High yield funds and investment trusts are always interesting, even though high dividend yields can indicate distress.
In this case, we have a trust owning a portfolio of corporate loans with a yield to maturity of 17% to 18%, trading at a 6% discount to net asset value (NAV) - surely this is too good to be true? It seems not, for reasons that Peter Staelens, manager of the CVC Income & Growth Trust, patiently explains.
A high yield investment trust to consider
The trust, launched in 2013, has £220m of assets and two share classes, denominated in sterling and euros. It invests in “senior secured credit” - loans to companies secured against assets, in other words. These loans, explains Mitchell Glynn, deputy manager, “used to sit on bank balance sheets but banks have been squeezed out by regulation and excessive risks taken in the past.”
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Instead, investment banks arrange the loans and syndicate them to investors, such as CVC. CVC, founded in 1981, describes itself as “a leader in global credit and private equity,” with £32bn under management in credit strategies. The trust is therefore only a small part of the total but “we could double or triple the present size of the fund without changing the investments”, says Staelens.
The loans can be traded in the secondary market, making it possible for CVC to manage the portfolio based on market conditions. 80% of the portfolio is in floating-rate assets (yields rise and fall with base rates) and the average loan-to-value is 56%. What’s more, 80% of assets are “first lien or senior secured” meaning they’re first in line to be paid if the company gets into trouble.
About 20% of the portfolio is in fixed-rate debt but has only three-and-a-half to four years to maturity, suggesting it has low vulnerability to higher yields on long-dated bonds. Besides, says Staelens, exposure was only 10% a year ago so much of it was acquired at low prices.
Managing defaults
The biggest risk the company faces is the threat of firms defaulting on their debt. CVC’s record here is good with the average annual default rate over the past 17 years standing at just 0.88% of the portfolio with the loss rate coming in at just 0.17%. In 2012, the worst year for the strategy, the default rate hit 6.2% and the loss rate was 2.7%. Clearly, CVC knows how to restructure companies to keep losses down.
“We do our analysis to the downside,” says Staelens. “We get more than fairly compensated for the risk we run. At present, “credit markets are incredibly attractive - we haven’t seen these yields for a long time. We do see signs of stress in the portfolio but nothing that will lead to a material capital loss. We are assuming a small recession but it would take much worse to threaten our credits. The interest cover from cash flow is down to three times from four, due to higher rates, but would have to fall below two for us to get worried.”
CVC staff “are large investors in the master fund” which provides around 40% of the assets for the trust, suggesting a good alignment with shareholders and managers. A 7.5p (7c for the euro class) gives a yield well-covered by income of 7.7%. A bonus dividend was also paid out last year. The trust returned -7.7% last year as performance was held back by rising yields, but 2023 has seen a good bounce-back with a 13% return in the first six months.
Despite this, Staelens still sees the asset class as very attractive with “the highest ever yield to maturity barring a short-lived Covid spike.”
Investors have been too quick to write off debt funds, such as CVC, on interest rate and recession fears, ignoring high yields and outstanding value in the rush for the apparent safety of government bonds. It’s not too good to be true.
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