While being told “this is one of the most boring charts I have ever seen” may not seem like a ringing endorsement of your presentation skills, NB Global Floating Rate Income’s Martin Rotheram is wearing this critique from a potential client as a badge of pride.
In the graph in question – printed below – the difference between the top of the blue bar and 100 per cent is what has been written off by the loan market in every year since 1990. It shows that the market has preserved an average of 98.58 per cent of capital over the past 26 years.
“Even through the dark days of 2009 where we saw a double-digit default rate, that number for these non-investment grade assets was 93 per cent, so quite a compelling chart – I think – for investors to highlight the relative resilience of the asset class,” said Rotheram.
“An investor once said to me this is one of the most boring charts they had seen in a presentation. Now that’s a good thing as far as this asset class is concerned.”
NB Global Floating Rate Income invests in a global portfolio of senior secured floating rate loans. These are loans made to non-investment grade companies to finance some type of corporate activity, typically a merger or acquisition. They are typically arranged by banks and then syndicated to institutional investors.
The trust only invests in companies with security, and as such will have charges over all of its assets. While Rotheram pointed out the team lends against the strength of the underlying company, meaning its ability to generate cash flow and profit independently of the security, he said this remains a key point.
“Because we have that backing, what that means for the asset class is that historically where there have been defaults in the industry, loans tend to recover around 75 cents in the dollar. Compare that with an unsecured high yield bond, which is typically in the mid-30s,” he added.
Another key feature is that the loans are floating rate, so the dividend earned is a combination of Libor plus a credit spread. This credit spread is fixed for the life of the loan and in a market that is generally rated ‘B’ or ‘BB’, this means a strong ‘BB’ credit will pay 2.5 points over Libor, and a weaker ‘B’ will pay 5.5 points.
The manager said the important thing here is that Libor resets every 90 days.
“So, in a rising rate environment, think of it as a 90-day lag before the interest that a company pays and that I can distribute catches up with underlying base rates,” he explained.
“It also makes loans very short duration instruments because of that quarterly reset. This is one of the most important parts of the equation in the argument for loans.
“The point I want to get over to you here is that while loans are a non-investment grade asset, from 2010 which has generally been a relatively benign default environment, annual average default rates were probably around a 1.5 to 2 per cent level against longer term annual average default rates of around 3.1 per cent. But even in this kind of environment, you have seen market value variations.
“There has been a variation in total returns over that period. You should expect that as a loan investor. But the constant here is that income generation has been very consistent.”
Rotheram said the team has a lot of flexibility in terms of where it can invest and is not constrained by region, although at the moment this is split 85:15 between the US and Europe respectively.
The only formal limit is the size of the bond basket at 20 per cent of the portfolio, but he said this is used sparingly as he is wary that this asset class brings duration risk into the trust.
“We have said already that investors like this portfolio because loans are a short duration product,” he added.
“They are also inherently more volatile, so we have decent NAV [net asset value] performance, but again if we are not smart about how we utilise that basket, it can impinge on NAV performance.”
He said a good example of where the trust used the bond allocation is a position in Virgin Media, which he bought at the start of last year.
“We bought the 5 per cent bond because the loan was paying 3.5 per cent – you can see there is clear daylight between the two instruments and that the bond is senior secured as well, so it makes sense in that strategy,” he finished.
Performance of trust vs sector since launch
Source: FE Analytics
Data from FE Analytics shows NB Global Floating Rate Income has made 48.16 per cent since launch in April 2011, compared with a loss of 1.07 per cent from the IT Debt sector.
The trust has a volatility score and maximum drawdown – the most investors would have lost if they bought and sold at the worst possible moments – of 17.6 and 10.4 per cent, compared with 5.49 and 19.94 per cent for the sector average, respectively.
It is currently yielding 3.49 per cent. Someone who invested £10,000 at launch would have received £4,407.27 in income alone over this time.
The trust is on a discount of 3.58 per cent compared with 2.83 and 2.47 per cent from its one- and three-year averages.
According to data from the AIC, it has ongoing charges of 0.92 per cent and does not currently use gearing.