Invesco Bond Income Plus publishes first results – In May 2021 the shareholders of both City Merchants High Yield Trust Limited (CMHY) and Invesco Enhanced Income Limited (IPE) voted in favour of a proposal to merge the two companies. The company has just published its first results as a combined entity. The shares returned 4.2% and the NAV returned 5.3% over the course of 2021 and this compares to a total return of 4.0% for the ICE BofA European Currency High Yield Index, and an average return of 0.9% for funds in the Investment Association Sterling Strategic Bond Sector. Dividends totalled 10.75p, which was 97% covered by earnings. A total of £435,000 was distributed from reserves. The board is targeting a dividend of 11.00p per share each year for the three years following the merger.. There was a reduction in ongoing charges ratio from 0.99% to 0.87% following the merger (the benefit of being bigger).
Rhys Davies’ manager’s report takes the form of a Q&A, here is an extract
Q: What were the key contributors and detractors of performance?
A: The portfolio’s total return was made up of a positive contribution from credit risk and a smaller, partially offsetting, negative contribution from interest rate risk (duration).
All the main categories of credit holdings in the portfolio produced positive returns. Corporate high yield bonds and subordinated financial debt instruments, the largest asset allocations in the portfolio, made the biggest contributions but there were also significant returns from other areas, such as corporate hybrid bonds and emerging market bonds.
The portfolio has a modified duration of 3.5, slightly below that of the European high yield market. This interest rate risk was, not surprisingly, a drag on returns in a period when rate expectations and government bonds yields rose.
The individual bonds that contributed and detracted most in the portfolio’s performance ranged across a number of sectors, including retail, industrials, banks and property. Given the largely supportive environment for high yield bonds over the course of the year, many of the best performers were bonds that came into the year with some potential for a ‘recovery story’. Some of the biggest gains we had were from issuers that successfully re-structured debt in 2021. Two of these, Petra Diamonds and Codere, are covered in more detail below.
Q: Has there been any significant change in the default environment?
A: The combination of policy support and improving credit fundamentals was reflected in falling rates of defaults and higher credit ratings. The Moody’s measure of global defaults fell from 6.8% in November 2020 to 2.0% in November 2021. Moody’s forecast a level as low as 1.6% in the first half of 2022. That would be the lowest since 2008 and helps to justify the current levels of yield and spread.
Away from the tail of defaulting and distressed debt, the wider tide of credit rating changes has turned around, with upgrades outnumbering downgrades by a relatively high margin.
Q: What defaults occurred in the Company’s portfolio?
A: There were two issuers held in the portfolio that are listed by Moody’s as having defaulted during 2021 (down from six in 2020). Both of these, Codere and Petra Diamonds, also made the default list in 2020 before successfully restructuring in 2021.
Distressed bonds, that are likely to default, can sometimes represent a source of opportunity for us. Whilst this is not a core area of investing for the Company, it is an area in which the Invesco team has significant expertise in both assessing and managing investments that have become distressed. Petra Diamonds is a very good example of this. This is a position the team already had some exposure to at the start of 2020. As it became apparent that a default was likely, we chose to increase that exposure, but at a ‘distressed price’ of 34.5 USD versus a par price of 100 USD. Our view was that the company should survive but would require a balance sheet restructuring. Purchasing bonds at a distressed price of 34.5 USD offered significant upside because we were prepared to follow through with the restructuring, even if it did mean recording a default. March 2021 saw the company successfully restructured and bondholders received new bonds as well as taking ownership of most of the existing equity.
Although Petra Diamonds cost the portfolio 18bps (basis points) in 2020, in 2021 it added 90bps of return. Meanwhile, Codere completed its restructuring towards the end of 2021, with bondholders receiving the majority of the company’s equity in exchange for a partial debt write-down. Invesco worked closely with Codere’s management team and advisors as part of this restructuring process. Codere added 28bps to returns in both 2020 and 2021 and we anticipate additional gains once the company returns to full operations with a refreshed balance sheet and a new capital structure. Both companies are examples where our experience in assessing distressed bonds, and working with companies through restructurings, can provide additional returns for the portfolio.
BIPS : Invesco Bond Income Plus publishes first results