Income Report / Income Note: Did listed income funds play their roll in the recent sell-off? (MXT, NBI, XARO, MOT, GCI, KKC, CRED AXW, CBAPF)

The ASX opened lower this morning following weakness overseas, however a decent fight back is underway with the market down just -16pts / 0.30%, around 40pts above the daily lows. There remains appetite to buy the market into weakness against a fairly choppy backdrop for stocks.  Today we’ve looked at the performance of listed income securities in the recent decline, the funds / trusts that generally hold debt securities and listed from around 2017 onwards to satisfy the markets thirst for yield. Some have performed poorly.  We also cover the new Macquarie Hybrid Security after a number of questions from subscribers.

The ASX 200 is currently trading  down -16pts /-0.30% to 5542

ASX 200 Chart

The Income Portfolio added 1.63% for the week thanks to gains of 14.43% from RIO and 14.1% from BHP. Super Retail Group (SUL) continued to perform adding 8.57% Financial year to date the portfolio has declined by -8.07% versus its absolute benchmark (RBA cash +4%) of +4.17%.  Since inception, the portfolio has added +6.06% vs. the benchmark of +15.09%.  

Did listed income funds play their roll in the recent sell-off?

Between 2017 and 2019 there were a high number of new income funds listed on the ASX, and the recent Covid-19 inspired sell-off has been their first real test of extreme market volatility, and unfortunately most came up short. As the Australian equity market fell nearly 40% a number of these funds were hit by a similar magnitude or more, the defensive style qualities in most cases  were illusive and the majority now trade at discounts to the value of their underlying holdings (Net Tangible Assets – NTA).

We hold 3 income securities in the MM Income Portfolio along with hybrid securities to fill out our approximate 50% allocation outside of listed equities. Given recent performance we question whether or not we should hold, fold, or even increase our allocation to this growing area.

Today we’ll have a quick look at the funds we track to see how they held up during the period, and whether or not we see any opportunities. To be clear, when we talk listed income securities we’re referring to funds that were listed on the ASX over the past few years designed to fill the appetite from yield hungry investors. These are generally structured as Listed Investment Trusts (LIT’s) holding underlying debt / income type exposures. Some are specialised while others are more generalised across debt markets.

We currently have 3 of these funds in the MM Income Portfolio which is a good place: MXT, NBI & XARO.

**Please forgive the higher than usual number of charts in the income note today**

Metrics Credit Partners (MXT) $1.855: This is a more concentrated / targeted fund that we hold in MM Income Portfolio after buying in the IPO 2 years ago at $2. When they listed, they were the first sort of listed vehicle tapping an alternative style income market, in this case being domestic corporate loans, so sitting alongside, or in place of banks, lending to Australian corporates. Over that time, MXT has been a consistent performer, have stayed true to label and led the charge into an asset class that retail investors generally couldn’t access. They target the cash rate plus 3.25% and to date have delivered versus that benchmark. Metrics are a specialist manager that was first mover in the space, now there are a lot of similar funds listed although newer funds typically have wider mandates. On the positive side, MXT has a realistic performance target, a good fee structure of 0.66% & no performance fee.

The negative aspect of MXT however, is that their underlying exposure is to corporate loans, pricing their value in this sort of environment is hard and the actual realised value of the loan may not be 100% accurate until the investment is exited. I had a zoom call recently with MXT and the portfolio to date is performing well. They have more than 140 different investments, 51% of those are investment grade which all sounds good, however their largest exposures are in Real-Estate Mgt and Development  Real-Estate Investment Trusts, followed by Hotels, Restaurants & Leisure., clearly areas that are doing it tough, something that does concern us a touch.  

The first chart looks at the share price versus the value of the underlying portfolio (NTA). NB Bloomberg are slow on updating NTA figures so use as a guide only to see trends rather than accurate absolutes.  

MXT Price (White) versus NTA (Blue)

The value of MXT’s portfolio has not moved through this period however I’d question whether or not there could be a lag effect here. With the current price trading at a ~9% discount to NTA the market is factoring in some type of deterioration, something that will be dependent on whether or not we see a second wave of infections once we open things up, and a further lockdown follows.

If we do see a second wave of lockdowns, MXT is a holding we will likely exit.

The price fell 39% during the period showing the level of panic selling that played out that was uncorrelated to any change in the value of the trust - it’s a big move and unsettling for holders however its proven to be a stark overreaction. While the bounce back has been strong, there has been a degree of damage already done. I doubt we will see MXT trade at a premium to NTA as it was prior to Covid-19.  

We reduced our holding here in February at $2.03 but retain a 5% weighting.  

MM is neutral / cautious MXT at current levels

MCP Master Income Trust (MXT) Chart

NB Global Income Trust (NBI) $1.565: NBI invests in global bond markets, holding a very diverse portfolio of overseas high yield bonds – junk bonds, mainly in the US. They are a very well credentialed manager however NBI has had a tough period.  US credit markets were hit very hard, particularly high yield credit which behaved very similar to equities. The price of NBI dropped to a low of 90c, more than halving while the NTA hit a low of $1.41 (BB data slightly off in the chart below), again showing the indiscriminate  panic that played out in these securities, a mass rush for the exits at any price. I was on a call with the portfolio manager last week who described some of the things that played out in markets, a Ford bond with ~6 months was offering ~10% yield to maturity.

In any case, NBI have a vast portfolio and while they took advantage of some opportunities liquidity was very low across the board and their portfolio suffered.   

NBI Price (White) versus NTA (Blue) – the data here is slightly off, although trends correct

NBI target a return of 5.25% per annum, however I doubt they will be doing this at the moment (our assumption). We like their diversified approach and specific focus on global high yield bonds, their fee structure of  0.85% is okay with no performance, however they do employ a fixed return objective and this becomes more difficult (relative to floating) as interest rates drop, it potentially forces more risk taking across their portfolio or an acceptance they won’t meet targets. Given there is no performance fee, I’m less concerned about this being an issue (I would be if they were incentivised from a financial sense to meet the target)

NBI is trading at $1.56, NTA as of the 18th May is $1.76. We did trim NBI late in 2019 at $2.10

MM likes NBI at current levels

NB Global Income Trust (NBI) Chart

ActiveX Ardea Bond Fund (XARO) $26.90: Our 3rd income fund held in the portfolio is XARO which uses a relative valuation strategy targeting high quality government bonds with 70+% exposure in Australia. They actively manage exposures through buying relatively cheap bonds and selling relatively expensive bonds, therefore eliminating risks around interest rate duration which is obviously a major consideration when investing in bonds at this low point for global interest rates.

The managers have a strong track record over the past 10 years, they manage around $13b across fixed income markets and many well-known Australian Institutions invest with them. They target a return of CPI +2% however have done significantly better over time, they charge 0.50% pa management.  

While their return objective is low, the risks are also low while the two discussed above (MXT & NBI) are higher up the risk curve.

Still, this is a listed security and suffered some selling on low volume in the recent panic sell-off, although the bounce back was quick as it should have been.

The XARO trades very much aligned with its NTA, the 11% drop in price during the March sell off was nearly all about price, the NTA did not meaningfully change.

XARO Price (White) versus NTA (Blue)

Last week we used XARO as a funding vehicle, trimming the position to free up some cash to buy Wesfarmers. This was an asset allocation call rather than a negative view on the XARO.

MM remains positive on XARO

Ardea Active X Bond (XARO) Chart

We don’t hold the following positions:

MCP Income Opportunities Trust (MOT) $1.65: This is MXT’s riskier cousin,  the fund invests in a number of different sub trusts with the underlying investments being higher risk credit described as sub investment grade. They pay higher yield but come with a higher level of risk.  The manager has more discretion in MOT than they do in MXT to take advantage of opportunities as they arise, however less structure means returns rely more heavily on the Portfolio Manager getting it right.

There is a bunch of risk management limitations in MXT that are not in MOT and as a consequence the risk is higher and so to the targeted returns, 7% p.a. income (plus a few % capital growth to get the 8-10% total return target). They charge high fees with annual management fee of 1.45% and a pretty aggressive +15.38% performance fee over RBA + 6% benchmark. Worth noting that with the RBA rates at 0.25%, the performance fee will be paid before the income target of 7% is hit and distributed.  

On the flipside, if the RBA raise rates this becomes a more challenging task and given the broad structure of the trust and discretion of the Manager it could push them to take more risk to achieve performance targets.   

MOT Price (White) versus NTA (Blue)

Given fee structure and performance incentive, plus the broader nature of the MOT mandate, we’re less keen on this security. The NTA staying resilient above $2 implies that the underlying assets may not be getting marked to market in a realistic way.

MM has no interest in MOT.

MCP Income Opportunities Trust (MOT) Chart

Gryphon Capital Income Trust (GCI) $1.685 GCI invests is residential mortgage backed securities (RMBS), which in simple terms is a security that is underpinned by a bunch of housing loans. They are a specialist manager in this area of the market with a good track record. RMBS got a bad wrap through the GFC however since then controls have improved and the market has performed well.

We think GCI is a good portfolio diversifier generally only available in unlisted managed funds and could be a replacement to bank shares for those investors focussed on lower capital risk and more certain income. They target income return of RBA Cash + 3.50% (net of fees) with a management cost of 0.96% with no performance. The only main issue is that most Australian investors are full to the brim with bank shares and domestic property and GC1 has a similar exposure, although is higher up the security curve.  

During March, CGI fell ~40% despite their NTA remaining stable. The market is clearly concerned about the level of defaults likely when loan holidays complete in about 4 months.

GCI Price (White) versus NTA (Blue)

At MM, we think the market is too bearish in the way they are pricing GC1 and see this as an opportunity.

MM is positive on GC1

Gryphon Capital Income Trust (GCI) Chart

KKR Credit Income Fund (KKC) $1.66 : When KKC listed towards the end of 2019 demand was strong with the deal being up scaled to $925m from the original $825m. This is a more diversified credit fund  meaning that they focus across the credit spectrum investing  in strategies / portfolios of loans, bonds, fixed and floating rate notes around the globe which includes both traded and private credit -  clearly a very broad church.  They target a net return of 6-8%p.a. although the actual income target pa is 4-6% and that is through a market cycle. Right now, we’re at a low point in terms of yields so the concept of through a market cycle would imply that 4% is a more realistic goal at this point.  

Clearly KKR is a big robust global manager however the composition of the trust is too broad for us, we prefer a more targeted approach like some of the funds outlined above. Fees are also fairly high for a credit product - when base fee, expense recovery, RE & indirect costs included, it equates to around ~1.2%, plus there is a performance fee. Fees could end up being around ~1.5% for a credit product in a low interest rate environment. When net target return is 6-8%, and fees are 1.5%, it means they are investing in credit delivering 7.5-9.5% return potential while they’re incentivized to deliver through a performance fee. This implies a higher risk exposure in our view.

The trust fell 50% in the recent decline in price terms reaching a 25% discount to its NTA – again, an example of panic selling.

GCI Price (White) versus NTA (Blue)

At MM we like more focussed securities, believing KKC is too much of a broad church.

We is neutral on KKC

KKR Credit Income Fund (KKC) Chart

An alternative to these actively managed credit funds in a passively managed ETF like the BetaShares Australian Investment Grade Corporate Bond ETF (CRED). As the name suggests, this holds investment grade corporate bonds whereas the majority above go down to non-investment grade, known as high yield (junk) bonds.

CRED has around $300m invested and tracks the Solactive Australian Investment Grade Corporate Bond Index. It currently has a running yield of 3.55% pa with a yield to maturity of 2.86% pa. Average maturity is longer dated, around 7.5 years. This is a low-cost product charging 0.25% pa

MM likes the CRED as a simple alternative to the above actively managed funds  

BetaShares Australian Investment Grade Corporate Bond ETF (CRED) Chart

We also hold Hybrids in the portfolio and have an overall preference for this sort of security. While hybrids declined in the recent volatility, a typical hybrid like the CBAPF we hold in the portfolio declined by 15% and has bounced back strongly.

CBA Hybrid (CBAPF) Chart

Staying on hybrids, we’ve had a number of questions about the new Macquarie Hybrid. See below from last weeks income note.  

New Macquarie Hybrid

Macquarie launched a hybrid security on Monday and the broker bookbuild opened and closed within the day due to strong demand. They were raising $400m in a longer dated tier 1 security, with first call in 8.5 years. Compensating for that was a solid 4.70% rate over bank bills landing the security at around 5% pa. Macquarie is a slightly higher risk issuer than a big 4 bank, and the note is longer duration hence the higher yield than many of the existing hybrids.

If you cast your mind back to early March this year, both Macquarie and NAB had new hybrids in the pipeline that were rightly pulled as credit markets went into meltdown. That security was being offered at a margin of 2.90% over bank bills meaning that the new security is costing MQG an additional 1.80% pa.

In terms of existing Macquarie Securities, they have 3 on issue:

MQGPB $101.70: 0.8 years to run paying 3.49% over bank bills  
MQGPC $98.20: 4.6 years to run paying 4.62% over bank bills
MQGPD $98.00: 6.3 years to run paying 4.67% over bank bills (we hold in the Income Portfolio)  

As a very general rule of thumb, we view hybrids offered with a margin of 4% as cheap and below 3% as expensive.

MM are positive the new MQG Hybrid however we already hold the MQGPD

Conclusion (s)

Listed income securities have been more volatile than many thought

MM likes NBI, MXT & XARO which we hold

MM also likes GCI at current levels which we don’t hold

We like the new MQG Hybrid

Have a great day!

James & the Market Matters Team


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