Inflation a ‘major danger’ warns CQS New City High Yield’s Franco – CQS New City High Yield (NCYF) has posted its interim results for the six months to 31 December 2021, during which time it achieved an NAV total return of 5.5% and a share price total return of 5.64%. The company declared two dividends of 1p per share, maintaining the level of those declared in the same period last year. The company’s earnings per share were 2.09 pence for the six months, compared to a figure of 2.12 pence earned in the same period last year and covering the dividends paid.
As things stand, the board expects to follow the same pattern of dividend payments as declared last year and maintain or slightly increase the total level of dividends for the year. Based on an annual rate of 4.47 pence and a share price of 55.4 pence at the time of writing, this represents a dividend yield of 8.07%. Should earnings fall below the anticipated annual dividend amount, the board is prepared to use a modest amount of reserves to make up a marginal shortfall and believes that this will be the most likely scenario for the next few years.
We spoke to NCYF’s manager, Ian Francis, last week for the weekly show. You can watch the interview back here.
Investment Manager’s Review – Ian (Franco) Francis
Market and economic review
During the six month period under review economists and market commentators began to realise that the spectre of inflation was more permanent than they had previously realised. At the end of June 2021 the UK CPI reading was an annual increase of 2.4%; by the end of December 2021 this had reached 5.4% with economists predicting higher numbers once the effects of higher energy costs are eventually passed on to consumers. There was a similar pattern in other major economies such as the US and the EU where inflation is unlikely to prove transitory. Equity stock markets over the six months seemed to shrug off worries over inflation and were generally positive with major indices at near all-time highs in many markets. For the high yield bond markets, the second half of 2021 was fairly muted apart from in Asia where property firm Evergrande’s continuing woes battered Chinese high-yield bonds with an average loss for the sector of 30%.
During the Summer and Autumn months of 2021 the UK economy suffered periods of supply chain disruption as there were shortages of key raw materials and cost pressures caused by rising inflation. As the year was coming to a close these issues were exacerbated by the appearance of the Covid Omicron variant which quickly established itself and caused further issues as many workers were forced to isolate. Fortunately, this particular variant, although very virulent, appears to be causing less severe illness than previous versions. In the US, the economy appears to be proving resilient to the effects of inflation and Covid; the same cannot be said of the EU at present with growth slowing sharply.
Government stimulus to protect economies and markets appears to be coming towards an end and it will be interesting to see how Omicron and higher inflation affects decisions on interest rates and subsidies. We saw increases of 0.25% each in UK interest rates in December 2021 and February 2022 and further modest rises are expected.
Portfolio Review
Turnover within the portfolio over the last six months increased as a number of our portfolio holdings took the opportunity to refinance their bonds at lower interest rates. Typically, this means that the higher yielding bond is “called” by the relevant company and replaced with a lower yielding instrument. For New City High Yield this means that we can get a capital uplift as the bond is repaid at a higher price but means that we have to replace the yield as the new instrument normally has a much lower interest rate. In our larger positions we saw the Onesavings Bank Floating Rate Note and the Bracken Midco 8.875% bonds redeemed. These were replaced with a substantial holding in both Stonegate Pubs 8.25% 2025 (the largest pub company in the UK) and an equity position in Diversified Energy Company plc (an independent energy group with natural gas assets in onshore US). New equity investments have also been made in M&G and Phoenix Group. The portfolio continues to be well diversified across a range of sectors and we have a good proportion of the portfolio in non-sterling currencies. The non-sterling exposure was 34.0% of the portfolio as at 31 December 2021.
Fortunately, we have not seen any problems in the portfolio where bond issuers or equity companies have been unable to pay their coupons or dividends. For the six months to 31 December 2021 the revenue account earnings per share were 2.09p compared to 2.12p for the same period last year. In my regular discussions with shareholders the revenue and dividends are topics of crucial importance and the ability of any portfolio company to pay its coupon or expected dividend is one of the major indicators we follow.
With the inclusion of dividends paid the total net asset return for the six months to 31 December 2021 was an increase of 5.49%.
Outlook
The outlook for 2022 is one of continuing recovery of the global economy, albeit slower than we saw in 2021. The major danger is inflation holding the higher levels that we are currently experiencing in Western economies for longer than Central bankers are forecasting. In the UK this will put even more upward pressure on wages when allied to the National Insurance increase hitting in April and not forgetting the massive hike everyone will be facing in the costs of domestic fuel. Although we believe the portfolio is in a good place we are cautious for the year because of the geopolitical situations in the Ukraine and Taiwan; those of us old enough to remember do not want a rerun of the Cold War, even more so with much of Europe relying on oil and gas from Russia. Markets may continue to be volatile but by the summer we should hopefully be in a far better position as regards the COVID epidemic worldwide which should improve supply chains as more countries get closer to economic normality.
NCYF : Inflation a ‘major danger’ warns CQS New City High Yield’s Franco