The Daily Telegraph
A 14pc return from a bond fund that has never suffered a default? Buy
Twentyfour Income’s dividend is in line for a major fillip and the value of its assets should follow suit to give us a total return in double digits
For that elusive combination of high returns and low risk, Questor has tended to favour either specialist property funds or specialist bond funds. Our thinking is that the professionals who run these portfolios develop such deep understanding of their markets, and have cultivated such fruitful networks of the contacts on which successful deal-making in these areas often depends, that they can buck the normal rules of investing and unearth assets that really can deliver good returns at disproportionately low risk.
Among the property funds tipped here, we would put into this category the likes of Residential Secure Income, Triple Point Social Housing and Regional Reit); for bond funds we would mention Real Estate Credit Investments, Biopharma Credit, Honeycomb – and Twentyfour Income, the portfolio we cover today. The share price chart since we first tipped the fund in 2018 at 116.5p may seem uninspiring; with the shares at 104.5p we are in the red to the tune of 10.3pc in capital terms. But this is to ignore its income – the portfolio has exceeded its dividend target of 6p a share every year since it listed in 2013. What is more, we can now expect big increases in the divi, and indeed in the fund’s net asset value and hence in all probability in the share price too, because of the way the portfolio’s assets work.
There are two forces at play here. First, the managers invest in “floating-rate” assets, so rises in interest rates mean more income for the fund. The second is more complex. The market value of many of its assets has fallen in recent months as investors more generally have sold bonds in response to the rise in inflation. But Twentyfour Income’s managers tend to hold their investments until they mature – which of course they do at “par” value, or the amount originally lent when the bonds were issued. As the maturity date approaches (and the fund’s assets are about three years from maturity on average), the market price naturally tends to rise back up to the par level at which investors will be repaid.
And, when the money from matured bonds is reinvested, it will generate higher interest rates if used to buy other bonds at depressed prices.
None of this, obviously, would hold water if the more perilous economic times we are entering led to a spate of defaults among the fund’s bond holdings. But this is where that specialisation on the managers’ part we referred to above comes into its own. Such is their skill at assessing the creditworthiness of those they lend to (and mortgage borrowers in Britain and Europe, via “mortgage-backed bonds”, account for about 60pc by value) that the fund has never suffered a default.
“Twentyfour Income has never held an investment that has defaulted, nor has it ever held a position that has subsequently defaulted after it owned it,” said Numis, the broker, last month. “There are no credit-impaired positions in the portfolio and bonds have been underwritten against adverse scenarios more severe than the global financial crisis.”
Let’s return to the rising income we can expect thanks to increases in interest rates. “We expect the [fund’s] dividends for the current year to be substantially higher than the prior year given the rise in base rates,” Numis said. “We see scope for a dividend of 8.6p-9p, equivalent to an 8.3pc-8.7pc dividend yield on the share price [almost unchanged since its note], based only on the change in market expectations for UK interest rates. This is assuming there is no benefit from reinvesting any [bond repayments] at the current attractive [rates].”
But the broker said it could see scope for “an even higher dividend” as more of the portfolio’s bonds matured and the proceeds were reinvested at better rates. For the year to March 2024 “we could see scope for a dividend of about 10p”, it said, although it said “a lot could change between then and now”.
But we also need to consider the potential for capital gains as the prices of its bonds drift upwards towards par value as maturity approaches. Adding together the yield and these likely capital gains, Numis said “total returns in the medium term should be closer to … about 14pc [a year]”. Fourteen per cent from a bond portfolio that has never suffered a default is a very attractive proposition. Buy.
Questor says: buy
Share price at close: 104.5p