Are ASX fixed income Listed Investment Trusts (LIT) a good investment opportunity at the moment?

Apr 8, 2020

Welcome to Finance and Fury, the Say What Wednesday edition. This weeks question comes from David.

 

David says: We have seen some ASX fixed income Listed Investment Trust (LIT) have fallen 10-30% from their NTA. Are you able to do a series to cover those to see if it is now a good investment opportunity? My thinking is that the massive drop is a function of retail investor fear (they don’t know what they are invested in) rather than the decline in the actual value of the investment.

 

Great question and we will look at some of the ones David sent through - NBI, PGG or KKC

 

important to note – not all fixed income is made equally

What is fixed income/interest?

1. A Fixed Interest is a debt instrument - a form of lending.
2. Financial Product designed to raise money for the entity that issues the bond
   1. I liken it to an interest only loan – You need money? You borrow morning with the mortgage as the product and pay interest back
   2. When a company or Government needs money – Someone (you) purchase that bond – Essentially loaning money to the issuer when then pays you interest
      1. At the Bond Maturity – you get the initial loan back (unlike a PI loan)
   3. LITs or ASX listed products – most of these are companies that are active managers of fixed interest –
      1. Similar to a LIC or ETF – the hold number of FI investments that make up the product
      2. For LITs – The price they trade is the price for demand for the investments themselves –
         1. Doesn’t always relate to the NTA value – or underlying investment values that the company holds –
      3. These LITs like NBI, PGG or KKC Buy and sell other companies debt
         1. Buy it off someone else who bought it – secondary market – trade to make a profit
      4. In most cases though, active bond managers tend to not hold FI to maturity to try and keep a longer term duration.
      5. As they sell these on the secondary market however, the funds invested aren't lost (even though the sale occurs before maturity) as someone else will buy this off them.
      6. Costs - It can be pretty expensive for the given returns (which are likely being represented after the MER) but they do at least provide capital protection on an investment without getting cash like returns.
         1. Index bonds – Cheap 0.1%
         2. Active – can be expensive, similar to a share managers costs – some of these charge around 0.8% MERs

 

First- the FI assets themselves

1. Why do they exist?
   1. Like People, Governments (Fed, State, etc)/companies need to fund their expenses with debt
   2. Create a product (bond) – Sell it to someone else – get the money and pay a yield on the amount to the purchaser
2. Issuer – Sets a Face Value – how much they want and how much they will pay
   1. Purchaser – transfers money to them and gets paid coupons – similar to interest you pay in loan
   2. Price – Price = FV at issue – as coupon rates are priced in based around interest rates
3. Purchaser – Can hold the bond and get income, or sell it on the secondary market
   1. If you buy fixed income/interest on the secondary market, it essentially works the same as if you bought it on the primary, except the maturity date is closer (so if you held you would get the face value back)
   2. you get it at a different price to the Face Value (due to interest and coupon payments being different in most cases)
      1. can go above – interest rates drop compared to coupon yield
      2. Below – interest rates goes up compared to coupon yield

Types of FI – and the risks attached - Meant to be safe/defensive – whole point of diversifying but corporate bonds are correlated to the shares

1. What is the type of debt instrument and who is the issuer –
   1. Government Bonds – Either safe or not – depends on country
   2. Types of Bonds – Who needs to raise money?- As of 2017, the size of the worldwide FI market (total debt outstanding) is estimated at $100.13trn – a lot of which is corporate
2. How you tell – Ratings system
   1. S&P and Moodys – AAA = High quality – BB to D = Junk
   2. Watch out – can be fooled – MBS was considered AAA – which are a large component of FI as well
3. What is the maturity – Long maturity leaves you open to interest rate risk
   1. Duration – measurement of sensitivity to interest rate movements
      1. 1 = $1 change in 1% interest
      2. 7 - $7 change for 1% interest

• Based around the time until maturity of bond

1. Interest rate movements crease bond movements
2. Tend to look for one about 5-7 duration, and another with -2 duration (can hold cash and loans)
3. One safe gov bonds, other takes a punt on under-priced debt (risk of default lower than price shows) –

4. Major issue with a lot of FI investments now –
   1. Interest rates are low to zero – so risk of price losses from rising interest rates have increased –
   2. Most important one right now – that a lot of companies may go out of business and default on their FI products
   3. At the moment – not a lot of Gov Bonds have dropped much in value – defaults risks have gone up but still not as high as corporate –
   4. Corporate debt has dropped in valuation though – as with the shut downs and the fact a lot of companies have issued out massive FI amounts over the past decade – lots of debt they may not be able to repay

 

But as David pointed out – the prices for the LIT investments have dropped more than the NTA of their underlying investments

5. Whilst LITs act like shares – managers buy and sell debt – two types of assets, equity and debt (only if you own it
   1. Debt is traded like a share – but then these LITs are also traded as a share – so have the double downside risk when people panic sell –
6. As david said - massive drop is a function of retail investor fear (they don’t know what they are invested in) rather than the decline in the actual value of the investment - Yes and no –
   1. The large drop is out of retail fear – but the quality of investment isn’t great – so the drop is technically justified
7. Issues that a lot of these FI managers face -
   1. Fixed income is debt instruments – types – Government, SemiGov – or corporate debt
      1. Most of these LITs have corporate debt – so the risk of defaults is going up and the NTAs are slow to be updated in some cases -
      2. Type of FI matters – as the risk of default is important –

• But also – the legislation changes that mean that the reporting requirements to markets isnt currently in place and also that creditors or debt holders can not be repaid for a time if the company is in trouble

1. Quality of credit as well – this is what really matters
   1. If the company doesn’t have to report to the market – like in the ASX – important information is
2. Duration – how sensitive they are to interest rate changes

 

Have a look at the individual investments

Prices – Dropped massively from the initial crash – 21-Feb to their bottoms in 23 March – Which is when the government and monetary responses started kicking in – rebound of 20%-50% since then in prices – but still below NTA values

NBI – NB GLOBAL CORPORATE INCOME TRUST

1. Price was about $2 until the crash – went down to $1 – 50% loss – back to about $1.45
   1. but the NTA is slow to be updated - NTA is now sitting at $1.60
   2. No need to point out that this is a little different – and why the prices came back – but they are still sitting below out of fear – but important to note that the NTA is unaudited estimates –
   3. Hazard a guess that it might be slightly off
2. Credit Quality – very low: BB – 40%, B – 44%, CCC or below – 16% - Average credit is B+ -
   1. Higher risk and higher yield
   2. Hedged to AUD – 55% of holdings in USD – so the NTA shouldn’t have changed in value from currency movement but this would have backfired in recouping any losses

 

PGG – Partners Group Global Income Fund

1. Price was about $2 until the crash – went down to $1.10 – 50% loss – back to about $1.38
   1. but the NTA is slow to be updated - NTA is now sitting at $1.34 – remember that this NTA is an unaudited estimates – but is closer in line with the actual price
2. Credit Quality – low as well: B

 

KKC – Credit Income Fund

1. Price was about $2.48 until the crash – went down to $1.45 – 40% loss – back to about $1.58 – small gain
   1. Unaudited estimate on NTA is now sitting at $1.98 – was sitting at $2.55 a month ago – so 25% drop – but it is still estimated above the prices – but may not be accurate - Hazard a guess that it might be slightly off – but could have just been a victim in the overall retail sector selloff
   2. The majority of the portfolio is focused on more defensive sectors such as Healthcare, Services, Software and Capital Goods which are less exposed to obvious negative impacts from the virus; and has low exposure to the energy and travel/leisure sectors, with no exposure to companies operating airlines or cruise ships.
   3. But the unit pricing is still done monthly – so see how the next month plays out

 

One thing to watch out for – the retail investors selling these LITs might be doing so due to the lack of disclosure and cutting their losses – hard to work out the true NTAs if companies are absolved of their reporting obligations – in environments like this hard to

Also – in investment structures like this – they are only as strong as their weakest link – defaults in the lower end of the credit quality can quickly result in redemptions and fund outflows which trigger further losses up the chain – of the whole price of the investment

Durations aren’t too bad – usually corporate credit isn’t that high – on average about 4-5

 

Summary – FI is meant to be in a portfolio if you want downside protection – but a lot of these

When is it needed? Why buy?

1. Downside protection – Prices can move, but not by much compared to shares – but also true on the update –
   1. For long term growth – and looking for rebound of markets – shares may work better
2. Higher yield than cash – in a lot of cases you get more income
   1. Middle ground to cash – better income for some risk – but a lot more risk due to corporate defaults at this stage -
3. Is it a good time to buy? Seemed to have averaged out in prices now and flattened – whilst some are slightly below the unaudited estimates on the NTAs at this stage, this might be for a valid reason – if looking to gain additional growth over long term – FI have a limited upside

 

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