M&G Credit Income Investment Trust plc (MGCI)
M&G Credit Income Investment Trust plc
Half Year Report and unaudited Condensed Financial
Statements for the six months ended 30 June 2022
Copies of the Half Year Report can be obtained from the following website:
The Directors present the results of the Company for the period ended 30 June 2022.
[a] Alternative performance measure.
Investment objective and policy
The Company aims to generate a regular and attractive level of income with low asset value volatility.
The Company seeks to achieve its investment objective by investing in a diversified portfolio of public and private debt and debt-like instruments (“Debt Instruments”). Over the longer term, it is expected that the Company will be mainly invested in private Debt Instruments, which are those instruments not quoted on a stock exchange.
The Company operates an unconstrained investment approach and investments may include, but are not limited to:
The Company invests primarily in Sterling denominated Debt Instruments. Where the Company invests in assets not denominated in Sterling, it is generally the case that these assets are hedged back to Sterling.
There are no restrictions, either maximum or minimum, on the Company’s exposure to sectors, asset classes or geography. The Company, however, achieves diversification and a spread of risk by adhering to the limits and restrictions set out below.
The Company’s portfolio comprises a minimum of 50 investments.
The Company may invest up to 30% of Gross Assets in below investment grade Debt Instruments, which are those instruments rated below BBB- by S&P or Fitch or Baa3 by Moody’s or, in the case of unrated Debt Instruments, which have an internal M&G rating below BBB-.
The following restrictions will also apply at the individual Debt Instrument level which, for the avoidance of doubt, does not apply to investments to which the Company is exposed through collective investment vehicles:
[a] Secured Debt Instruments are secured by a first or secondary fixed and/or floating charge.
[b] This limit excludes investments in G7 Sovereign Instruments.
For the purposes of the above investment restrictions, the credit rating of a Debt Instrument is taken to be the rating assigned by S&P, Fitch or Moody’s or, in the case of unrated Debt Instruments, an internal rating by M&G. In the case of split ratings by recognised rating agencies, the second highest rating will be used.
The Company typically invests directly, but it also invests indirectly through collective investment vehicles which are managed by an M&G Entity. The Company may not invest more than 20% of Gross Assets in any one collective investment vehicle and not more than 40% of Gross Assets in collective investment vehicles in aggregate. No more than 10% of Gross Assets may be invested in other investment companies which are listed on the Official List.
Unless otherwise stated, the above investment restrictions are to be applied at the time of investment.
The Company is managed primarily on an ungeared basis although the Company may, from time to time, be geared tactically through the use of borrowings. Borrowings will principally be used for investment purposes, but may also be used to manage the Company’s working capital requirements or to fund market purchases of Shares. Gearing represented by borrowing will not exceed 30% of the Company’s Net Asset Value, calculated at the time of draw down, but is typically not expected to exceed 20% of the Company’s Net Asset Value.
Hedging and derivatives
The Company will not employ derivatives for investment purposes. Derivatives may however be used for efficient portfolio management, including for currency hedging.
The Company may hold cash on deposit and may invest in cash equivalent investments, which may include short-term investments in money market-type funds (‘Cash and Cash Equivalents’).
There is no restriction on the amount of Cash and Cash Equivalents that the Company may hold and there may be times when it is appropriate for the Company to have a significant Cash and Cash Equivalents position. For the avoidance of doubt, the restrictions set out above in relation to investing in collective investment vehicles do not apply to money market type funds.
Changes to the investment policy
Any material change to the Company’s investment policy set out above will require the approval of Shareholders by way of an ordinary resolution at a general meeting and the approval of the Financial Conduct Authority (FCA).
The Company seeks to achieve its investment objective by investing in a diversified portfolio of public and private debt and debt-like instruments of which at least 70% is investment grade. The Company is mainly invested in private debt instruments. This part of the portfolio generally includes debt instruments which are nominally quoted but are generally illiquid. Most of these will be floating rate instruments, purchased at inception and with the intention to be held to maturity or until prepaid by issuers; shareholders can expect their returns from these instruments to come primarily from the interest paid by the issuers.
The remainder of the Company's portfolio is invested in cash, cash equivalents and quoted debt instruments, which are more readily available and which can generally be sold at market prices when suitable opportunities arise. These instruments may also be traded to take advantage of market conditions. Fixed rate instruments will often be hedged in order to protect the portfolio from adverse changes in interest rates. Shareholders can expect their returns from this part of the portfolio to come from a combination of interest income and capital movements.
The investment process for the Company consists principally of three stages: the decision to invest, monitoring and ongoing engagement and finally divestment.
Investment decision-making is undertaken by the Investment Manager, based on extensive research and credit analysis by the Investment Manager’s large and experienced teams of 135 in-house analysts who specialise in public and private debt markets. This rigorous in depth analysis is fundamental to understanding the risk and return profile of potential investments.
Regular monitoring is carried out to ensure that continued holding of an investment remains appropriate. This includes monitoring the performance of investments by fund managers, analysts and internal control and governance processes. The Investment Manager engages with relevant stakeholders on any issues which may, potentially, affect an investment’s ability to deliver sustainable performance in line with those expectations.
At some point, the Investment Manager may decide to divest from an investment (or the investment may complete in line with agreed terms, including pre- payment), although typically, private investments are held to their full maturity. Divestment can occur for a variety of reasons including; the investment being no longer suitable for the investment mandate, the outcome of engagement being unsatisfactory or as a result of the investment team’s valuation assessment. Investment decision making is only undertaken by the fund managers designated by the Investment Manager.
As part of the investment process, full consideration is given to sustainability risks, which are set out in more detail on pages 35 to 36 of the Annual Report and audited financial statements for the year ended 31 December 2021.
Your Company performed robustly through a very difficult period for bond and equity markets. It was the worst first half of the year for developed market equities in over fifty years, whilst sovereign and corporate U.S. and European bonds experienced record losses. The Company’s NAV total return for the half year to 30 June 2022 was -3.4% which compared favourably to the performance of fixed income indices such as the ICE BofA Sterling and Collateralised Index (-14.17%) and the ICE BofA European Currency Non-Financial High Yield 2% Constrained Index (-15.25%).
The beginning of 2022 had already been dominated by sharply higher inflation in developed economies prior to the Russian invasion of Ukraine. However, the invasion greatly compounded the global inflation problem given the economic importance of both countries in food and energy supply chains. A combination of the conflict, inflation and higher official rates drove government bond yields higher and saw credit spreads move wider over the first quarter. Our Investment Manager continued to hedge interest rate risk and maintain low duration which negated the effect of rising risk-free rates. That said, the wider credit spreads lead to modestly negative portfolio returns.
The second quarter saw market sentiment vary between growth and inflation concerns. The combination of growth concerns and an uncertain path for monetary policy saw both investment grade and high yield credit spreads continue to sell off notably as the quarter progressed, which impacted valuations and saw most government and credit indices end the period with sharply negative year-to-date returns. The low duration and investment grade credit quality of your Company’s portfolio contributed to its significant outperformance of the relevant indices.
Share buybacks and discount management
Your board remains committed to seek to ensure that the Ordinary Shares trade close to NAV in normal market conditions through buybacks and issuance of Ordinary Shares. Since the start of the year, the Company has undertaken a number of share buybacks and share issuances pursuant to the ‘zero discount’ policy initially announced on 30 April 2021. The first quarter saw the share price trade at a discount to NAV although it moved to trade at a premium from mid-April until the period end. The Company issued a net 1,415,000 shares from treasury in order to satisfy demand in the market. The Company’s Ordinary Share price traded at an average discount to NAV of 0.5% during the period ended 30 June 2022. On 30 June 2022 the Ordinary Share price was 98p, representing a 2.6% premium to NAV as at that date. As at 30 June 2022, 1,607,749 shares were held in treasury with an additional net 650,000 shares repurchased since the period end.
Your Company is currently paying three, quarterly interim dividends at an annual rate of SONIA plus 3%, calculated by reference to the adjusted opening NAV as at 1 January 2022. In addition your Company will pay a variable, fourth interim dividend to be determined after the year end, which will take into account the net income over the whole financial year and, if appropriate, any capital gains, together with the board’s view of the ability of the portfolio to deliver our longer-term objectives. The Company paid dividends of 0.82p and 0.96p per Ordinary Share in respect of the quarters to 31 March 2022 and 30 June 2022 respectively.
Your Company’s Investment Manager continues to believe that an annual total return, and thus ultimately a dividend yield, of SONIA plus 4% will continue to be achievable although there can be no guarantee that this will occur in any individual year.
Even though the Company’s year-to-date NAV total return has been affected by the volatility in credit markets, our Investment Manager believes that current market conditions provide a good opportunity to position the portfolio to deliver increased yield over the longer term. Your board notes that this was also achieved with great success after the market setback in 2020.
Your Company’s portfolio (including irrevocable commitments) is now 62% invested in private (not listed) assets, with an additional investment of some 12% in illiquid publicly listed assets which are intended to be held to maturity. Whilst our Investment Manager will continue to grow the private asset portion of the portfolio in line with the Company’s longer term strategy, it currently sees opportunity to add public bonds into the portfolio at yields that are attractive, relative to the target return of the Company. The Investment Manager recently drew £4 million of the Company’s available £25 million revolving credit facility in order to take advantage of the pronounced volatility and enhanced returns available in the public bond market. Subsequently, a further £1 million was drawn down.
Your board believes that the Company remains well positioned to achieve its return and dividend objectives, as set out above in the section entitled ‘Dividends’.
22 September 2022
Investment manager’s report
We are pleased to provide commentary on the factors that have impacted our investment approach since the start of the year, looking in particular at the performance and composition of the portfolio built in accordance with the Company’s investment policy.
So far 2022 has been one of the worst years on record for bond markets. In fact, financial markets ended the first half of the year with nearly all asset classes (public bonds, sovereign bonds, equities) suffering material losses. The market narrative thus far and one set to extend through the remainder of the year can best be characterised in one word– inflation. 2021 saw extraordinary demand for goods and services as countries emerged from winter lockdowns with record levels of household savings accumulated during 2020 as consumers stockpiled spending firepower. At the same time, ongoing measures to contain the spread of the Covid-19 virus had caused disruption to global supply chains which resulted in a shortage of available goods and commodities. These simultaneous supply and demand shocks created considerable upwards inflationary pressure. Additionally, the post-pandemic reaction of central banks was to allow inflation temporarily to overshoot their well-established long term target of 2% in order to boost economic growth and reduce unemployment. This confluence of factors saw 2022 begin with inflation across developed economies already at multi-year highs, albeit with a path of interest rate hikes plotted to bring this supposedly “transitory” inflation under control. However, inflation has proved more entrenched and persistent than anticipated, confirming the fears of many market participants - that central banks had fallen behind the curve (i.e. not raising interest rates at a pace fast enough to keep up with inflation). The situation was greatly exacerbated following Russia’s shocking invasion of neighbouring Ukraine in February. Economic damage from the war in Ukraine has been a significant factor in the slowdown in global growth in 2022 and has greatly compounded the global inflation problem. Fuel and food prices have increased rapidly, hitting vulnerable populations in low-income countries hardest. The end result is an inflation problem far starker than previously forecast and populations facing a cost of living crisis that has crushed consumer confidence and seen companies slash profit guidance for 2022.
Against this backdrop, central banks have been forced to embark on more aggressive paths of monetary policy normalisation despite the risk of leading economies into stagflation or recession. Market expectations of future official interest rate increases have changed substantially since the start of the year both in the magnitude and timing of the expected rate rises, with multiple increases now anticipated across major markets throughout the remainder of the year, alongside a faster run-down of asset purchase programmes. Market sentiment has become split between growth and inflation concerns, driving volatility in government bond markets as investors grapple with constantly changing forward guidance and an uncertain outlook. The combination of growth concerns and an uncertain path for monetary policy has seen both investment grade and high yield credit spreads sell off (widen) notably in the first half of the year, significantly decreasing bond valuations.
We entered the year with the Company’s portfolio relatively defensively positioned, as credit spreads remained at levels where, in our opinion, investors were not being compensated adequately for taking on risk. Simply put, bond valuations looked expensive in the context of the prevailing economic headwinds and heightened macroeconomic uncertainty. In light of this, portfolio activity in the early part of the year saw us sell down BBB and BB bonds that offered very little spread over risk free rates. We redeployed proceeds into a handful of credit specific public opportunities as well as adding further private exposure via a senior secured term loan to the UK’s leading and only full-service provider of temporary traffic lights and related products. Investor concerns over inflation had already caused credit spreads to widen notably prior to Russia’s invasion of Ukraine, and the economic implications of the invasion accelerated the sell off. With bond returns beginning to look attractive again, we reduced holdings in AAA cash proxy ABS and redeployed proceeds into higher yielding, BBB-rated public bonds with good credit fundamentals. We were able to purchase these bonds at valuations which appeared attractive relative to historical levels. In our opinion, the most compelling risk-adjusted returns were to be found in Real Estate Investment Trusts, banking and insurance subordinated debt and hybrid bonds. Our flexibility in being able to invest across different markets and fixed income asset classes saw us add selectively in investment grade dollar credit which, given the more aggressive path of interest rate hikes signalled by the Federal Reserve, looked cheap on a relative value basis (vs sterling credit). We hedged our US rate exposure using 30 year Treasury futures, in accordance with the wider portfolio strategy of running with low interest rate sensitivity (duration). In line with the Company’s core investment objective we have continued to increase the portfolio’s allocation to private assets over the period. These assets are not immune to the headwinds faced by public bonds but typically provide greater stability of capital via stronger structural protections, particularly during times of market stress. Private debt can also be an important diversifier to returns available in public fixed income markets. £5.6m (c.3% of NAV) was invested into a diverse range of private opportunities during the first half of the year, including a facility for a leading provider of high end audio systems; a bilateral real estate loan for the acquisition and refurbishment of an office block in London Victoria; and the mezzanine tranche in a regulatory capital transaction backed by a diversified portfolio of UK small and medium enterprise business loans.
It is now clear that inflation is more embedded and broad-based than previously forecast and can no longer be considered transitory. We believe contributors such as rent and wage growth along with structural factors in the economy are supportive of persistently higher inflation for the foreseeable future. In the UK, the fastest rate of real wage destruction since 1997 has contributed to political and worker unrest, with forecasts predicting the fall in mean disposable income will be the worst for at least a century. Soaring energy prices are creating unprecedented challenges for businesses already facing a convergence of input cost pressures, whilst simultaneously impairing household finances, affecting both sides of the supply-demand dynamic. Businesses will need to adapt to a new operating environment where margins are squeezed by higher input costs and consumer demand is lower as inflation diminishes household purchasing power.
At a global level, geopolitical developments remain central to the economic outlook given the inextricable link with the path of inflation. The economic implications of the ongoing Russia-Ukraine war are widespread, whilst tensions between China and the U.S. over Taiwan continue to escalate. The consequences of both situations should see an acceleration in the trend toward deglobalisation, which will only serve to create additional inflationary pressure. There is also a risk of EU political fragmentation on issues such as the relationship with Russia, particularly given the uneven distribution of economic vulnerability amongst member states, which could create dissent within the bloc and complicate the path of future policy.
Central banks continue to ramp up their hawkish rhetoric, with policy makers from Europe and the U.S. unequivocal in their message that fighting inflation is the primary mandate and they will do what is required to bring it under control. Uncertainty being the nemesis of markets means the lack of clarity over future monetary policy should see volatility in both sovereign and corporate bond markets continue for some time whilst seeking to achieve that goal. In the short to medium term it is difficult to foresee a return to the type of ultra-loose monetary policy that has underpinned the financial system in developed markets over the past decade or so. Undoubtedly, a prolonged period of higher all-in bond yields and wider credit spreads would be attractive for income investors, albeit selectivity and detailed credit analysis will remain key.
Although credit spreads have widened out notably since the start of the year, in our opinion the market isn’t fully pricing in the toxic cocktail of restrictive financing conditions, lower corporate profitability, and an extended period of low or no growth. In the current environment we favour going up in credit quality rather than reaching for yield. We have been opportunistically purchasing recent public new issues which were attractively priced to secondary curves, with some issuers paying up to meet financing needs and to manage future debt profiles.
The predominantly floating rate nature of our underlying portfolio and low modified duration means the Company is well positioned for a rising interest rate environment, or one in which rates remain elevated. We expect current market conditions to provide attractive opportunities to deploy capital as we continue to be both patient and selective in our approach.
M&G Alternatives Investment Management Limited
22 September 2022
Top 20 holdings
Source: State Street.
Source: M&G and State Street as at 30 June 2022
Source: State Street.
Credit rating breakdown
Source: State Street.
Note: ELF is an open-ended fund managed by M&G that invests in leveraged loans issued by, generally, substantial private companies located in the UK and Continental Europe. ELF is not rated and the Investment Manager has determined an implied rating for this investment, utilising rating methodologies typically attributable to collateralised loan obligations. On this basis, 78% of the Company's investment in ELF has been ascribed as being investment grade, and 22% has been ascribed as being sub-investment grade. These percentages have been utilised on a consistent basis for the purposes of determination of the Company's adherence to its obligation to hold no more than 30% of its assets in below investment grade securities.
Interim management report and statement of directors’ responsibilities
Interim management report
The important events that have occurred during the period under review, the key factors influencing the financial statements and the principal factors that could impact the remaining six months of the financial period are set out in the Chairman’s statement and the Investment Manager’s report.
The principal risks faced by the Company during the remaining six months of the year can be divided into various areas as follows:
These are consistent with the principal risks described in more detail in the Company’s Annual Report and Financial Statements for the year ended 31 December 2021, which can be found in the Strategic Report on pages 18 to 24 and in note 13 on pages 97 to 101 and which are available on the website at: www.mandg.co.uk/creditincomeinvestmenttrust
Since the writing of the Annual Report and Financial Statements, the geo-political and macro-economic environment has been impacted by commodity price inflation in Europe, influenced by tactical constraints in flows of natural gas from Russia. The key mitigants and controls remain in place for the Company.
The Directors believe that the Company has appropriate financial resources to enable it to meet its day-to-day working capital requirements and the Directors believe that the Company is well placed to continue to manage its business risks.
In assessing the going concern basis of accounting, the Directors have also considered the Russian invasion of Ukraine and the impact this may have on the Company’s investments and the Company’s NAV.
The Directors consider that the Company has adequate resources to continue in operational existence for the next 12 months. For this reason they continue to adopt the going concern basis of accounting in preparing these condensed financial statements.
Related party disclosure and transactions with the Investment Manager
The Directors of the Company are related parties. The Chairman receives an annual fee of £43,000, the Chairman of the Audit Committee receives an annual fee of £37,500 and each non-executive Director receives an annual fee of £32,250.
There are certain situations where the Company undertakes purchase and sale transactions with other M&G managed funds. All such transactions are subject to the provisions of M&G’s fixed income dealing procedures and prior approval by senior fixed income managers authorised by M&G to approve such trades. Trades are conducted on liquidity and pricing terms which at the relevant time are no worse than those available to the Company from dealing with independent third parties.
Statement of directors’ responsibilities
The Directors confirm that to the best of their knowledge:
The Half Year Report and unaudited condensed set of financial statements were approved by the Board of Directors on 22 September 2022 and the above responsibility statement was signed on its behalf by:
22 September 2022
Condensed financial statements (unaudited)
Condensed income statement
The total column of this statement represents the Company's profit and loss account. The ‘Revenue’ and ‘Capital’ columns represent supplementary information provided under guidance issued by the Association of Investment Companies.
All revenue and capital items in the above statement derive from continuing operations.
The Company has no other comprehensive income and therefore the net return on ordinary activities after taxation is also the total comprehensive income for the period.
The accompanying notes form an integral part of these condensed financial statements.
Condensed statement of financial position