A copy of the Company’s Annual Report will shortly be available on the Company’s website (https://ncim.co.uk/cqs-new-city-high-yield-fund-ltd), on the National Storage Mechanism (https://data.fca.org.uk/#/nsm/nationalstoragemechanism) and will also be provided to those shareholders who have requested a printed or electronic copy
CQS NEW CITY HIGH YIELD FUND LIMITED
Annual Results Announcement
for the year ended 30 June 2023
Financial Highlights
| NAV and share price total return2 | 12 months to 30 June 2023 | 12 months to 30 June 2022 | ||
| NAV1 | 2.04% | 2.04% | ||
| Ordinary share price | (0.68)% | 1.21% | ||
| Capital values | As at 30 June 2023 | As at 30 June 2022 | % change | |
| Total assets less current liabilities (with the exception of the bank loan facility) | £275.4m | £268.0m | 2.76% | |
| NAV per ordinary share1 | 45.83p | 49.30p | (7.04)% | |
| Share price (bid)3 | 46.60p | 51.20p | (8.98)% | |
| Revenue and dividends | 12 months to 30 June 2023 | 12 months to 30 June 2022 | % change | |
| Revenue earnings per ordinary share2 | 4.51p | 4.16p | 8.41% | |
| Annual dividends per ordinary share2 | 4.49p | 4.48p | 0.22% | |
| Dividend cover2 | 1.00x | 0.93x | ||
| Revenue reserve per ordinary share (after recognition of annual dividends)2 | 3.05p | 3.26p | ||
| Dividend yield2 | 9.64% | 8.75% | ||
| Premium2 | 1.68% | 3.86% | ||
| Gearing2 | 11.81% | 12.35% | ||
| Ongoing charges ratio2 | 1.16% | 1.19% | ||
| Dividend history | Rate | xd date | Record date | Payment date |
| First interim 2023 | 1.00p | 27 October 2022 | 28 October 2022 | 25 November 2022 |
| Second interim 2023 | 1.00p | 26 January 2023 | 27 January 2023 | 28 February 2023 |
| Third interim 2023 | 1.00p | 27 April 2023 | 28 April 2023 | 26 May 2023 |
| Fourth interim 2023 | 1.49p | 27 July 2023 | 28 July 2023 | 31 August 2023 |
| Annual dividend per ordinary share | 4.49p | |||
| First interim 2022 | 1.00p | 28 October 2021 | 29 October 2021 | 30 November 2021 |
| Second interim 2022 | 1.00p | 27 January 2022 | 28 January 2022 | 25 February 2022 |
| Third interim 2022 | 1.00p | 28 April 2022 | 29 April 2022 | 27 May 2022 |
| Fourth interim 2022 | 1.48p | 28 July 2022 | 29 July 2022 | 26 August 2022 |
| Annual dividend per ordinary share | 4.48p | |||
1 The definition of the terms used can be found in the glossary below.
2 A description of the Alternative Performance Measures (“APMs”) used above and information on how they are calculated can be found below.
3 Source: Bloomberg
Statement from the Chair
Key Points
• NAV total return of 2.04%
• Ordinary share price total return decline of 0.68%
• Dividend yield of 9.64%, based on dividends at an annualised rate of 4.49 pence and a share price of 46.60 pence as at 30 June 2023
• Ordinary share price at a premium of 1.68% at 30 June 2023
• £24,235,000 of equity issued during the year to 30 June 2023
• Dividend cover of 1.00x
Investment and share price performance
The NAV total return of the Company for this financial period was a positive 2.04% (coincidentally the exact same level as the previous year), thanks to the dividends paid to Shareholders during the year. This outcome was despite a difficult background as rising inflation and interest rates worried investors in the high yield debt markets in which the Company mainly invests. Many investment trusts, particularly those with an income focus, were negatively impacted by this environment with premiums eroded and in many cases, wide discounts appearing. The Company was not immune and the share price premium declined but only modestly (from 3.86% at the close of the last financial year to 1.68% this year) which resulted in a slight fall in the share price total return of 0.68%. In these circumstances, I believe this is a commendable outcome, particularly as the Company’s shares remained on a premium and we were able to continue issuing shares (see below). I also believe that the Company’s longer term performance remains strong.
In the early part of the year under review, the UK debt market was rattled by the short lived “mini budget” which triggered an increase in UK Gilt yields to levels not seen in 15 years. Although they then fell back, investor concerns about the UK, particularly stubborn inflationary pressures, have subsequently pushed yields back up, nearly to the levels seen at the time of the mini budget. Furthermore, the rapid demise of Credit Suisse in March was an issue for the portfolio. The junior debt of Credit Suisse was written down to zero ahead of the Company’s equity and this unusual turn of events destabilised the junior debt of banks and financial companies across the UK and Europe and led to bond prices of these instruments being written down. Although the Credit Suisse holding was small, the Company has a material position in other such instruments. The investment manager, Ian “Franco” Francis, gives more detail in his report and believes that these junior debt prices will recover. He discusses the financial year in his review below.
Earnings and dividends
Despite this difficult environment, I am pleased to report that the Company’s revenue earnings per ordinary share were 4.51 pence for the year to 30 June 2023, which compares to 4.16 pence earned in the same period last year. This 8.41% increase was the result of the Investment Manager being able to take advantage of the decrease in prices to invest in more quality higher yielding bonds as interest rates rose. We also saw the repayment of previous arrears by several positions in the portfolio.
The Board decided to increase this year’s dividend, albeit marginally, maintaining the Company’s record of annual dividend increases which has been unbroken since 2007. The Company declared three interim dividends of 1.00 pence in respect of the period and one interim dividend of 1.49 pence since the year end. The aggregate payment of 4.49 pence per ordinary share represents a 0.22% increase on the 4.48 pence paid last year. It is pleasing to be able to report that this year’s total dividend is covered by revenue earnings.
As things stand, the Board intends to follow the same pattern of dividend payments as declared last year and maintain or slightly increase the total level of dividends for the year. Based on an annual rate of 4.49 pence and a share price of 47.40 pence at the time of writing, this represents a dividend yield of 9.47%. As I stress in every report, the Board pays great attention to dividend payments as we understand how much shareholders value this aspect of the Company.
Gearing
The Company has a £45,000,000 loan facility with Scotiabank which is due to expire in December 2023. Out of this facility, £35,000,000 was drawn down as at 30 June 2023 and at the time of writing the Company has an effective gearing rate of 13.45%. As interest rates have risen, the cost of borrowing to gear has increased. The Board monitors this on a regular basis to judge whether the benefits of gearing outweigh these costs. At present, we believe that Shareholders will benefit from a modest but meaningful amount of gearing (a notable advantage of closed-ended funds compared to open-ended) and expects to maintain approximately this level of gearing during the next financial year.
Share issuance
Taking advantage of the premium rating that the market continued to attach to the Company’s shares, £24,235,000 was raised from new and existing shareholders during the financial year, with 47,950,000 ordinary shares issued from the block listing facility. Shares were only issued when the Investment Manager was confident it could invest the additional funds favourably. As well as a modest increase in NAV from any issue of shares, the Board believes that over time, existing Shareholders will benefit from lower ongoing charges and greater liquidity in the Company’s shares, all other things being equal.
Environmental, Social and Governance (“ESG”) statement
The Board’s intention is to invest responsibly and to consider the Company’s broader impact on society and the environment. We believe the integration of ESG factors in the investment process is consistent with delivering sustainable attractive returns for Shareholders through deeper, more informed investment decisions. The Board has reviewed and agreed the ESG approach adopted by the Company and a summary of this is set out in the Company’s Annual Financial Report and Financial Statements.
Outlook
With the majority of UK interest rate increases likely to be behind us and inflation showing some signs of moderation, the outlook for Sterling fixed interest securities appears more stable. Nevertheless, potential for turbulent events in the macro economic and geopolitical space remains and although the UK has managed to avoid a recession thus far, concerns linger. In his ‘Outlook’ report, your investment manager provides a bit more detail on what he is particularly watching. From a revenue perspective the Board maintains a positive outlook, anticipating strong revenue earnings and the ability to sustain the relatively high dividend levels appreciated by our shareholders.
Caroline Hitch
Chair
14 September 2023
Investment Manager’s Review
Introduction
All our previously expressed fears about higher inflation and correspondingly higher interest rates came home to roost over the course of our last financial year to 30 June 2023. For a high yielding bond fund, higher interest rates are a mixed blessing. On one hand there are more opportunities to find quality investments in stocks and sectors that have previously been too difficult to invest in as yields have been lower. This has helped the revenue account and we have covered the dividend this year. On the other hand, higher rates put pressure on the operating abilities of companies in the portfolio which can lead to problems. We saw issues in the retail sector with our holding of Matalan Finance 9.5% 18-31/01/2024 and also in the banking sector where the troubles of Credit Suisse affected the portfolio. More details of that are in the portfolio review below. The Company raised new monies this year as we issued shares at a premium. Proceeds have been invested into a wide range of sectors and the continuing diverse nature of the portfolio has meant that the overall NAV total return for the 12 months to 30 June 2023 is a positive one at a modest 2.04%.
Market and economic review
When I wrote the market review for the interim report six months ago, I noted that the period under review from 30 June 2022 to 31 December 2022 was one which most people would want to forget. The seemingly unending litany of woe – weak markets, higher inflation, unstable governments, crippling energy prices and rising interest rates were but a few of the horror stories we saw during the late Summer and Autumn of 2022. With a feeling of déjà vu, we have moved six months further on and it feels hard to be more positive – interest rates have continued to rise and are probably yet to peak in the UK, US and Europe. Inflation in the UK is starting to come down with the last reading at 6.80% but food price inflation remains stubbornly high. The bright spot in the UK has been the service sector which has seen consumer spending continue at elevated levels. Despite all the bad news, we saw some signs of stabilisation towards the end of the year and the forward-looking stock markets managed to eke out a positive return for the six months.
The bond markets had a very volatile year. UK 10-year gilts reached a 15 year high at 4.5% at the end of September on the back of former Prime Minister Liz Truss’s growth plan which proposed billions of pounds in unfunded tax cuts, shooting up the country’s risk premium. 10-year gilt yields then fell back to 3.7% at the end of December 2022 but have risen over the last six months as stubbornly high inflation and weak growth have worried international investors. At the time of writing the UK 10 year gilt yield is at 4.44%. This is an important measure for the bond market as companies wishing to raise money have to reference the gilt yield which pushes their interest costs up.
In the US, the economy appears to be proving more resilient to the effects of inflation. Nevertheless the US Federal Reserve has continued to raise interest rates to try and tame inflation. Whether this policy will work remains to be seen. In Europe, interest rates have risen at a slower pace as EU policy makers worry about anaemic job growth.
Portfolio and revenue review
During the period from June to December 2022, there were several bonds called or repaid and we were able to invest the proceeds at higher coupon rates than we have done previously. Good examples of this would be the Barclays AT1 (Additional Tier 1 bond) 7.75% being rolled over into an 8.75% coupon and the Shawbrook Group 7.785% FRN (Floating Rate Note) being called and replaced with a 12.10% coupon. We also took the opportunity in September when sterling was weak to sell some of our US dollar denominated Bombardier 7.5% 2025 bonds and replaced them with more attractive UK and Euro bonds. The Company still has a meaningful exposure to the US$ with 19.09% of the portfolio investment in that currency and a further 13.79% in the Euro and other currencies.
There were two major disappointments in the portfolio to report. Firstly, Matalan Finance 9.5% 18-31/01/2024 underwent a refinancing of its various bonds and equities in early 2023 and unfortunately our position was reduced to zero. This reduced the NAV by 1.20%. Secondly, we had a small position in Credit Suisse 31/12/2049 FRN AT1 which was written to zero in March 2023 following a forced take-over of Credit Suisse by Union Bank of Switzerland (“UBS”). This affected the NAV by 0.30% but the forced write-down to zero ahead of equity holders was unprecedented and rocked the bond markets. AT1 holdings are the junior debt of banks and financial institutions and are normally ranked higher than shareholder equity. The AT1 market is spooked at the possibility of being ranked lower than equity and caused the bond prices of these instruments to fall sharply. The Company’s portfolio is exposed to around 18.00% in AT1 holdings in companies such as Barclays and Deutsche Bank and on average the prices of those securities have been marked down by between 5.00% and 10.50%. We believe these positions to be robust and will recover and regulators in the UK have taken pains to state that the situation that arose in Switzerland with Credit Suisse would not occur here. We have added to some of our investments at attractive prices.
New entries into the top 10 this year are Barclays Plc 22-15/12/2170 FRN in the global banking sector and Albion Financing 8.75% 21-15/04/2027 which is the financing company for Aggreko, a global provider of power and temperature control solutions.
For the year to 30 June 2023, the revenue account earnings were 4.51 pence compared to 4.16 pence for the same period last year. Earnings per share have improved as we have invested at slightly higher yields and received repayment of historic arrears from the REA preference shares we hold. It is noticeable that as markets settle around current levels, there are more opportunities to invest, particularly as UK Gilt yields have elevated which pushes up the coupons paid by companies when they issue debt instruments priced at a margin over the relevant UK Gilt. In our regular discussions with Shareholders, the revenue and dividends are topics of crucial importance and the ability of any portfolio company to pay its coupon or expected dividend is one of the major indicators we follow.
Outlook
The economic outlook for the UK will be affected by several factors in the months ahead. These include any continued rise in interest rates, how fast inflation continues to fall towards Government targets and whether the UK falls back into recession. Another factor we look at is the UK housing market, how resilient prices are over the next 12 months and whether the recent weakness is set to continue. Finally, as we approach the end of 2024, the prospect of the general election with a possible (at this time according to polls) change of Government makes us look at how policies could change.
Globally, a lot will depend on the world’s two biggest economies, the USA and China. The USA economy is moving along nicely but there will be a lot of political factors to consider in the run up to the 2024 Presidential elections. The Chinese macro-economic picture looks horrible with major weakness in the property sector which is 30% of their GDP.
As regards markets affecting the Company, we believe that we are nearing the top of the interest rate cycle and that we will see a recovery in capital values of higher yielding bonds in the next year or so which would positively impact the ability of companies to refinance debt. But a word of caution: all of this can be affected by external influences.
Ian “Franco” Francis
New City Investment Managers
14 September 2023