drop in NTA, page-15

Interesting reading from one of the newsletters I subscribe:

Are corporate bonds becoming  too risky?

Lastweek we penned a note on the US corporate bond market and asked the question whetheror not it was a concern for stocks, which it is, as are a lot of other things.

Theonly direct exposure to US Bonds we have is the holding in the NB GlobalCorporate Income Trust (ticker NBI.ASX), which commenced trading on the ASX inSeptember of 2018. As a refresher, this is a US based asset manager calledNeuberger Berman and they raised $413mil for a listed trust that invests inglobal corporate bonds – the area that we wrote about with a negative slantlast week, hence why hold such a security?  It’s a good question.

Thisfund uses a currency hedged corporate bond strategy and they aim to pay 5.25%p.a. paying distributions monthly. It was obviously a new product when itlaunched however the underlying portfolio and strategy have been in existencefor over 20 years, and they’d booked returns of 8.93% pa on average over thatperiod – which is a strong track record over a long period of time.

Trackrecords are essential when managing money however it’s by no means a guaranteeof success – the most high profile example last year came from the guys over atL1 Capital (ASX:LSF) who listed last May to much fanfare, had an exceptionaltrack record prior to listing, before losing ~27%  in 8 months! Whilethese are completely different funds with different exposures and inherentrisks, it still highlights how important it is to continually trackinvestments, particularly in the current environment.

NBIpublishes a daily NTA report (net tangible assets) which provides a good lookthrough on the value of the underlying portfolio versus the price of the listedtrust. We track this through Bloomberg and plot it on a chart, The blue line isthe value of their holdings and the white line is the price of the security.The green shaded area at the bottom outlines the premium (or discount) the fundtrades relative to its assets. Since listing, and bear in mind it’s only ashort period of time, the fund has averaged a 3.06% premium to its NTA while ithas only once traded at a discount to NTA very briefly just a few weeks ago.Currently, NTA sits at $1.97 while the fund closed yesterday at $2.02.

NBI,NTA versus price since listing

 

Fromthe above, we can see that the end of December was weak and NTA dropped by 5% toa low of $1.90. The price of the trust held up better however it’s a red flagto look at what drove the decline in NTA. The other obvious trend has been theslight / gradual decline in NTA between September and December. The Fund paysmonthly distributions targeting 5.25% pa. To date, they’ve paid 3 totalling2.64c, or on an annualised basis, they’ll get to the 5.25% targeted income. 

Firstly,what drove the decline in December? Pretty much the theme we discussed in amorning note last week, which was the increase in spreads between lower quality US bondsand risk free US Treasuries, or in other words, the premium that investorsdemand to take on additional risk. In that report, we were looking through thelens of an equity investor saying that increased spreads made borrowing moneymore expensive for US corporates and that could reduce the amount of capitalavailable for company buy-backs.

Wesaid at the time, the belowchart shows the trend is slowly moving against stocks but it’s still fairlycheap for corporate America to borrow money – identifying where the uncle pointis obviously the million dollar question.

USBBB/Baa Corporate bond – US Treasuries spread Chart

 

Thatchart shows the move in corporate spreads nicely from September (when NBIlisted) to December with a clear widening of spreads during that time. Theenvironment has clearly gotten tougher, and the push up in spreads during theDecember quarter would explain the decline in marked to market asset valuesthat flow into the NTA of the fund.

Thechart above though is a relatively short time frame. Investing in bonds is adefensive position and looking longer term is more important. The below chartlooks at spreads back to 2004 and incorporates the GFC to put the recent moveinto context. While spreads have increased, the current move is a ‘slightelevation’ rather than a blowout. If a slight elevation led to a decline in NTAof 5%, that suggests a bigger widening would impact NTA by more, and thereforethe pricing of the listed trust. In short, if credit markets get more volatile,then the NBI will likely struggle.

USBBB/Baa Corporate bond – US Treasuries spread Chart – longer dated

 

Theother trend though that we’re conscious of has been the gradual decline in NTAsince listing. This is probably more important from an overall perspective.While I haven’t spoken to the investment managers since listing, and it’s onlyearly days, it seems like the fund may be using more than just regular couponpayments to support the monthly distribution which is creating a negative trendon the NTA. i.e. they’re dipping into capital to maintain consistent distributions. That could be a short term theme given it’s only just been listed /portfolio set, and it’s not uncommon in the listed fund space as a way ofsmoothing distributions (Geoff Wilson at WAM has done this for a long time), however I’ll endeavour to find out from the managers and report back. (Asan aside, for those interested in our view of WAM, we covered it towards theend of last year)  

Whenwe added NBI to the income portfolio we wrote… With huge diversification across the portfolio, they holdaround 300 individual holdings with position sizes between 0.25% – 0.50% of theportfolio. Normally we like to hold assets directly, however simply put, wecan’t get the level of diversification or access to these sort of investmentsoutside a fund structure such as this one. We like NBI for an income play, andso too does the market with the trust currently trading 2.5% higher to $2.05today, above their NAV at listing of $2

Thatdiversification reduces company specific risk, however it does mean they’remore or less exposed to what the broader corporate bond market does – somethingwe’ll continue to monitor. For now, we’ll retain the holding but watching USbond spreads carefully.  

NBGlobal Corporate Income Trust (ASX: NBI)

 

Conclusion (s)

A widening in spreads is a negative for the price of bonds andtherefore the price of NBI
However,we’ve only seen a slight uptick so we’re alert, but not alarmed at this stage.