When economic growth is looking fragile and uncertainty creeps into equity markets, having the flexibility to diversify your exposure to different asset classes can be beneficial – particularly for income-seeking investors.
At Henderson High Income Trust (HHI), we have the ability to invest in bonds (government and/or corporate debt) in order to diversify the income generated from the underlying holdings and reduce the overall volatility of the Trust.
In recent years, government and investment grade corporate bonds (the higher quality bonds as defined by the rating agencies), have offered little in way of income for investors given the level of interest rates and bond yields.
That has been reflected in the Trust’s positioning with around 90% typically invested in equities. However, with yields becoming more attractive recently we decided to move part of the portfolio out of equities and into bonds, specifically US investment grade corporate bonds, including some well-known companies like Amazon and McDonald’s.
End of cycle?
Over the past 12 months there have been signs that the global economy is slowing at the same time as corporate profitability and equity markets are close to peak levels. Closer to home, the UK is surrounded by Brexit and political uncertainty so we believe it’s prudent to both move defensively and consider other markets for investment opportunities. Having the ability to own bonds and invest overseas are key benefits of the Trust in this regard.
Given bond prices, especially investment grade credit, these generally fall less than equities in more challenging economic environments.
Why US bonds?
The rationale was two-fold: firstly, it meant we could reduce our exposure away from equity markets by allocating more to bonds without impacting the income of the Trust; and secondly, it presented an opportunity to diversify away from the UK by buying the debt of US companies. With the US Federal Reserve increasing interest rates, we saw an opportunity late last year to buy investment grade US corporate bonds, yielding on average an attractive 4.5%, which hasn’t been possible for some time.
Increasing the bond exposure also helps reduce the overall volatility of the Trust’s net asset value (NAV), given bond prices, especially investment grade credit, generally fall less than equities in more challenging economic environments. Having increased the Trust’s exposure to US investment grade bonds, the overall bond portfolio is now 19% of net assets.
The bond portfolio has always been a key feature of the Trust; it dampens the overall volatility of the NAV and offers a predictable revenue stream. The other important aspect of the Trust is its ability to use gearing(1), especially to fund the bond portfolio given its relative stability, to help enhance the overall income of the Trust.
With the Trust’s borrowing costs currently lower than the yield on the bond portfolio, we have utilized gearing fully to fund the bond portfolio, which boosts the revenue generation and helps support the Trust’s 5.5% dividend yield.
It also means that within the equity portfolio we don’t have to chase the highest yielding areas of the market where dividend cuts and value traps are more prevalent. With this structure the equity portfolio can continue to own some high quality companies with attractive dividend growth prospects.
Given the increasing probability of an economic slowdown and uncertainties in the UK, we have utilized the Trust’s ability to own bonds and invest overseas to position the Trust more defensively.
(1)Gearing is a measure of the debt level of a company. Within investment trusts it refers to how much money the trust borrows for investment purposes and is normally expressed as a percentage of net assets
Writer - David Smith, Fund Manager of Henderson High Income Trust
Focus on Funds
This article was featured in the second edition of Focus on Funds magazine.
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