23 March 2020
TwentyFour Income
Fund Limited
(a non-cellular company limited by shares incorporated in the
Island of Guernsey under the Companies (Guernsey) Law 2008, as
amended, with registered number 56128 and registered as a
Registered Closed-ended Collective Investment Scheme with the
Guernsey Financial Services Commission. LEI:
549300CCEV00IH2SU369)
Re:
Portfolio Update
Market Commentary
It has been a challenging couple of weeks for obvious reasons,
which by turns we have compared to the market volatility seen in
late 2018 (the Fed at odds with the market about rate policy, the
US-China trade war, Brexit), early 2016 (deteriorating economic
data, energy/oil crisis, Deutsche Bank solvency), and 2011
(Spain/Italy default risk, US downgrade, introduction
of Basel III) as well as the global financial crisis of 2008.
Notably these are all periods where it felt incredibly challenging
to be an investor, but which also provided some of the best
investment opportunities most of us have seen.
As with most of those other events, European ABS have lagged
behind the volatility seen elsewhere principally as market
participants believed that the direct link to fundamental risk in
European ABS remained weak – a belief we continue to hold for the
significant majority of the market. However, as also seen during
those other periods, as risk sentiment deteriorates we expect to
eventually experience some correlation with other markets, which
can often happen sharply. We won’t necessarily see the same kind of
moves, but history suggests that some of the changes experienced
can happen in more of a step-like manner, which exaggerates the
aggression of the move. Typically this is a function of bank
trading desks feeding prices through into pricing vendors. For
mezzanine ABS, where TFIF tends to invest, the moves are greater
than for the lower yielding parts of the market.
What we can continue to have faith in is the performance of our
asset class. Unlike the US ABS market, the European version does
not feature aircraft securitisations, European CLO exposure to the
oil and gas industry is close to zero, there are very few
hotel-backed CMBS deals and relatively low levels of retail in CMBS
as well. We have written recently on the resilience of RMBS to
exaggerated, prolonged non-payment of mortgage interest
(https://twentyfouram.com/2020/03/17/how-will-rmbs-cope-with-covid-19-disruption/).
There is no primary European ABS issuance in the pipeline that
we’re aware of, so the technical driver of performance we’re seeing
is purely through secondary trading, where supply (selling by
investors repositioning/fund outflows) is keeping demand at bay. We
think every ABS fund manager would welcome the opportunity to
invest at current levels, but won’t until they are confident that
the supply has abated. As a closed ended fund TFIF is optimally
placed to deal with this volatility and expects to find excellent
investment opportunities.
We have included below a table showing current spreads available
and the movement since the market sell-off.
|
19-Mar-20
(bp) |
21-Feb-20
(bp) |
Change
(bp) |
EUR BBB CLO |
750 |
295 |
+455 |
EUR BB CLO |
1200 |
535 |
+665 |
EUR B CLO |
1600 |
795 |
+805 |
UK Prime AAA (£3mL) |
120 |
38 |
+82 |
UK NC AAA (£3mL) |
200 |
69 |
+131 |
UK 2nd Pay (£3mL) |
475 |
110 |
+365 |
UK NC Deep Mezz (£3mL) |
675 |
245 |
+430 |
CS Eur Lev Loans |
1030 |
409 |
+621 |
EUR HY (HE00 index) |
678 |
270 |
+408 |
Portfolio Commentary and Outlook
As a closed ended vehicle investing in the less liquid part of
the market, and with a clear aim to provide a high level of income,
TFIF’s portfolio tends to remain well invested. However as we have
commented before, during 2019 we rebalanced the portfolio
incrementally to reduce exposure to what we saw as building risks
away from our market. Principally this reflected the belief that
the ongoing trade war, Brexit negotiations and their effect on UK
politics, the changing global growth outlook and other risks might
see a spill-over into European ABS performance in terms of risk
sentiment rather than fundamentals. As a result the PM team reduced
beta principally by dropping the allocation to CLOs from 37% to 31%
(Dec 18 vs Feb
20) and shortening the time to maturity of the portfolio
from 4.1yrs to 3.3yrs (Dec 18 vs
Feb 20), as well as increasing our
exposure to higher rated assets.
Clearly we have seen significantly more volatility than was
expected, however we continue to believe in the quality of our
investments, and will look to take advantage of the extraordinary
value on offer when appropriate by rebalancing the portfolio back
towards its more traditional bias, and deploying the flexibility
offered by the financing facility introduced last year.
Historically we have not disclosed the mark-to-market yield on
the portfolio, principally as the fund pays dividends based on the
purchase yield (which we do disclose in our factsheet and was 7.80%
at the end of February based on a NAV of 111.69). However bearing
in mind the material change in spreads and pricing on the
portfolio, as well as the establishment of a significant discount
on the fund, it is worth pointing out that that the MTM yield at
the publication of the last NAV (106.29) was 8.94% (compared to
6.85% at February end).
While a period of lockdown would naturally be expected to lead
to a higher level of arrears, the offsets to this are a) the credit
profile of the borrowers are typically biased away from the most
susceptible to a downturn (e.g. those within the gig economy), b)
banks already have ongoing forbearance policies that are in line
with what we are hearing from banks/politicians, c) the structural
benefits of junior bonds, excess profit and cash reserves and d)
the transparency of the loan pools that allow for accurate
modelling of missed payments and defaults. In addition, the
multiple recent announcements of government support are intended to
act as an offset to further stress at a corporate and consumer
level, and affordability should be further supported by likely
lower rates for longer in the UK and Europe. In such a scenario of low rates and
government bond curves, yield will be driven by credit spread,
which ABS has traditionally had more of than the rest of fixed
income.
For further information, please contact:
Numis Securities Limited:
Nathan Brown +44 (0)20 7260 1000
Hugh Jonathan
TwentyFour Income Fund Limited:
John Magrath +44 (0)20 7015 8900
Alistair Wilson