M&G Credit Income Investment Trust plc (MGCI)
M&G CREDIT INCOME INVESTMENT TRUST PLC
The Company announces that its quarterly review as at 31 March 2023 is now available, a summary of which is provided below. The full quarterly review is available on the Company’s website at:
Financial markets were volatile in the first quarter of 2023, driven by changes in expectations for inflation and interest rates and turmoil in the banking sector. Despite the turbulence, equities and bonds both rose for the second quarter in a row. The year started positively, with optimism about China’s reopening and hopes that inflation might be slowing fuelling a market rally in January. Share prices retreated and bonds declined in February amid concerns that central banks would keep raising interest rates to tackle persistently high inflation. In March, volatility spiked as the collapse of Silicon Valley Bank in the US and the emergency rescue of Credit Suisse in Switzerland raised fears about the health of the banking system globally. The controversial details of the rescue package saw all outstanding Credit Suisse additional tier 1 (“AT1”) bonds completely wiped out ahead of equity holders, breaking capital structure seniority established in the wake of the Great Financial Crisis as part of regulatory reforms that required banks to increase their capital levels. This roiled markets, sending AT1 bond prices plummeting, dragging with them other tiers of subordinated bank debt. The Bank of England, ECB and Fed were quick to reassure markets that the ranking waterfall for European banks in the effect of resolution or insolvency meant that equity (in their jurisdictions) would be completely wiped out before bail-in capital (AT1 instruments), essentially rebuking the actions of the Swiss central bank. This brought relative stability back to markets and saw losses in the AT1 market largely reversed by the end of the quarter. Markets stabilised as the quarter drew to a close amid the belief that the banking crisis had been contained whilst central bankers took the view that the financial system was strong enough to withstand the pressure and continued raising rates.
The portfolio performed well in Q1 driven predominantly by strong returns in January, with market weakness in March mitigated by our low allocation to financials. The Company’s NAV total return was +2.19% which outperformed the comparative benchmark ICE BofA 1-3 Year BBB Sterling Corporate Index, which returned 1.46%.
As credit spreads tightened in January we sold lower yielding bonds from banks and insurers and redeployed proceeds into new issues in financials which priced with an attractive new issue premium. We also sold down investment grade bonds purchased at significantly wider spreads in the wake of the mini-budget crisis which had rallied to well inside out target return. During the period we used additional cash proceeds from asset sales to pay down the outstanding loan balance on the Company’s credit facility, in line with our current strategy of reducing portfolio risk.
Like much of the market, in March our focus was on conducting a deep dive examination on the extent of risk in the banking sector and how the portfolio might be exposed. We currently hold one bank issued additional tier 1 instrument (0.4%) which has reversed most of the spread widening seen in March. The portfolio also holds one senior unsecured Credit Suisse bond (0.6%) which has more-than reversed any price weakness seen in March and is currently trading 200bps inside its level at the start of the year (or +7% in valuation terms). Due to the diversified nature of the portfolio we have a relatively low allocation to debt issued by banks, which has mitigated the effects of underperformance in the sector.
In March we reduced exposure to M&G European Loan fund by £1.75m and used redemption proceeds to fund a £2m subscription in M&G Lion Credit Opportunity Fund IV (“Lion IV”). This was a strategic decision to take advantage of wider spreads and attractive yields available in the mezzanine ABS space, in which Lion IV invests. We remain happy to maintain an outsized position in the M&G European Loan fund as the diversification available from investing in a collective investment vehicle gives the asset defensive qualities whilst still providing an attractive risk-adjusted return. However, on the balance of risk, we felt that reducing exposure to the leveraged loan space and investing in a fund backed by a portfolio of AA-rated ABS yielding c.7%, felt like a prudent move based on our market view.
In the private space we added £0.65m to an existing holding in the senior secured tranche of a bilateral loan secured on a luxury, business-to business retail asset. We also purchased £1m of the mezzanine loan in a commercial real estate transaction secured over a freehold office building, approximately 60% of which has already been pre-let to a global blue-chip tenant on a long-term lease. An additional £1.2m of remaining commitments to existing private loans were also funded over the quarter.
After a positive start to 2023 for bonds and equities, hopes of a “soft landing” gave way to a mini banking crisis, restoking recessionary fears. Silicon Valley Bank and Credit Suisse are the first major casualties to emerge from the most synchronized and aggressive global rate hiking cycle in 40 years. The evidence so far is that the recent banking episode was a crisis triggered by fear rather than fundamentals, fuelled by specific instances of idiosyncratic risk rather than something more systemic. Despite this, markets remain fragile and fears of wider contagion in the financial sector remain close to the surface. What is clear is that there has been an adjustment in the risk appetite of investors which has resulted in credit spreads moving notably wider once more. Additionally, increased risk aversion from lenders is causing credit conditions to tighten and in our opinion will only worsen already anaemic growth forecasts. Although the banking sector is where the first visible stresses have occurred, the viability of capital structures in the non-financial corporate bond market look set to be tested by weaker growth and tighter financial conditions in the next 12-18 months. The private sector, both corporate and consumer, has so far been largely shielded from the impact of higher interest rates because of a lag in policy rate transmission. This lag has been extended by the increased liquidity built up through corporate issuers extending maturity profiles on their debt and consumers building up savings in the aftermath of Covid-19. However, we are starting to see signals in economic data which indicate a deterioration in macroeconomic conditions and a recession in late 2023 has remerged as the base-case amongst market participants.
Given the more challenging operating environment, fundamental credit analysis at this stage of the economic cycle becomes even more imperative and our experience in fixed income investing alongside our large in-house credit research capacity will be key in navigating markets over the next 12 months. We have constructed a sector agnostic, welldiversified portfolio, designed to offer protection from the type of valuation drawdowns that can occur from overexposure to any one sector, region or issuer, particularly during periods of market stress. Also, by investing predominantly in the higher quality (investment grade) part of credit markets we look to mitigate the potential impact of rising default rates which typically occur in the lower-rated (sub-investment grade) space. We maintain an overall c.24% exposure to sub-investment grade issuers, however half of this is in invested in private assets where we take comfort from enhanced controls and monitoring that exist in these largely bilateral transactions, with robust covenant packages designed to prevent write-downs or capital loss.
2022 witnessed a material shift for fixed income investors. After a decade of depressed bond yields and credit spreads remaining largely within a (tighter) lower range, we are now seeing an increased volume of opportunities in the public market to purchase good quality, investment grade credits which can offer returns in line with the Company’s dividend objective. Additionally, in the private space, a prolonged period of adjustment to the higher interest rate environment has meant we are seeing fewer opportunities which offer attractive relative value versus public comparators or that match the Company’s return objective. In many instances there is an insufficient illiquidity premium on offer and relative value analysis has not supported allocation of capital over a multi-year horizon, particularly considering the uncertain economic outlook. We therefore expect the ratio of private to public assets to trend lower in the short term, although as always this will remain dependent on our appraisal of where the most attractive relative value can be found. The Company, in our view, is well positioned to take advantage of future episodes of market volatility. We have recently fully repaid our credit facility after increasing leverage in late 2022, which, as we move through the year, will provide us the flexibility and firepower to capitalise on opportunities as and when market conditions present them.
Link Company Matters Limited
28 April 2023
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