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City Merchants High Yield Trust Ltd - Half-year Report

PR Newswire

London, August 19

City Merchants High Yield Trust Limited

Half-Yearly Financial Report for the Six Months to 30 June 2020

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 instruments consistent with the overall objective.

Performance Statistics

Period End Information

(1) Source: Refinitiv.

(2) Alternative Performance Measures (APM). See page 7 for the explanation and calculation of APMs. Further details are provided in the Glossary of Terms and Alternative Performance Measures in the Company’s 2019 annual financial report.

INTERIM MANAGEMENT REPORT INCORPORATING THE CHAIRMAN’S STATEMENT

CHAIRMAN’S STATEMENT

Covid-19’s initial impact on high yield markets was both sudden and dramatic. As the virus took hold it quickly became apparent that the only way to control its spread and to prevent healthcare systems being overwhelmed was for governments to impose draconian restrictions on social movement. The resulting sharp drop in economic activity was a pattern seen in the UK and throughout the world.

Thankfully, the response of policymakers both in the UK and abroad was rapid and on a massive scale. Governments strove to offset the economic effects of social distancing with huge expansions in fiscal expenditure while central banks intervened aggressively in financial markets. This did much to calm market nerves, and a more stable environment, in which yields continued to decline steadily from their March peaks, subsequently emerged.

Against this backdrop it is no surprise that the Company’s Net Asset Value (NAV) experienced something of a roller coaster ride during the first six months of the year. Having at one point fallen by over 18% from the start of the year, the NAV recovered from its March low to end the six months to 30 June 2020 down just 2.4%. In comparison the ICE Bank of America European Currency High Yield Index returned –4.9% during this period.

Fortunately the portfolio entered the crisis on a strong footing with raised cash levels and a defensive stance, a reflection of the degree to which yields had declined in 2019. Despite the challenging market environment during the first half of the year, I am pleased to report that the Company remains on track to achieve its full year dividend target of 10 pence per share and we have declared first and second interim dividends of 2.5 pence per share in respect of the current financial year.

The Company’s share price ended the period at a discount of 3.0% to NAV. However, for a significant part of the period under review the share price traded at a premium to NAV and demand for the Company’s shares allowed us to issue a further 1,700,000 shares.

Since no one can say with any certainty how the Covid-19 crisis will develop, it is foolish to suppose that there is any clarity regarding the outlook for high yield markets. However, we can identify several characteristics of the current environment which will shape market developments in the months ahead.

First, given the scale of the disruption caused by social distancing, the economy’s recovery will be slow and we will remain particularly vulnerable to setbacks (Brexit negotiations being one major source of ‘event risk’ on the immediate horizon). Secondly, default rates will rise amongst companies that have been particularly badly hit by the profound and probably permanent changes in consumption and working patterns brought on by Covid-19. Lastly much will depend on the course of the pandemic and whether the race to find a vaccine is successful.

Given the strong possibility of further macroeconomic disappointment a cautious view of the next six months is therefore appropriate, and having guided the portfolio though the initial stages of the crisis I am confident that the Manager’s rigorous investment approach will allow the Company to continue to navigate the challenges that undoubtedly lie ahead.

Tim Scholefield

Chairman

21 August 2020

Manager’s Investment Report

Market Background

The first six months of 2020 have been an extraordinary period for both society and financial markets. The effective closure of developed economies to combat Covid-19 and subsequent policy responses have been the dominant influence on returns.

During February and March, as economies were shuttered, credit spreads (the premium over government bonds that companies need to pay to borrow) widened significantly. The credit spread of the ICE Bank of America European Currency High Yield Index(1) was 324 basis points (bps) at the start of the year. After tightening in January and February, spreads then widened to reach a peak of 884bps in late March. This was its widest level since the height of the eurozone sovereign crisis in 2011 and resulted in the index delivering a Q1 sterling hedged total return of –14.6%.

The deterioration in sentiment was compounded by a collapse in the oil price that followed the start of a price war between Saudi Arabia and Russia at the beginning of March. This was more significant for the US high yield market, which has a high allocation to the energy sector.

From late March sentiment turned with European high yield delivering a sterling hedged total return of 11.35% – its best quarterly return since 2012. This occurred despite the release of some of the worst economic data ever recorded. The reason for this turn in sentiment was the extraordinary monetary and fiscal policy response of central banks and governments.

The US Federal Reserve in particular has gone well beyond the remit of its previous quantitative easing programme to directly purchase corporate bonds. These purchases include bonds downgraded to high yield after the pandemic began. In Europe the European Central Bank increased its bond purchases, but significantly there was also a proposal for a fund in which the nations of the eurozone would jointly borrow to help fight the pandemic. A €750 billion recovery fund of both grants and loans has since been agreed.

Against this backdrop corporate bond issuance levels have soared as issuers have sought to take advantage of the demand for yield to build up cash surpluses and repair their balance sheets. Indeed, Bloomberg report that June 2020 was the busiest ever month for US high yield issuance.

By 30 June 2020, European currency high yield credit spreads had recovered from the wide levels of late March to a level of 541bps. Although below the March peak, this level is still well above the average for the past decade. It was a similar story in the US market with spreads widening from 554bps at the start of the year to 1087bps in late March before falling back to 647bps by 30 June 2020.

Portfolio strategy

Thankfully, the Company entered the Covid-19 crisis on a relatively strong footing. The portfolio was cautiously positioned by the end of 2019, which was a natural response to yields having fallen so much and our sober view on valuations. At the very early stages of the virus outbreak, we raised cash in the portfolio significantly. As the crisis developed, we also put a hedge in place via a credit default swap. This defensive stance meaningfully reduced the impact of market volatility on the Company’s NAV and left the Company with a solid base from which to invest.

The NAV of the Company ended June 2020 at 182.2p from 192.1p at the close of 2019. In a period in which many companies have been forced to suspend dividend payments, the Company paid a total dividend of 5p over the period. The NAV total return for the six months was –2.4%, which compares well to the ICE Bank of America European Currency High Yield Index at –4.9%.

The widening of credit spreads in March created significant investment opportunities that we sought to exploit across both financial and non-financial issuers. We were able to purchase bonds from good quality companies that had dramatically fallen in price, in some cases by over 20 or even 30 points. For example, the Company purchased bonds from Dutch cable operator, Ziggo, that had fallen 25 points below their February issue price.

As well as opportunities within the high yield market, we were able to add some higher yielding investment grade names to the portfolio as issuance re-started in that market. For example, BMW came to the market in April with a 5-year bond offering a coupon of 3.9%. This is more than some high yield issuers were paying to raise capital at the start of the year. Elsewhere, we also participated in two new issues by travel company, Expedia, which was offering coupons of 6.25% and 7%.

In the high yield market itself, bonds were added across many sectors and also included new issues such as Ford. The US car manufacturer was downgraded by the rating agencies as a result of the disruption to production and sales due to Covid-19. It subsequently came to the market to shore up its balance sheet offering bonds with coupons of 8.5% and 9.625%, which we viewed as compelling.

Some opportunistic positions, where we felt the market was mispricing risk, were also taken, such as Codere, a gaming company that was forced to shut operations around the world. With Codere’s ability to refinance a 2021 bond maturity the Company was able to purchase bonds at a price of 40 and below. We believe that a consensual deal to alleviate pressure on the balance sheet can benefit both the company and bondholders and lead to Codere bonds trading significantly higher.

Following purchases made during this period of market weakness, at a sector level the portfolio’s largest exposure remains financials (both subordinated bank and subordinated insurance bonds). As at 30 June 2020, 31% of the portfolio was invested in this area of the market. Elsewhere, the portfolio’s largest allocations are to telecoms, autos and food companies.

The Company utilised borrowing during the period under review. Prior to the sell-off in March, borrowing was used to selectively add lower risk bonds in order to strengthen income. During the market sell-off additional borrowing was utilised on a more tactical basis, resulting in a net gearing of 5.8% at 30 June 2020.

Outlook

As we look ahead, we are cognisant that the main driver of the current rally in financial markets has been the unprecedented monetary and fiscal policy support. The message from central banks and governments is that this support is not likely to change in the near term. Therefore, while it is difficult to see markets moving much higher, it is equally difficult to see a catalyst for any significant sell-off. The approach from here is therefore cautious while continuing to take advantage of any investment opportunities that arise.

Rhys Davies

Portfolio Manager

21 August 2020

(1) Index includes both sterling and euro denominated issuers.

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, contemporary examples being the market uncertainty in relation to Brexit during 2019 and in 2020 the Covid-19 outbreak. The Board cannot control 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.

– Borrowing Risk – borrowings for investment purposes will amplify the reduction in NAV in a falling market, which in turn is likely to adversely affect the Company’s share price. The Company borrows principally using repo financing arrangements. In certain circumstances it may have to realise investments at short notice to repay amounts owing under those arrangements and may not be able to realise the expected market value of those assets.

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 pursue successfully 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.

Pandemic Risk

– Restrictions to the movement of people and disruption to business operations are impacting portfolio company valuations and returns that could impact operational resilience of service providers. As the uncertainty of Covid-19 remains, the Directors continue to monitor the situation closely, together with the Manager and other service providers. A range of actions has been implemented to ensure that the Company and its service providers are able to continue to operate as normal, even in the event of prolonged disruption.

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.

More detailed information including mitigating procedures and controls in relation to these principal risks and uncertainties is summarised on pages 13 to 15 of the Company’s 2019 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 2019 annual financial report gives details of related party transactions. The basis of these has not changed for the six months being reported. The 2019 annual financial report is available on the Company’s section of the Manager’s website at: www.invesco.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 liquidity of its investments which could be used to meet short-term funding commitments, and the ability of the Company to meet all of its liabilities and ongoing expenses from its assets.

BOND RATING ANALYSIS (STANDARD AND POOR’S RATINGS)

Standard and Poor’s (S&P) ratings. Where a S&P rating is not available, an equivalent average rating has been used. Investment grade is BBB– and above.

For the definitions of these ratings see the Glossary of Terms and Alternative Performance Measures on page 68 of the Company's 2019 annual financial report.

* NR: not rated.

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

21 August 2020

THIRTY LARGEST INVESTMENTS AT 30 JUNE 2020

(1) Moody’s/Standard & Poor’s (S&P)/Equivalent average rating.

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 (loss)/profit 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 STATEMENT OF CHANGES IN EQUITY

CONDENSED BALANCE SHEET

Registered in Jersey No. 109714

CONDENSED STATEMENT OF CASH FLOWS

NOTES TO THE INTERIM FINANCIAL STATEMENTS

1. Basis of Preparation

The condensed financial statements have been prepared using the same accounting policies as those adopted in the Company’s 2019 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 October 2019.

During the period the Company utilised credit default swaps (CDSs) for protection against credit risk within the investment portfolio. Within the Condensed Statement of Comprehensive Income the loss on disposal of the CDSs of £874,000 is included within `(Loss)/profit on investments held at fair value' and the premiums paid on CDSs are included within `Other expenses'. The fair value at period end would be included in `Investments held at fair value through profit or loss' within the Balance Sheet however, at the period end, no CDSs were held by the Company.

2. Income

3. Management Fee, Finance costs and Other expenses

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 per annum for administrative purposes.

Finance costs relate to interest payable on borrowings from securities sold under agreements to repurchase (repo) or bank overdrafts. For repos that have a negative interest rate, the interest is receivable and has been netted against repo interest payable within finance costs, as they relate to borrowing costs.

Included within Other expenses are costs of £109,000 (30 June 2019: nil) relating to premiums paid on CDSs.

4. Taxation

The Company is subject to Jersey income tax at the rate of 0% (2019: 0%). The overseas tax charge consists of irrecoverable withholding tax.

5. Dividends Paid

Dividends paid in the period have been charged to revenue except for £49,000 which was charged to stated capital (six months to 30 June 2019: £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 (2019: 2.5p) has been declared and was paid on 19 August 2020 to ordinary shareholders on the register on 17 July 2020.

6. Stated Capital, including Movements

Allotted ordinary shares of no par value.

Nil shares issued since the period end.

7. Classification Under Fair Value Hierarchy

Note 19 of the Company’s 2019 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 aggregate 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 2020 and the half year ended 30 June 2019 has not been audited. The figures and financial information for the year ended 31 December 2019 are extracted and abridged from the latest audited accounts and do not constitute the statutory accounts for that year.

By order of the Board

JTC Fund Solutions (Jersey) Limited

Company Secretary

21 August 2020