CQS New City High Yield (NCYF) has published its annual results for the year ended 30 June 2024, showing a strong year of performance during which it provided an NAV total return of 19.07% and a share price total return of 22.73%. The dividend yield was 8.62%, based on dividends at an annualised rate of 4.50 pence and a share price of 52.20 pence as at 30 June 2024. NCYF continued to trade at a premium allowing it to continue to issue new shares and grow (it raised £13,480,000 of equity during the year). Revenue earnings remained strong, which enabled the board to marginally increase the dividend to 4.50 pence per share and maintain NCYF’s record of unbroken dividend increases since 2007 (dividend cover of 1.00x for the year). [QD comment: These are impressive returns that in part reflect an increase in the capital values of the bonds in NCYF’s portfolio as interest rates have edged down (fixed interest rate bonds see their capital values increase as interest rates fall and vice versa). We would expect to see more of this assuming that inflation and therefore interest rates continue to fall, as seems to be quite widely expected. However, it is also worth noting, NCYF should benefit from this effect over time anyway. In selecting higher-yielding bonds (or issues) for its portfolio, NCYF’s manager is mostly, if not always, buying bonds at a discount to their repayment or par value. NCYF will then benefit from a ‘pull to par’ (the tendency for the value of a bond to move towards its repayment value as its repayment or ‘maturity’ date approaches) or from an uplift where issues are retired early, as the borrower (or bond issuer) typically incurs a cost for repaying a bond early.]
Stock markets were higher during the year as markets shrugged off geo-political worries arising from the conflicts in Ukraine and Israel/Gaza and, with inflation continuing to ease, focused on potential interest rate cuts. However, major central banks have been fairly cautious and interest rate cuts that were widely expected at the beginning of the year have been pushed back as core wage inflation has proven to be stubborn. In the UK for example, the 10-year gilt yield came down sharply from its August 2023 highs, reaching 3.50% at the end of December 2023 but has since risen to 4.10% as at 30 June 2024. NCYF’s portfolio performed well in this environment with no major setbacks and several corporate actions which helped the overall return.
Caroline Hitch, NCYF’s chair, says that, against a backdrop of declining rates forecast, albeit at a steady pace, the global economic outlook appears reasonably good, and she remains optimistic for healthy performance from the company in the coming year.
NCYF’s manager, Ian “Franco” Francis said, “Prevailing higher interest rates in the financial year have enabled us to find quality investments in stocks and sectors that were previously too difficult to invest in due to lower yields. The broader economic backdrop has also improved, albeit marginally, which has helped both market confidence and the fixed interest markets. We remain positive in our outlook as we continue to identify investment opportunities across a wide and diverse range of sectors and stocks, and we expect to see a resumption of high yield and financial issuances at the end of the third and beginning of the fourth quarters of 2024.”
Revenue earnings and dividends
Revenue earnings were 4.50p per share for the year (2023: 4.51p per share). Receipts were stable over the year and NCYF continued to receive repayment of previous arrears by securities in the portfolio. There’s been a 0.22% increase in the total dividend for the year to 4.50p per share (2023: 4.49p), which has allowed NCYF to maintain its record of unbroken annual dividend increases since 2007. The 4.5p comprises three interim dividends of 1.00 pence that were paid during the year and one interim dividend of 1.50p since the year end (NCYF has followed a pattern of three interims of this size and a larger fourth interim for many years and expects to do so for the 2024/25 financial year). The total dividend of 4.50p represents a yield of 8.6% on the last closing share price of 52.2p per share.
Gearing
NCYF has a £45m loan facility with Scotiabank which is due to expire in December 2024, of which £35m was drawn down as at 30 June 2024 (NCYF had an effective gearing rate of 12.40% at the time the annual report was written). NCYF’s board believes shareholders benefit from a modest but meaningful amount of gearing, citing this as a notable advantage of closed-ended funds compared to open-ended funds, and says it expects to maintain approximately this level of gearing during the next financial year. The board expects that NCYF will refinance its loan facility on similar terms later in the year.
Premium rating and share issuance
NCYF traded almost continually at a premium during the last financial year (typically in the 5-6% range but sometimes higher), which has allowed it to continue to issue shares and grow, providing shareholders with the benefits the additional scale offers (for example greater liquidity and the improved efficiencies of spreading its fixed costs over a wider asset base). As noted above, NCYF issued 26.85m shares during the year from its blocklisting facility, raising £13.48m from new and existing shareholders. It is important to note that shares were only issued when the investment manager was confident he could invest the additional funds favourably (for example, considerable care is taken to make sure there is no revenue dilution).
Investment manager’s comments on the market backdrop
“Our central thesis that stubborn inflation will mean higher interest rates will be in place for longer than market commentators in 2023 were predicting has been very much evident over the course of our last financial year to 30 June 2024. For your Company, the prevailing higher interest rates have meant that we have seen good opportunities to find quality investments in stocks and sectors that have previously been too difficult to invest in as yields have been lower. In addition, the economic backdrop has improved, albeit marginally, which has helped market confidence and assisted the fixed interest markets. We have thankfully not seen any shocks in the portfolio from either a capital or revenue perspective and returns have been good across both metrics in the portfolio. More details of that are in the portfolio review below. The Company raised new monies this year as we issued shares at a premium. Proceeds have been invested into a wide and diverse range of sectors and stocks. The overall NAV total return for the 12 months to 30 June 2024 was a very positive one at 19.07%.”
Investment manager’s market and economic review
“When I wrote the market review for the interim report six months ago, I noted that a lot was going on which might impact markets, but the net result was probably less negative for Western economies than in previous years. That theme seems to have continued over the last six months with political news and widespread upheavals everywhere; meanwhile the economic news has continued to improve with recessions seemingly avoided and interest rates starting to reduce in the UK and Europe with hopefully more to follow. Inflation remains as a major concern for central banks and the unending game of “whack-a-mole” keeps popping up, be it wage inflation or unexpected cost pressures causing an issue.
“Bond markets in general had a good year with the average investment rated fixed interest return being around the plus 10% mark, admittedly with most of that occurring in the first six months of our financial year. At the end of 2023, UK 10- year gilts were anticipating earlier interest rate cuts and fell to 3.50% but then have risen over the last six months to 4.20% as markets have worried that the Bank of England will be slow to reduce rates.
“In the US, although the economy has seen growth across both the service and manufacturing sectors, sticky wage inflation has caused the US Federal Reserve to resist reducing rates there. Europe has seen weak manufacturing output which has caused the European Central Bank to recently cut their key interest rates by 0.25% in the hope of stimulating growth.”
Investment manager’s portfolio and revenue review
“We saw two of our larger positions being acquired during the course of our financial year. Our Virgin Money FRN position is in the process of being acquired by the Nationwide Building Society and our holding of Co-operative Bank FRN is also being acquired by the Coventry Building Society. Over our financial year, both positions have seen their bond prices increase by around 20.00% as a result and we await to see whether the terms will be amended as we go forward. We have also seen a good capital re-rating from the AT1 positions we have held in other financial institutions such as Barclays and Lloyds – these have increased by around 10% over the year as confidence has returned to the banking sector. In the equity portion of the portfolio we sold our position in Euronav at a healthy profit in the latter part of 2023 and re-invested the proceeds into another shipping company called Frontline which has generated good returns to date.
“The Company still has a meaningful exposure to the US dollar with 15.73% of the portfolio investment in that currency and a further 13.87% in the Euro and other ‘non-sterling’ currencies.
“New entries into the top 10 this year are Frontline plc which is a world leader in shipping natural resources, TVL Finance, which is part of the Travelodge hotel group and we have been buying the 10.25% 2028 and finally RL Finance FRN is the financing company for the Royal London Mutual Insurance Society. The Co-op Bank Holdco position was rolled over into a new bond during the year.
“For the year to 30 June 2024, the revenue account earnings were 4.50 pence compared to 4.51 pence for the same period last year. Earnings per share were stable during the year with no negative surprises and we continued to receive repayment of historic arrears from the REA preference shares we hold. The current balance of revenue reserves provides a good level of comfort and in our regular discussions with Shareholders, 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.”
Investment manager’s comments on outlook
“For the UK economy a lot will depend on how painful the first Labour budget will be and how this impacts investors and the knock on to markets. Nevertheless, we do expect another interest cut in the UK before the end of 2024. The inflation outlook is positive for now, but the public sector inflation busting pay rises given in the early days of the new government may come home to roost in future pay rounds. The presidential elections in the USA look to be a close run thing at time of writing and will have an effect on the world’s largest economy. The geopolitics of the wars in Ukraine and Gaza show no signs of de-escalating, and the recent attacks by Houti rebels on tankers in the Red Sea threaten not just economic but major environmental disaster too. We expect to see a resumption of high yield and financial issuance in the end of the third and beginning of the fourth quarter of 2024.”