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City Merchants High Yield Trust Ltd - Half-year Report

PR Newswire

London, August 15

City Merchants High Yield Trust Limited

Half-Yearly Financial Report for the Six Months to 30 June 2018

KEY FACTS

City Merchants High Yield Trust Limited is a Jersey incorporated investment company listed on the London Stock Exchange. The Company commenced trading on 2 April 2012 as a successor company to City Merchants High Yield Trust plc.

Investment Objective

The Company’s investment objective is to seek to obtain capital growth and high income from investment, predominantly in high-yielding fixed-interest securities.

Investment Policy

The Company seeks to provide a high level of dividend income relative to prevailing interest rates mainly through investment in bonds and other fixed-interest securities. The Company also invests in equities and other equity-like investments consistent with the overall objective.

Performance Statistics

Period End Information

* Source: Thomson Reuters.

† Defined in the Glossary of Terms and Alternative Performance Measures on pages 58 and 59 of the 2017 annual financial report.

INTERIM MANAGEMENT REPORT INCORPORATING THE CHAIRMAN’S STATEMENT

CHAIRMAN’S STATEMENT

In recent years high yield investors have become used to a market environment characterised by falling yields and contracting credit spreads. In contrast, the first six months of 2018 saw yields and credit spreads rise from the lows reached in late 2017.

The cautious tone to markets reflected a number of factors. Concerns over the pace of economic growth in the UK and in Europe, rising political tensions and the prospect of an end to the exceptionally favourable monetary stimulus maintained since the financial crisis of 2008 all provided significant headwinds for high yield securities in the first six months of the year.

In this more challenging environment the Company’s net asset value (NAV) total return for the six months to the 30 June 2018 was –1.5%. By comparison, the Bank of America Merrill Lynch European Currency High Yield Index returned –1.0% during this period, and the average return for funds in the Investment Association Sterling Strategic Bond sector was –1.5%. The Company’s performance over longer periods remains positive. For example, over the three years to 30 June 2018 the NAV total return was 19.9% compared to the Bank of America Merrill Lynch European Currency High Yield Index return of 16.8%.

The Company remains on course to meet its dividend target of 10p for the year, having declared first and second interim dividends of 2.5p each in respect of the year ending 31 December 2018.

Turning to operational matters, continued demand for the Company’s shares allowed a further 1,025,000 shares to be issued during the six months to 30 June 2018 adding £2 million to shareholders’ funds. The Company’s share price stood at a premium to NAV of 1.9% on 30 June 2018. Shareholders benefit from the issue of shares in a number of ways. First, the fixed costs of running the Company become spread more widely. Secondly, liquidity is improved, and shareholders who choose to reinvest their dividends are more likely to be able do so at a price that is closer to NAV.

Looking forward over the remainder of the year and into 2019 we have seen some positive developments within credit markets in recent months, notably signs of a shift in the balance of influence away from issuers and back to investors. We are also encouraged by recent evidence that global economic activity appears to be growing at a healthy clip, despite the worrying rise in political and trade tensions. In the UK, activity has rebounded from the slowdown in the first months of the year, and there are indications that growth has stabilised within the Euro bloc.

Nevertheless, the Board believes a note of caution continues to be appropriate. Credit spreads remain low by historical standards, global trade tensions seem likely to continue to rise, and central banks have barely begun the process of unwinding the policy of Quantitative Easing. Brexit remains very much a ‘wild card’, and will no doubt continue to dominate the political landscape for the foreseeable future.

Three particular features of your Manager’s strategy are important to highlight in the context of our continued caution. First, there is a focus on consistency of income given the importance placed by shareholders on an attractive and stable yield. Secondly, the portfolio remains well diversified, by sector, issuer and credit risk. Finally, the Manager maintains a rigorous and disciplined approach to assessing the risks and returns of individual securities, and hence in the Board’s view remains well placed to take advantage of opportunities as and when they emerge.

Tim Scholefield

Chairman

15 August 2018

MANAGER’S INVESTMENT REPORT

Market Background

After the strong returns of recent years, the first half of 2018 has been a more testing time for the high yield bond market.

By 30 June 2018, the premium over government bonds that high yield issuers need to pay to borrow in euros had increased to 388 basis points (bps), up from 279bps at the start of the year. The U.S. high yield bond market was more stable. Credit spreads there rose just 8bps over the six-months.

At the start of the year, the market’s demand for yield, the supportive backdrop of economic growth, accommodative monetary policy and positive sentiment from US tax cuts continued to provide a favourable environment for high yield bonds. Companies were able to exploit this and issue bonds with very low yields and sometimes with aggressive terms that weakened some of the usual protection for bond holders.

Conditions started to change toward the end of January. Some data releases suggested that global economic growth might not have been as strong as had previously been thought. A rise in trade tensions between the US and China and the US and the European Union increased these concerns. The IMF warned that while it still expected global growth of 3.9% the risks had increased.

High yield bond yields had been rising steadily since late January. However, in May the increase accelerated, largely as a result of political uncertainty within Italy. Concerns were centred on the expenditure programmes of the new coalition government and the potential impact these would have on the Italian government’s level of debt.

During June, the European Central Bank (ECB) announced that it would be ending its Quantitative Easing programme at the end of 2018. The programme has been an important support for the European bond market and so its termination is clearly a potential headwind. However, this relatively bearish message was offset by news that the ECB will leave all three of its policy rates at their current levels until at least summer 2019.

The rise in yields over the period has helped to shift the initiative from borrowers back in favour of investors. As a result, there has been push-back on some of the more aggressive terms issuers had sought at the start of the year.

Year-to-date, euro denominated high yield bond issuance has slowed compared to levels for the same period in 2017. Data from Barclays shows that just over half of this issuance has been in the financial sector.

Portfolio strategy

The NAV of the Company ended June 2018 at 187.52p per share, a decrease on the NAV of 195.40p at the close of 2017. The Company paid a total dividend of 5p over the period. The NAV total return for the six months was –1.5%.

The portfolio holds a core (46%) of non-financial high yield corporate bonds, focused on seasoned issuers that we consider have a low likelihood of default. In addition, we have significant exposure to areas of the financial sector, which we believe offer relatively attractive yields. Approximately 21% of the portfolio is invested in bank capital, predominantly in the subordinated debt of large European banks (Additional Tier 1 and legacy Tier 1). We also have a 13% allocation to subordinated bonds in the insurance sector. Elsewhere we have holdings in hybrid capital instruments (subordinated bonds with some equity-like characteristics). These instruments are held across various sectors including telecoms and utilities. We believe the subordination risk of these more junior debt instruments is attractive in the context of the companies’ relatively strong balance sheets.

Outlook

The rise in euro denominated credit spreads over the past six months has brought some value back into the European high yield bond market.

That said, credit spreads are low by historical comparison and are only back to levels of late 2016. Furthermore, the market faces significant headwinds including: political uncertainty in Italy, the removal of the ECB stimulus at the end of the year, disruptions to global trade and the ongoing uncertainty surrounding Brexit. On the other hand, companies have been able to lock in very favourable borrowing costs. As a result, despite the likelihood for interest rates to rise, we would expect, all else being equal, default rates to remain low in the months ahead.

Given this mixed outlook, we remain cautious. Nonetheless, we are pleased to see some value come back into the market and, as lenders, welcome the opportunity to be able to influence the terms on which borrowers are raising capital.

Our overall approach remains focused on seeking to deliver a consistent and attractive level of income.

Rhys Davies Paul Read Paul Causer

Portfolio Managers

15 August 2018

PRINCIPAL RISKS AND UNCERTAINTIES

The principal risk factors relating to the Company can be summarised as follows:

Strategic Risks

– Market risk – the Company invests primarily in fixed interest securities, the majority of which are traded on global security markets. The principal risk for investors in the Company is a significant fall and/or a prolonged period of decline in these markets. This could be triggered by unfavourable developments globally and/or in one or more regions. The Board cannot mitigate the effect of such external influences on the portfolio. Market risk also arises from movements in foreign currency exchange rates and interest rates.

– Investment objectives – the Company’s investment objectives and structure no longer meet investors’ demands.

– Lack of liquidity in the Company’s shares – lack of liquidity and lack of marketability of the Company’s shares leading to stagnant share price and wide discount.

Investment Management Risk

– Performance – the portfolio persistently underperforms relevant indices and/or peers because of the investments selected. Performance will also be affected by market risk, addressed above, and by credit risk. A significant portion of the Company’s portfolio consists of non-investment grade securities which by their nature have a higher risk of default as well as the likelihood of price volatility.

Third Party Service Providers Risk

– Unsatisfactory performance of third party service providers (TPPs) – failure by any service provider to carry out its obligations to the Company in accordance with the terms of its appointment could have a materially detrimental impact on the operations of the Company and affect its ability to successfully pursue its investment policy and expose it to reputational risk. Disruption to the accounting, payment systems or custody records could prevent the accurate reporting and monitoring of the Company’s financial position.

– Information technology resilience and security – the Company’s operational structure means that all cyber risk (information technology and physical security) arises at its TPPs. This cyber risk includes fraud, sabotage or crime perpetrated against the Company or any of its TPPs.

Regulation and Corporate Governance Risk

– Failure to comply with or adverse changes to law or regulation – a serious breach of law or regulation could lead to suspension from the Official List and from trading on the London Stock Exchange, a fine or a qualified audit report. Adverse changes to law or regulation could affect the ability of the Company to operate or the practicality of its domicile.

Mitigating procedures and controls in relation to these principal risks and uncertainties are summarised on pages 12 and 13 of the Company’s 2017 annual financial report.

In the view of the Board, these principal risks and uncertainties are as applicable to the remaining six months of the financial year as they were to the period under review.

RELATED PARTIES

Note 22 of the 2017 annual financial report gives details of related party transactions. The basis of these has not changed for the six months being reported. The 2017 annual financial report is available on the Company’s section of the Manager’s website at: www.invescoperpetual.co.uk/citymerchants.

GOING CONCERN

The financial statements are prepared on a going concern basis. The Directors consider that going concern is the appropriate basis as they have a reasonable expectation that the Company has adequate resources to continue in operational existence for the foreseeable future. In reaching this conclusion, the Directors have taken into account the Company’s investment objective, its risk management policies, the diversified nature of its investment portfolio, the borrowing facility which can be used to meet short-term funding requirements, the liquidity of most of its investments which could be used to repay any borrowings in the event that the facility could not be renewed or replaced and the ability of the Company to meet all of its liabilities and ongoing expenses.

BOND RATING ANALYSIS (STANDARD AND POOR’S RATINGS)

The definitions of these ratings are set out on page 59 of the 2017 annual financial report.

DIRECTORS’ RESPONSIBILITY STATEMENT

in respect of the preparation of the half-yearly financial report.

The Directors are responsible for preparing the financial report, using accounting policies consistent with applicable law and International Financial Reporting Standards.

The Directors confirm that to the best of their knowledge:

– the condensed set of financial statements contained within the half-yearly financial report have been prepared in accordance with International Accounting Standards 34 ‘Interim Financial Reporting’;

– the interim management report includes a fair review of the information required by DTR 4.2.7R and DTR 4.2.8R of the FCA’s Disclosure Guidance and Transparency Rules; and

– the interim management report includes a fair review of the information required on related party transactions.

The half-yearly financial report has not been audited or reviewed by the Company’s auditor.

Signed on behalf of the Board of Directors.

Tim Scholefield

Chairman

15 August 2018

THIRTY LARGEST INVESTMENTS AT 30 JUNE 2018

THIRTY LARGEST INVESTMENTS AT 30 JUNE 2018 continued

CONDENSED STATEMENT OF CHANGES IN EQUITY

CONDENSED STATEMENT OF COMPREHENSIVE INCOME

The total column of this statement represents the Company’s statement of comprehensive income, prepared in accordance with International Financial Reporting Standards as adopted by the European Union. The profit/(loss) after taxation is the total comprehensive income. The supplementary revenue and capital columns are both prepared in accordance with the Statement of Recommended Practice issued by the Association of Investment Companies. All items in the above statement derive from continuing operations of the Company. No operations were acquired or discontinued in the period.

CONDENSED BALANCE SHEET

Registered in Jersey No. 109714

CONDENSED STATEMENT OF CASH FLOW

NOTES TO THE INTERIM FINANCIAL RESULTS

1. Basis of Preparation

The condensed financial statements have been prepared using the same accounting policies as those adopted in the 2017 annual financial report. They have been prepared on an historical cost basis, in accordance with the applicable International Financial Reporting Standards (IFRS), as adopted by the European Union and, where possible, in accordance with the Statement of Recommended Practice for Financial Statements of Investment Trust Companies and Venture Capital Trusts, issued by the Association of Investment Companies in November 2014, as updated in February 2018.

2. Management Fees

Investment management fees and finance costs are allocated 35% to capital and 65% to revenue.

The management fee is payable quarterly in arrears and is equal to 0.1875% of the value of the Company’s total assets under management less current liabilities at the end of each quarter.

In addition, the Manager is paid a fee based on an initial fee of £22,500 plus RPI increases in May of each year.

3. Taxation

The Company is subject to Jersey income tax at the rate of 0% (2017: 0%). The overseas tax charge consists of irrecoverable withholding tax.

4. Dividends Paid

Dividends paid in the period have been charged to revenue. £Nil was charged to stated capital (six months to 30 June 2017: £10,000). This amount is equivalent to the income accrued on the new shares issued in the period (see note 6).

A second interim dividend of 2.5p (2017: 2.5p) has been declared and will be paid on 20 August 2018 to ordinary shareholders on the register on 20 July 2018.

5. Income

6. Stated Capital, including Movements

Allotted ordinary shares of no par value.

No shares have been issued since the period end.

7. Classification Under Fair Value Hierarchy

Note 19 of the 2017 annual financial report sets out the basis of classification.

There were no Level 3 holdings at any period end, and the total (not shown) is therefore the aggregated of Level 1 and Level 2.

(1) Fixed interest securities include both fixed and floating rate securities.

8. Status of Half-yearly Financial Report

The financial information contained in this half-yearly report, which has not been audited by the Company’s auditor, does not constitute statutory accounts as defined in Article 104 of Companies (Jersey) Law 1991. The financial information for the half year ended 30 June 2018 and the half year ended 30 June 2017 have not been audited. The figures and financial information for the year ended 31 December 2017 are extracted and abridged from the latest audited accounts and do not constitute the statutory accounts for that year.

By order of the Board

R&H Fund Services (Jersey) Limited

Company Secretary

15 August 2018