My job as manager of Invesco Bond Income Plus Ltd (BIPS) is to supply income to enable the investment trust’s board to pay dividends to shareholders.
The income comes from a portfolio of bonds. If we think of the portfolio as the income engine, then higher coupons¹ and higher yields over the past two years have allowed me to refuel.
A lot has changed since 2022. It has become much easier to earn yield from bonds without taking too much risk. For a long time, it wasn’t like that. For several years before 2022, ultra-low interest rates enabled bond issuers to finance very cheaply, with historically low coupons. It was a challenge to keep a good level of fuel in the tank!
In European high yield² coupons on newly issued bonds fell to just 3.7% in 2021. In contingent capital bonds³ (Cocos), another important market for investors seeking higher income, coupons fell to an average 4.6%. The yield to maturity (YTM)4 of these markets fell too.
European High Yield Index2 |
Contingent Capital Index³ |
|||
Average coupon of new issues |
YTM of index |
Average coupon of new issues |
YTM of index |
|
|---|---|---|---|---|
Issue year |
% |
% |
% |
% |
2018 |
3.75 |
5.18 |
5.77 |
6.83 |
2019 |
3.56 |
3.61 |
6.13 |
5.58 |
2020 |
3.76 |
3.34 |
5.24 |
4.76 |
2021 |
3.69 |
3.43 |
4.58 |
5.13 |
2022 |
6.44 |
8.00 |
7.43 |
8.60 |
2023 |
7.55 |
6.80 |
8.80 |
7.97 |
Source: ICE BoAML as at 31 December 2023
This changed in 2022. Higher interest rates meant that the high yield bond market had to adjust to remain competitive with government bonds and cash deposit accounts. The price of existing bonds (including all those ones that had been issued with low coupons) fell below issue price (‘par’), to a point where their total yield to maturity was acceptable to investors.
Source: ICE BoAML as at 22 February 2024
As new bonds have come to the market, coupons have had to rise too (see table above). So far, issuance of corporate high yield bonds has been relatively low. As the table below shows, the supply of new bonds has fallen substantially since 2021.
Little issuance in 2022 & 2023
| 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Issuance €bn | 37.4 | 75.7 | 83.7 | 75.9 | 59.5 | 101.2 | 65.2 | 87.0 | 103.3 | 149.9 | 31.8 | 56.9 |
| % BB | 54% | 45% | 41% | 49% | 58% | 55% | 46% | 65% | 60% | 53% | 49% | 56% |
| % B | 32% | 44% | 51% | 38% | 34% | 35% | 50% | 29% | 32% | 39% | 46% | 38% |
| % CCC | 8% | 7% | 5% | 6% | 2% | 7% | 3% | 4% | 2% | 5% | 3% | 0% |
| % NR | 2% | 3% | 3% | 4% | 1% | 3% | 1% | 2% | 3% | 3% | 2% | 6% |
| Redemptions €bn | 15.6 | 26.2 | 45.3 | 48.6 | 57.8 | 81.6 | 50.2 | 70.3 | 45.4 | 66.0 | 34.1 | 54.3 |
| Net €bn | 21.7 | 49.0 | 38.4 | 27.3 | 1.7 | 19.6 | 15.0 | 16.7 | 57.9 | 83.9 | -2.3 | 2.7 |
| # of bonds issued | 110 | 216 | 219 | 176 | 145 | 233 | 163 | 184 | 206 | 307 | 72 | 127 |
Source: JP Morgan European High Yield Quarterly Review, 8 January 2024
Bonds rated BB, B, CCC and NR are non-investment grade and categorised as ‘high yield’. Credit or default risk is the primary risk for high yield bonds. For this reason, thorough credit analysis is an important part of an active manager’s process when investing in these securities.
But there has been issuance, in high yield bonds and in subordinated bonds and senior investment grade bonds. Yields and coupons have risen in all these markets and we have been very happy to take many of the opportunities on offer. In some cases, we have been able to buy investment grade bonds with higher coupons than prevailed in the high yield market just a couple of years ago.
As a result, the level of income produced by the BIPS portfolio has risen. At the end of 2021, the weighted average coupon5 of the portfolio was 6.1%; By the end of 2022 it was 6.5% and it is now (December 2023) 7.0%6. The yield to maturity, which accounts for future capital returns as well as income, is even higher.
Pleasingly, this increase has occurred even as the overall credit quality of the portfolio has improved (see below). We have added investment grade bonds along with high yield bonds. The common theme is of companies whose creditworthiness we trust, having to pay us more in coupon than they did before. This is a much better situation for bond investors.
Source: Invesco as at 31 December 2023
I believe that the bonds we are adding now can contribute a valuable level of income and total return for the portfolio. I also expect to have more opportunities like this as companies re-finance in a higher rate environment, which should support the board in its quest to deliver dividends7.
Dana is a large, global auto supplier. Its business is diversified by vehicle type and geographic market. It is well-positioned for the growth of electric vehicles (EVs) as axles and drive-shafts, its primary products, are required for both conventional vehicles and EVs.
Like all auto suppliers, Dana has come through a period of weakness related to the pandemic and supply chain pressures. This hit earnings, but EBITDA (earnings before interest, taxes, depreciation and amortization) is now recovering and earnings and free cash flow are expected to grow from here. The level of debt on Dana’s balance sheet (borrowing is 3.1 times EBITDA), and management have indicated they will deleverage as free cash flow grows. The company also has a strong liquidity buffer.
Dana issued their EUR 8.5% 2031 (BB-) bond in May 2023. We bought it at par. Dana issued a similar bond in 2021, with a coupon of only 3.0%.
To illustrate this change in the borrowing costs for the company, and the improvement in return for creditors, Dana will pay a total of EUR 325m in coupons on this new bond (the bond size is EUR 425m and the life is nine years). At a 3% coupon, they would pay EUR 115m.
BT (British Telecom) is one of the main providers of phone, broadband and mobile in the UK. These are essential services. It has some particular challenges, which warrant a yield premium to peers. Although the company is cashflow negative, this is due to a heavy programme of investment in the build out of fibre infrastructure, which is tax-efficient and should support growth.
Revenue and earnings are growing. Borrowing is about 2.4 times earnings (excluding pension deficit).
BT issued their GBP 8.375% (BB+) hybrid capital instrument in June 2023. As a hybrid, it has a lower position in the company’s capital structure but the overall credit quality of BT remains high. The final maturity date is 2083 but we expect the bonds to be called (re-purchased) in 2028. There is a commitment to re-purchase the bond at a price of 101 should it rise above par price, in the event of a change of control. We bought around par. BT issued a similar bond in USD in 2021, with a 4.25% coupon.
Europe’s largest lottery operator, Allwyn operates in what we think is a relatively safe niche of the European gaming market, with resilient revenues and lower regulatory scrutiny. The company’s main operations are European state lotteries. The company is owned by private investor group KKCG, with the expectation that they are aiming for an initial public offering (IPO) exit.
Net leverage is low (1.9 times earnings in Q2 2023). EBITDA margins are above 40% and free cash flow generation is steady.
Allwyn issued their EUR 7.25% 2030 (BB-) bond in April 2023. We bought at face value.
Markets were relatively volatile during the quarter, with investors being pulled between the negatives of geopolitics and weaker industrial demand, and the potential benefit of lower interest rates.
Better inflation data prompted a strong start to the quarter, however, there was a sharp sell-off in August as positivity around interest rates was swamped by fears of a US recession. These fears gradually dissipated, and markets largely recovered by the end of the quarter.
In this video, fund manager Martin Walker discusses what has been happening in UK markets, economic news and recent fund performance, plus his outlook for UK equities.
1 A coupon is the amount the borrower will pay each year as a reward to the lender until the bond matures and the debt is repaid.
2 ICE BofA European Currency High Yield Index
3 Contingent convertible capital (CoCos) are debt instruments that allow the write down or conversion of the bond into equity in certain, defined circumstances. ICE BofA Contingent Capital Index
4 Yield to maturity is the total return that will be paid out by a bond's expiration date.
5 The weighted average coupon rate is determined by multiplying the coupon rate of each bond based on its size within the portfolio.
6 The yield shown is expressed as a % per annum of the current NAV of the fund. It is an estimate for the next 12 months, assuming that the fund’s portfolio remains unchanged and there are no defaults or deferrals of coupon payments or capital repayments. The yield is not guaranteed. Nor does it reflect any charges. Investors may be subject to tax on distributions.
7 Dividend payments are determined by the Board and are not guaranteed.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Invesco Bond Income Plus Limited has a significant proportion of high-yielding bonds, which are of lower credit quality and may result in large fluctuations in the NAV of the product.
Invesco Bond Income Plus Limited may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.
The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall.
Invesco Bond Income Plus Limited uses derivatives for efficient portfolio management which may result in increased volatility in the NAV.
All information correct as at 20 February 2024 unless otherwise stated.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
If investors are unsure if this product is suitable for them, they should seek advice from a financial adviser.
Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns.
The yield shown is expressed as a % per annum of the current NAV of the fund. It is an estimate for the next 12 months, assuming that the fund’s portfolio remains unchanged and there are no defaults or deferrals of coupon payments or capital repayments. The yield is not guaranteed. Nor does it reflect any charges. Investors may be subject to tax on distributions.
Views and opinions are based on current market conditions and are subject to change.
For more information on our products, please refer to the relevant Key Information Document (KID), Alternative Investment Fund Managers Directive document (AIFMD), and the latest Annual or Half-Yearly Financial Reports. This information is available on the website: https://www.invesco.com/uk/en/investment-trusts/invesco-bond-income-plus-limited.html.
Further details of the Company’s Investment Policy and Risk and Investment Limits can be found in the Report of the Directors contained within the Company’s Annual Financial Report.
Invesco Bond Income Plus Limited is regulated by the Jersey Financial Services Commission.
