«PFS TwentyFour Investment Funds - Asset Backed Income Fund Short Report 31 March 2015 PFS TwentyFour Investment Funds - Asset Backed Income Fund ...»
PFS TwentyFour Investment Funds -
Asset Backed Income Fund
Short Report 31 March 2015
PFS TwentyFour Investment Funds - Asset Backed Income Fund
Authorised Corporate Director (ACD) & Registrar
Phoenix Fund Services (UK) Ltd
Springfield Lodge, Colchester Road, Chelmsford, Essex CM2 5PW
Telephone: 01245 398950
Fax: 01245 398951
(Authorised and regulated by the Financial Conduct Authority) Customer Service Centre Springfield Lodge, Colchester Road, Chelmsford, Essex CM2 5PW Telephone: 0345 026 4286 Fax: 0845 280 0963 E-mail: TwentyFour@phoenixfundservices.com (Authorised and regulated by the Financial Conduct Authority) Directors of the ACD P.J. Foley-Brickley D. Jones (appointed 1 April 2014) R.W. Leedham D.W. Munting D.C. Tibble Investment Adviser TwentyFour Asset Management LLP 24 Cornhill, London EC3V 3ND (Authorised and regulated by the Financial Conduct Authority) Depositary National Westminster Bank plc Trustee & Depositary Services 135 Bishopsgate, London EC2M 3UR (Authorised and regulated by the Financial Conduct Authority) Independent Auditor PricewaterhouseCoopers LLP Chartered Accountants & Statutory Auditors 7 More London Riverside London SE1 2RT 1 PFS TwentyFour Investment Funds - Asset Backed Income Fund PFS TwentyFour Investment Funds - Asset Backed Income Fund Investment Objective and Policy Investment objective The Fund aims to provide an attractive level of income along with an opportunity for capital growth.
Investment policy The Fund will invest in a diversified portfolio of European Asset Backed Securities, where the securities will be backed by the assets of European institutions and issuers such as residential mortgages, commercial mortgages, automobile leases and loans, SME loans and other secured bonds. From time to time it is possible that a significant portion of the portfolio may be invested in securities from a particular geographical region of Europe. A portion of the portfolio may from time to time be held in cash or cash equivalents, such as treasury bills and government bonds, in order to help manage the liquidity. The Fund will aim to minimise currency risk by materially hedging the Fund’s exposure in the foreign exchange markets. The Fund will also have the ability to use derivatives to reduce or mitigate other risks.
The choice of Asset Backed Securities will typically be guided by the risk and the yield, although the potential for capital growth may also be a material factor.
The minimum recommended holding term is medium to long term.
The Investment Adviser has overall responsibility for investment policy and authority to select service providers pursuant to the Investment Management Agreement entered into with the ACD.
Securities may be traded over-the-counter, although any securities that the Fund will invest in will be listed on Eligible Markets and will be cleared through a major clearing system such as Euroclear or Clearstream.
The Asset Backed Income Fund will not invest in any Collective Investment Schemes.
2 PFS TwentyFour Investment Funds - Asset Backed Income Fund PFS TwentyFour Investment Funds - Asset Backed Income Fund Investment Adviser’s Report for the year ended 31 March 2015 Market Commentary During the first half of the year there were a number of drivers of fixed income performance. Many of these were shorter-term negative drivers (the Scottish referendum, the conflict in Ukraine and subsequent sanctions, European elections and other geopolitical events) from which the market recovered as the specific threat to stability dissipated. However against a backdrop of continuing disinflationary and low growth data in the Eurozone, and with at times significant bond supply, most markets performed poorly for the majority of the summer and into September.
The pressure on the European Central Bank (ECB) to recognise the danger and act to contain the risk of a potential deflationary spiral grew markedly during May. While the ECB has been long on rhetoric, it has typically been short on action until it announces and implements market-changing tools such as the Long Term Refinancing Operation (LTROs). This time the action was taken on multiple fronts;
a cut to the Main Refinancing Rate from 0.25% to 0.15% (and cut again in September to 0.05%), and to the Deposit Rate from 0% to -0.1%, (and cut again in September to -0.2%), the announcement of Targeted Long Term Repo Operations (T-LTRO) and that the ECB was close to completing work allowing the bank to directly buy European Asset Backed Securiries (ABS).
While the two rate cuts are traditional policy measures, the T-LTRO is more specific; it allows for cheap borrowing for banks who are lending money to corporates and is aimed at encouraging financing to the Small and Medium sized Enterprise (SME) community. The first take-up of the facility was disappointing, at only €82.6bn. The ABS Purchase Programme (ABSPP) and Covered Bond Purchase Programme (CBPP3) were formally announced in September. At this point Mario Draghi suggested that between the TLTRO, the ABSPP and CBPP3 the ECB’s balance sheet would grow by c.€1tn, however since then he has been reluctant to repeat this.
The suggestion that the ABSPP could buy hundreds of billions of euros of European ABS securities was initially a positive driver of performance after announcement, given the low volumes of supply seen in the market, providing a backstop bid for the sector and driving spreads down and prices up in anticipation of such a large and relatively price-insensitive buyer. Along with other pressure from ECB Board members it also helped to push regulators to improve the treatment of ABS securities under legislation such as Capital Requirements Directive (CRD IV) (bank capital weightings), Solvency II (insurance company capital weightings) and the Liquidity Coverage Ratio. As this regulation loosens, the demand for ABS securities will increase, and given many market participants think that European ABS is still unnecessarily penalised in comparison to other low risk asset classes (e.g.
covered bonds), there is plenty of scope for further future upside.
The only part of the European ABS markets that didn’t participate in the sustained tightening in spreads at the time was the new issue Collaterallized Loan Obligations (CLO) market where, at times, new issues have struggled to find adequate levels of interest for the deal to be placed. During August, spreads on single-B rated tranches of news deals widened as a result of this, although without any weakening in the underlying credit.
3 PFS TwentyFour Investment Funds - Asset Backed Income Fund PFS TwentyFour Investment Funds - Asset Backed Income Fund Investment Adviser’s Report continued Market Commentary (continued) A further theme during the year saw the Fund reallocate some investments from UK and Spanish Residential Mortgage-Backed Securities (RMBS) and also from Spanish SME paper into Italian names, reflecting an increase in Italian Commercial Mortgage-Backed Securities (CMBS) new issuance, as well as secondary purchases in RMBS. The Fund also increased its exposure to panEuropean CLOs as the new issue market showed increasing value through spread widening.
Towards the end of the calendar year and into the first quarter of 2015, the fixed income markets were subject to a number of other performance drivers, from commodity prices, politics and central bank policies. At the start of October the global economies were moving in different directions; China and Japan both eased policy through either rate cuts or additional direct stimulus through Quantitative Easing (QE), whilst in Europe the ECB was in the process of putting the final touches to the third Covered Bond Purchase Programme and the ABSPP. In contrast, in the US the markets were trying to decide on the likely timing for any tightening in policy through upward rate moves. These changes in individual policy and the divergence between the US and other economies created instability throughout the second half of the year and continue to divide opinion. In the US the removal of the word “patient” in relation to the Fed’s willingness to raise rates continues to keep the market guessing around a summer “lift-off” or whether the decision will continue to be data-dependent right up until the first move. In Europe, the requirement to invest a certain amount of QE money into German Bunds is coming into conflict with the requirement to only buy bonds that yield more that the deposit rate (-20bps), something that is not possible in Bunds that are less than 4 years in length; leading the market to question whether the ECB will be able to buy enough bonds to fulfil its target.
The significant correction in oil prices has been bad for energy companies, leading to significant outflows from high yield across all geographies, however, the resulting drop in costs for both corporates and consumers has been comparable to a rate cut. The ongoing conflict in Ukraine, and the victory of Syriza in the Greek general election have also continued to hog headlines, and at the end of the year both issues continue to distract investors and are now becoming intertwined as Greece threatens to turn to Russia and China for funding, suggesting a potential exit from the Eurozone, and in turn refusing to agree to further sanctions on Russia for their support for the Ukrainian rebels.
Against this backdrop it is of little surprise that most markets have seen mixed performance. The European ABS market has enjoyed a period of significantly greater stability than other markets, although has probably not performed quite as strongly as might have been expected to date. The disappointment has largely been focussed around the slow progress of the ABSPP which many participants foresaw as driving spreads tighter across the board, however whilst performance prior to launch was good, since then it has lagged somewhat – particularly in the latter months of 2014.
Much of this was the result of an onerous credit review and approval process, with the appointed external asset managers having to work alongside national central banks and leading to the programme buying bonds at a much slower rate than was expected. This was compounded by many ABS dealers buying large amounts of bonds prior to launch in the anticipation of being able to sell them to the ECB at inflated prices. The slow pace of purchases somewhat scuppered this plan, and as the year-end reporting date approached this put pressure on traders’ risk limits, forcing many to 4 PFS TwentyFour Investment Funds - Asset Backed Income Fund PFS TwentyFour Investment Funds - Asset Backed Income Fund Investment Adviser’s Report continued Market Commentary (continued) offload bonds, resulting in a general widening of bid/offer spreads and for some assets a drop in prices. Much of this was recovered quite quickly in early 2015, however, once the balance sheet pressures were removed, although non-eligible assets classes have notably remained wider. In the second half of 2014 CLO mezzanine spreads widened 100-200bps as a result of increased supply of new transactions, although once again demand picked up quickly in early 2015, partly driven by QE, and spreads are closing the gap again.
Market Outlook The advent of Eurozone QE in materially greater size than was expected, and in an open-ended format, has been and will continue to be a significant positive driver, overriding the slow growth of the ABSPP and any material negative performance driven by external influences such as the Greece/Eurozone deliberations, unless such events take a significant turn for the worse. Any impending change to the interest rate environment in the UK continues to be pushed back, however the majority of members of the Monetary Policy Committee have emphasized that the recent drop in inflation is largely commodity driven and not likely to be a long-term threat to a normalisation of rate policy. As such, it is expected that the return journey of interest rate policy towards the long-run average will be spread out over a significant period of time, meaning that the upside to the Fund’s yield will occur in a measured manner. Continued spread performance and at some point a beneficial rate environment should provide steady performance for the Fund over the medium to long term.
Performance review The Fund benefitted a lot from the announcement of the ABSPP, even though the direct exposure to eligible assets for that program was low. The Fund’s exposure to predominantly high quality Portuguese, Spanish and Italian RMBS offset the spread widening witnessed in the primary CLO market. The Fund’s RMBS/CMBS positioning was heavily weighted towards Eurozone assets, expecting to see a differentiation in performance. Since the ABSPP launch, this allocation has been reweighted towards UK domiciled assets as many Eurozone assets have performed well, as expected, and a material yield basis has been established to non-Eurozone assets and in particular UK Nonconforming mezzanine bonds. The Fund has kept the exposure to European CLOs relatively high, as we expected this sector to perform well on the back of the announced QE program, and a lot of the Fund’s early 2015 NAV performance can be attributed to this asset class.
Ben Hayward Founding Partner, Portfolio Management
^ Operating charges include indirect costs incurred in the maintenance and running of the Fund, as disclosed (but not limited to) the detailed expenses within the Statement of Total Return. The figures used within this table have been calculated against the average Net Asset Value for the accounting year.
Direct transaction costs include fees, commissions, transfer taxes and duties in the purchasing and selling of investments, which are offset (where applicable) against any dilution levies charged within the accounting year. The figures used within the table have been calculated against the average Net Asset Value for the accounting year.