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

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