked around 5.9% in May; with many of the problems in highly cyclical and highly levered sectors such as energy and retail. Projected defaults, per Credit Suisse for the next 12 months are a paltry 2.5%.
Asset Allocation and Stock Selection
We tend to run approximately 20-25% gearing as a neutral level being a combination of financial gearing (borrowing money and investing at a better yield than the cost of the debt) and synthetic gearing (the use of credit derivatives). As discussed in last year’s review we increased this into the eye of the storm in March/April 2020. We were able to add risk profitably whilst many others were forced to reduce gearing, a benefit of our closed-end structure. The gearing has been run at above average levels for much of the period but was reduced into the summer period as valuations returned to more normal levels. In addition, over the period we broadly rotated our better quality investment grade bonds into shorter duration, but higher yielding, high yield bonds as the recovery progressed.
New high yield bonds were bought in both the primary and secondary markets. In keeping with our sensible income philosophy, we favoured larger, less cyclical modern day facing businesses which have a reason to exist in the post COVID era. Some examples include Virgin Media, Davita, Rackspace Technology, Sirius, Broadcom, Avantor, Black Knight, Crowdstrike & Expedia. A lot of these names tend to be American based global technology companies specialising in the modern economy in areas such as media/cable tv, cloud infrastructure, cyber security and payment processing. These businesses are of significant size and proven for the digital age. We feel shareholders are much better served by our holding the bonds of such companies rather than scrapping around in the much smaller and illiquid, old world analogue UK based high yield market.
There are, of course, obvious exceptions, but as a rule we continue to be attracted to the size, depth, breadth and diversity of the US corporate bond markets. Having said that, certain European financials also offer good value. We added some junior banking and insurance bonds to enhance the yield of the portfolio in names such as RBS, Lloyds, Aviva, Direct Line Insurance, ING, Rabobank and Barclays. The banks have had a remarkably good crisis – they went into this period with record levels of capital; they over-provisioned early in the crisis, making prudent use of the more flexible accounting rules. In addition, they have greatly benefitted from the direct and indirect Government support schemes aimed at the UK housing markets and company support schemes. Finally, we have added a little to our loan holdings – although the all in yield is not overly attractive, they do add some diversification and low beta carry to the portfolio.
Outlook
Volatility and measures of distress in credit markets are at 15 year lows. Credit markets are priced tight but arguably fairly given the remarkably benign outlook. In this market it is more important than ever that we keep focused on sensible income and not get drawn to illusory “fools yield” bonds where the yield is so high you are almost guaranteed to lose capital. We are very mindful of value traps, illiquid, esoteric and exotic credits. The COVID crisis accelerated many of the existing structural themes we have spoken about in previous reports and if anything, in the longer term we see a more deflationary world. We completely understand the markets obsession with inflation but feel it is predominately a cyclical and transitory phenomenon. The modest rise in bond yields may well give us an opportunity to lock in higher yields for shareholders and, reassuringly, in the current environment we feel the annual dividend remains secure.
HDIV : Henderson Diversified Income outlines new investment objective and policy