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Debt investment trusts hits discount growing pains
One sector to have been the worst affected by discounts is debt, which hasn’t really had much of a problem in the past.
The last couple of months of unsettled markets have been accompanied by a widening of discounts in many parts of the investment companies market. One sector to have been worst affected is debt, which hasn’t really had much of a problem with discounts in the past.
I am slightly puzzled by this. Yes, US interest rates have edged higher but only by a quarter point, and further rate rises seem to be on hold again. Faltering economies could presage an increase in default rates but the tick up in defaults we have seen so far has been concentrated in the oil and gas and mining sectors, areas that most listed debt funds have no exposure to.
I am forced to conclude that nervous investors have just been raising cash and the debt sector, which dominated the new issue market in 2015, was one of the first places they turned to.
Six of the 28 debt funds are on premiums today. Axiom European Financial Debt (AXI) fund, which I wrote about last December, is, according to Numis, trading on a 5.1% premium.
All too often, we see new funds trade up to absurd premiums only for this to unwind, disappointing many investors and leaving an impression in the performance tables that the fund isn’t doing very well. The same thing happened to P2P Global (P2P ), once the darling of the debt sector and one of the fastest growing funds I have seen.
Just over a year ago, P2P’s ordinary shares were trading on a 17.5% premium (this despite the company’s aggressive programme of C share issuance). Once reality dawned that these shares were not really that scarce, the premium began to unwind.
However, as so often happens, the shares overshot in the other direction, as investors seeing a falling share price panicked and sold as well. Last month, the shares hit a discount of 15.5%. The company has made a statement about its discount management policy and the discount has now narrowed to 11.4%. The statement was a bit weak in my opinion – along the lines of ‘the discount will narrow when we start paying decent levels of dividend, there’s a dividend reinvestment plan that will supply some demand and we do have powers to buy back shares’ (although they have never used them, even when the discount spiked downwards).
To be clear, I don’t think it deserves to trade at a wide discount but if it starts to widen again, P2P should be more on the front foot and draw a line in the sand by announcing it will buy back if the discount exceeds a certain level.
One group of funds that seems to have suffered in particular are those invested in collateralised loan obligations (CLOs).
Blackstone GSO Loan Financing (BGLF ) and Carador (CIFU ) are on discounts of 14.6% and 1% respectively. Fair Oaks Income (FAIR ) has held up better but has moved from over a 9% premium in January to a 5.8% today.
Crucially, these funds don’t have liquid enough portfolios to support a regular buy-back programme and so investors might just have to grin and bear it. However, in the meantime, they are churning out enormous yields.
In the midst of all this, we are also seeing a departure from the sector as JPMorgan Senior Secured Loan (JPSL ) falls on its sword.
I wrote about JPSL a year ago. It was smaller than it wanted to be and seems to have experienced more than its fair share of falling loan prices – the NAV is down to 87.4p, having launched at £1.
JPSL had an aggressive discount control policy that said it had to make a redemption offer for up to 50% of its shares if its discount traded on average at 5% or more during the period 1 November 2015 to 31 January 2016. This offer had been triggered, and shareholders had told the board they would be unhappy soldiering on with a smaller fund.
In my view, despite the success of the past few years, the debt sector is still relatively immature.
I think there is scope for it to grow significantly over the next few years but, like the rest of the investment companies market, it will have to develop a range of tools to deal with discounts along the way.
James Carthew is a director at Marten & Co. The views expressed in this article are his and do not constitute investment advice.
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Look up the investment trusts
- P2P Global Investments (Ordinary Share)
- Blackstone/GSO Loan Financing (Ordinary Share)
- Carador Income Fund EUR (Ordinary Share)
- Fair Oaks Income Fund (Ordinary Share)
- JPMorgan Senior Secured Loan (Ordinary Share)
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