Sequoia Econ Infra - Annual Financial Report
29/06/2023 07:00
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RNS Number : 3613E Sequoia Economic Infra Inc Fd Ld 29 June 2023
29 June 2023
SEQUOIA ECONOMIC INFRASTRUCTURE INCOME FUND LIMITED
(the "Company" or "SEQI")
RESULTS FOR THE YEAR ENDED 31 MARCH 2023
The Directors of SEQI, the specialist investor in economic infrastructure
debt, are pleased to announce the Company's results for the year ended 31
March 2023.
RESILIENT PERFORMANCE DESPITE VOLATILE MARKET
ROBERT JENNINGS, CHAIR, COMMENTED:
"The Company has remained resilient against a backdrop of an increase in
credit spreads and tighter lending conditions globally, driven by interest
rates which rose at almost unprecedented speed in FY23. Our income for the
year increased due to the high proportion of floating rate investments in our
diversified portfolio which has allowed us to increase our annual dividend by
10% to 6.875p per Ordinary Share, starting with the February 2023 dividend
payment in respect of the quarter ended 31 December 2022.
The Board and the Investment Adviser are very mindful of the wide discount to
Net Asset Value per share which our shares currently trade on. In that
context, SEQI's shorter duration is beneficial and allows us to take a
flexible approach to capital allocation in optimising the balance between
share buy backs, leverage and attractively yielding portfolio investments."
We believe our economic infrastructure portfolio is well positioned in the
current high interest rate environment and are taking advantage of credit
markets that are favourable to debt providers. We have demonstrated our
resilience throughout the challenges of the last eight years and, our
well-diversified portfolio, growing interest income and disciplined approach
to capital deployment gives us confidence for our future."
HIGHLIGHTS
· Annualised portfolio yield-to-maturity of 11.9% (2022: 8.4%) as
at 31 March 2023
· Dividends totalling 6.5625p per Ordinary Share (2022: 6.25p) paid
in respect of the year in line with annual dividend targets
· Strong dividend cash cover of 1.21x (2022: 1.06x)
· Defensive, diversified portfolio of 68 investments across 8
sectors, 26 sub-sectors and 12 mature jurisdictions
o 98% of investments in private debt (2022: 95%)
o 58% floating rate investments (2022: 50%), capturing short-term rate rises
o Short weighted average life of 3.5 years (2022: 4.1 years) creating
reinvestment opportunities
o Weighted average equity cushion of 34% (2022: 33%)
· NAV per Ordinary Share cum-dividend of 93.26p (31 March 2022:
100.50p) mostly reflecting the mark-to-market effect of higher interest rates
and credit spreads
· NAV total return of -0.9% (2022: 3.5%) in the year
· Share price total return of -16.1% (2022: 4.5%) in the year
· Ongoing charges ratio of 0.96% (2022: 0.87%) (calculated in
accordance with AIC guidance)
· ESG score of the portfolio is on a long-term and sustainable
upward trend
ANNUAL REPORT
A copy of the annual report has been submitted to the National Storage
Mechanism and will be shortly available at
https://data.fca.org.uk/#/nsm/nationalstoragemechanism
(https://data.fca.org.uk/#/nsm/nationalstoragemechanism) . The annual report
is also available on the Company's website at
https://www.seqi.fund/investors/results/
(https://www.seqi.fund/investors/results/) where further information on SEQI
can be found.
INVESTOR PRESENTATION
The Investment Adviser will host a presentation on the annual results for
investors and analysts today at 10:00am BST. There will be the opportunity for
participants to ask questions at the end of the presentation. Those wishing to
attend should register via the following link:
https://stream.brrmedia.co.uk/broadcast/648c3fe1cdb8783915128cb1
(https://nam12.safelinks.protection.outlook.com/?url=https%3A%2F%2Fstream.brrmedia.co.uk%2Fbroadcast%2F648c3fe1cdb8783915128cb1&data=05%7C01%7CFaye.Calow%40teneo.com%7C041a6b57b73e4a7baca208db770b763c%7C3601ef954dea4cfc9a88eaef968ce713%7C0%7C0%7C638234663340294498%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000%7C%7C%7C&sdata=eEYgKNy04mdVt1v2LBBwavzLZz2SYRVbKSNvspKCD%2BE%3D&reserved=0)
For further information, please contact:
Sequoia Investment Management Company +44 (0) 20 7079 0480
Steve Cook
Dolf Kohnhorst
Randall Sandstrom
Greg Taylor
Anurag Gupta
Jefferies International Limited (Corporate Broker & Financial Adviser) +44 (0) 20 7029 8000
Gaudi Le Roux
Stuart Klein
Teneo (Communications Adviser) +44 (0) 20 7353 4200
Martin Pengelley
Faye Calow
Sanne Fund Services (Guernsey) Limited (Company Secretary) +44 (0) 20 3530 3107
Matt Falla
Lisa Garnham
LEI: 2138006OW12FQHJ6PX91
CHAIR'S STATEMENT
Dear Shareholder,
It is my pleasure to present to you the Annual Report and Audited Financial
Statements of the Company for the financial year of operations ended 31 March
2023. In the absence of unforeseen circumstances, this will be my final report
to you as your Chair, as I am now in my ninth year.
The financial year saw interest rates rise at almost unprecedented speed, as
central banks strove to tame rapidly rising inflation. This led to an increase
in credit spreads and tighter lending conditions globally.
This environment has resulted in mixed fortunes for the Company, as our NAV
declined on the back of higher rates, but our income increased due to the high
proportion of floating rate investments in the portfolio - this enabled us to
increase its dividend by 10%, to 6.875p per Ordinary Share, starting in
January 2023. Less pleasingly, our share price fell to below its NAV - this is
an unwelcome development, largely driven we believe by sentiment towards the
wider alternative income sector rather than a specific reflection of the
attractiveness of the Company. Nonetheless, we have taken a number of measures
to limit the discount to NAV.
NAV and share price performance
Over the financial year, the Company's NAV per Ordinary Share(1) decreased
from 100.50p to 93.26p, after paying dividends of approximately 6.41p,
producing a NAV total return(1) of -0.9% (2022: +3.5%), compared to our target
return of 7-8%.
The decline in the NAV is mostly down to the mark-to-market effect of higher
interest rates and credit spreads, which rectifies itself as loans move closer
to repayment. If we were to hypothetically disregard this effect, the NAV
total return for the year(1) would have been over 6%. It could be argued that
this 6% return represents the true underlying performance, since this decline
in marks is an unrealised loss, much of which should substantially reverse
itself over time through the pull-to-par effect. In other words, as our loans
approach their maturity date, their marks will inevitably (absent any credit
event) rise towards their par value. As interest rates start to plateau
gradually, this represents a helpful tailwind to our NAV in the years ahead.
Moreover, we have once again outperformed the liquid credit markets, with high
yield bonds generating total returns of -4.7%, and leveraged loans -4.2%, over
the same period, compared to -0.9% in our case.
The Company's share price also declined over the year, from 102.80p to 80.40p,
a share price total return(1) of -16.1% (2022: +4.5%), once dividends are
taken into account. This was almost entirely a result of the decline in the
rating of the shares, from a premium(1) of 2.3% at the beginning, to a
discount(1) of 13.8% by the end of the year.
We are disappointed in this fall in our share price, which we believe is
predominantly a result of investors' concerns over rising interest rates, high
inflation, a sluggish global economy and geopolitical risks, as well as
technical factors specific to investors but unrelated to the Company, such as
the consequences of redemptions from their own funds. We do not believe it is
a reflection of the fundamental attractiveness of the Company - all our peers
in the infrastructure and debt sectors also trade at a discount. However, we
are not complacent and the following measures were put in place from an early
stage to address this issue:
· an active buy-back programme, with 33.4 million Shares repurchased
over the financial year, which we have continued since the year end. Not only
does this partly address the excess supply of shares in the market, but most
notably the purchases are accretive to NAV;
· ongoing Share purchases by the Directors of the Company and Sequoia
Investment Management Company Limited (the "Investment Adviser") and its
directors. In total, 1,609,258 Shares were bought by insiders during the year;
· a 10% increase in the dividend, keeping pace with UK inflation, which
should improve the attractiveness of the Company to investors looking for
strong income; and
· enhanced investor communication including a revamped website
(www.seqi.fund), a well-attended investor capital markets day and numerous
meetings with individual investors.
1. See Appendix for Alternative Performance Measures ("APMs").
Dividend
As noted above, on the back of higher short-term interest rates, which has
resulted in increased income from the Fund's investments in floating rate
loans, we were able to increase our dividend by 10%, from 6.25p per Ordinary
Share to 6.875p per Ordinary Share. This increase took effect from January
2023. As in previous years, the dividend remains fully cash-covered.
For the time being, we intend to hold the payout at its current level. However
if, as we anticipate, our interest income continues to increase, further
strengthening in our dividend cash cover ratio, we will review the situation
again later in 2023, in the context of our ambition to pay out a sustainable
and attractive level of income to our Shareholders.
Portfolio performance
Most of our portfolio has performed well over the course of the year, with
many sectors previously adversely affected by COVID-19 improving materially.
Specifically, the Fund's exposures to the transportation sector (excluding
aviation), student accommodation and midstream assets all improved in credit
quality, while other sectors such as telecommunications and healthcare
infrastructure remained robust.
Of the three non-performing investments identified a year ago, one has now
been exited, albeit at a loss. That leaves only Bulb Energy and a loan backed
by the property at 4000 Connecticut Avenue, Washington DC (formerly called
Whittle Schools). Progress has been made on these two investments, which
represent only 3.3% of NAV. The Investment Adviser discusses these specific
transactions in more detail in the NAV and Fund Performance section of its
report.
While most of the bonds and loans in our portfolio are performing in line with
expectations, some 10% of our portfolio, including the two aforementioned
loans, are receiving enhanced scrutiny by our Investment Adviser. The Board
has closely reviewed these positions and is comfortable that their current
marks, which are generated by our valuation agent PricewaterhouseCoopers, and
reviewed by our independent Auditor Grant Thornton, fairly reflect the current
value of these positions.
During the financial year, the Investment Adviser has had a highly selective
approach to new investments. In general, we have prioritised investments in
lower-risk parts of the infrastructure market, which typically have only a
moderate or low correlation to the economic cycle, such as businesses with a
high degree of contractual income. While net leverage has increased due to the
substantial effect the foreign exchange market's volatility has had on the
Fund's hedging book, we have refrained from drawing too much on the Company's
revolving credit facility ("RCF") and are now rebuilding liquidity reserves -
in part, because having low net leverage is clearly prudent in turbulent
markets.
A retrospective review of the Company since its IPO
The Company has now been in operation for slightly more than eight years since
its IPO on 3 March 2015. As my tenure as Chair is nearing its end, this seems
like a natural time to reflect on the Company's performance.
Firstly, it is clear that the Company's strategy, as set out in its very first
Prospectus before the IPO, was both attractive to investors and successfully
implemented. Through 11 well‑supported capital raises, the Company grew
approximately 12‑fold and became a constituent member of the FTSE 250. This
scale has produced some important benefits for investors, including:
· lower costs, since the fixed costs of the Fund are spread over a
larger capital base and the Investment Adviser's fee has reduced in percentage
terms through a fee‑tapering mechanism;
· reduced risk due to an increase in diversification;
· increased access to investment opportunities thanks to our ability to
fund larger, more important, infrastructure projects; and
· greater "pricing power" in the loan terms that we offer to the
companies we finance.
Secondly, the Fund has operated through some turbulent times, which have
helped to demonstrate the robustness of infrastructure debt as an investment
class. Periods of high volatility in the liquid credit markets; COVID-19
lockdowns followed by a recession or a near-recession; the Ukraine war;
ultra-low interest rates followed by a normalisation of rates at an almost
unprecedented speed; and periods of both abnormally low and abnormally high
energy prices have all challenged us. That is a lot in only eight years!
During all this, we have of course had some loans default. That is a natural
part of running a loan portfolio - it would be naïve to imagine that the Fund
could keep lending money in perpetuity without experiencing some bad debts.
However, as the chart below shows, our proportion of defaulted loans is much
lower than both the broader credit markets, and indeed comparable
infrastructure lending.
Note that within this calculation we are including not just the actual
defaults we have experienced but also cases when we have sold loans at a loss
to avoid a further deterioration in credit quality and the likelihood of a
default in the future.
Moreover, when we have had a default, we have on average recovered more than
other lenders. This means that our "loss rate" (i.e. annualised credit losses,
expressed as a percentage of the loan book) is very low indeed, at
approximately 0.56% per annum. This number includes not just realised losses
but projections of future losses, which have not yet come to pass,
on non‑performing loans.
Thirdly, the Company has been able to earn its target yield on its
investments, net of costs, and this has enabled us to pay a growing and
cash‑covered dividend. In its eight years, the Company has met every
dividend payment and target.
Fourthly, as discussed below, the Company has adopted a market‑leading ESG
policy. This has involved implementing ESG scoring, exiting some non-compliant
investments, targeting new investment sectors, engagement with borrowers and a
high (and growing) level of sustainability reporting.
Our goal on ESG is to be a market leader, not a follower. We believe that by
acting today we are positioning the Company for success in the future, and
this is what our investors want.
Liquidity
One important, but easily overlooked, aspect of listed funds is the importance
of having sufficient liquidity. This is especially true for companies such as
ours that invest in illiquid private assets. Liquidity can be needed to meet
potential margin calls on FX hedging, finance share buy‑backs and manage
borrowing and funding investment commitments.
We derive liquidity through cash sitting on the balance sheet, the undrawn
portion of the RCF, the natural high level of cash generation arising from our
investment portfolio and a reasonable number of liquid investments, typically
rated infrastructure bonds.
I am pleased to say that the Company has remained liquid at all times since
its inception. This is because we are cautious by nature and conservatively
assess our liquidity requirement. In response to the deteriorating market
conditions over the opening months of the financial year, in September 2022,
the Board and the Investment Adviser agreed that it would be beneficial to
increase liquidity via targeted asset sales. Over the last nine months since
then, the Investment Adviser has cumulatively raised £460 million through
sales and loan redemptions. This has provided funds to support our share price
through our buy-back programme and has allowed our Investment to make
selective purchases at attractive prices of more liquid infrastructure bonds
and broadly syndicated leveraged loans.
Environmental, social and governance ("ESG")
This year has seen continued progress on the development of the Company's
approach to ESG. We have focused on applying the comprehensive ESG policy
which we published in June 2021, and refreshed earlier this year, across all
of our portfolio and deal pipeline. Our policy sets out in detail our approach
to asset selection and portfolio construction, as well as broader themes such
as how we can engage with our borrowers on ESG-related matters.
We continue to report under Article 8 of the EU Sustainable Finance Disclosure
Regulation ("SFDR") directive.
In February 2023 we were delighted that our Investment Adviser won the 2022
global award for Best ESG Infrastructure Investment Strategy by Capital
Finance International ("CFI"), in recognition of its progress against its ESG
commitments and framework.
Overall, the portfolio has shown progression during the year from an average
score of 61.88 to 62.29. A significant number of the lowest‑scoring loans
have been sold or allowed to roll off at their maturity, and most of our new
investments generally score higher than the ones they replace. Generally, we
expect this trend to continue, and believe that our scoring framework will
allow us to continue to allocate more capital towards sectors and borrowers
who demonstrate appropriate environmental, social or governance
characteristics. However, because we are willing to lend to borrowers who are
seeking finance transition programmes to improve their ESG metrics, sometimes
from a relatively low base, it is not a given that our portfolio's average ESG
score will improve at every future reporting date.
For the third year running we have mandated KPMG LLP to provide independent
limited assurance of our portfolio's overall ESG score, which we believe is
indicative of our intention to raise standards of rigour in the qualification
of ESG credentials across portfolios of loans.
As noted in my review last year, the Board wrote to all the Company's key
service providers to request information about the management of their carbon
footprints and the steps they are taking to reduce these over time. We were
greatly encouraged to discover that the majority of our larger key service
providers have already set up impressive programmes to monitor and reduce
their carbon intensity.
We also put in place a programme to offset our emissions from our own
activities, such as the difficult-to-avoid ones relating to flights to and
from Guernsey. This programme is financed by a voluntary levy on Directors'
fees and by contributions from some of our key suppliers, most materially from
our Investment Adviser.
The credits we acquired during 2022 are expected to be sufficient to offset
estimated corporate-level emissions for 2022 and, pending verification of the
Peatland Code certified units due for conversion in 2025, for 2023 and 2024 as
well.
Overall, I continue to believe that the policies that our Investment Adviser
is operating and developing firmly establish us at the forefront of
ESG thinking in the context of an infrastructure debt‑focused fund.
Board succession plans
In previous Chair's statements, I have discussed Board succession planning,
and I would now like to introduce Fiona Le Poidevin, who joined the Board in
January 2023, having previously been the Chief Executive Officer of The
International Stock Exchange Group and, before that, the Chief Executive of
Guernsey Finance, the promotional body for Guernsey's finance industry
internationally. Fiona is a Chartered Director, a Fellow of the Institute of
Directors and a Chartered Accountant and brings a wealth of experience in
listed funds. Going forward, Fiona will chair the Company's Audit Committee.
I would like to thank Sarika Patel, who has diligently served as a Director of
the Company for two years and is now stepping down for personal reasons at
this year's AGM. She has brought many years of experience to the Board and has
contributed significantly to the Company's success and we wish her the best
for the future. The process to recruit a replacement for Sarika is already
underway.
Of the original four Directors on the Board at the time of the Company's IPO
in March 2015, only two now remain, Sandra Platts and I. In accordance with
best practice, it is anticipated that we will both retire from the Board over
the course of the next 12 months.
Outlook
As noted above, we are taking advantage of credit markets that are currently
favourable to debt providers. As loans mature, we are able to redeploy capital
at higher returns for less risk, and improve our cash yield and average credit
rating on our portfolio. Tight lending conditions, across not just the banking
sector but also the liquid credit markets (specifically the high yield and
leveraged loan markets) mean that the Investment Adviser can be extremely
selective in the opportunities it chooses to pursue.
In general, not only do the assets that we add to the portfolio carry
attractive yields, but they also:
· improve the average credit quality of the loan book, for example by
targeting senior over subordinated debt, and defensive over cyclical sectors;
· improve the balance of the portfolio by investing in parts of the
infrastructure market where the Fund currently has no or little exposure; and
· improve the portfolio's ESG profile.
In addition, higher yields available in the market have allowed the Investment
Adviser to add investments (typically rated infrastructure bonds) to our
liquid asset bucket.
We believe that this approach will position us well to deliver attractive and
sustainable returns for Shareholders.
We will also continue to monitor our Share price closely and, where
appropriate, to engage in limited Share buy-backs. The rate at which we buy
back Shares will flex depending on various factors, including the level of our
Share price discount to NAV. We believe that buying in Shares at greater
discounts will generate Shareholder value over the long term, even if it means
that the size of our portfolio has to fall somewhat over the interim.
I would like to end by noting that the Company has demonstrated its resilience
throughout the challenges of the last eight years. Our well diversified
portfolio, growing interest income and disciplined approach to capital
deployment give us confidence for our future.
Robert Jennings
Chair
28 June 2023
INVESTMENT ADVISER'S REPORT
The Investment Adviser's objectives for the year
Over the course of the financial year, Sequoia Investment Management Company
Limited ("Sequoia" or the "Investment Adviser") has had the following
objectives for the Fund:
Goal Commentary Achieved
Gross portfolio return(1) of 8-9% The Fund is fully invested with a portfolio that yields(1) in excess of 11%, Yes
compared to 8% as at 31 March 2022, the increase being primarily driven by
increases in long-term interest rates during the year
Manage the portfolio responsibly through an inflationary and rising interest The Fund has continued to position its portfolio beneficially considering the Yes
rate environment rise in interest rates and has increased the floating rate proportion of its
portfolio from 50.1% at 31 March 2022 to 58.4% at 31 March 2023
Follow a sustainable investment strategy The Fund has improved the overall ESG score of its portfolio from 61.88 to Yes
62.29 by allocating capital to higher-rated opportunities and selling off
legacy investments
Timely and transparent investor reporting Factsheet, commentary and the full portfolio have been provided monthly for Yes
full transparency, with increased investor engagement over the year
Continue to improve the ESG profile of the Fund and the portfolio The Fund's pioneering ESG approach was recognised by investors when the Yes
Investment Adviser won the 2022 global award for Best ESG Infrastructure
Investment Strategy by Capital Finance International
Dividend target of 6.875p per Ordinary Share per annum, increased by 10% from The Company paid two quarterly dividends of 1.5625p and two of 1.71875p per Yes
6.25p per annum starting in Q3 Ordinary Share in respect of the year, in accordance with the increased
dividend target, amounting to a total of 6.5625p
Economic infrastructure is a diverse and highly cash‑generative asset class
Economic infrastructure debt is a type of investment that is widely recognised
for its stability and reliability. This asset class is characterised by
several key features that make it attractive to investors. Firstly, there are
high barriers to entry, which means that it is difficult for new players to
enter the market, creating a certain level of protection for existing
investors. Secondly, the cash flows generated by economic infrastructure debt
are typically stable and predictable, providing a steady income stream to
investors. This is due to the essential nature of the services provided, which
ensures a consistent level of demand. Finally, the physical assets that
support economic infrastructure debt provide tangible collateral that can be
used to secure the investment. These features have made economic
infrastructure debt an increasingly popular asset class among investors
seeking a stable source of income and a reliable long-term investment.
Economic infrastructure debt sectors such as transportation, utilities, power,
telecommunications and renewables are often supported by long-term concessions
or licences to operate infrastructure assets. Projects in these sectors
typically earn their revenues from demand, usage or volume, such as a data
centre's revenue depending on the number of clients using its services. This
contrasts with social infrastructure, such as parks and hospitals, which are
often compensated for the physical asset simply being available for use.
To mitigate demand risk, economic infrastructure projects are typically less
highly geared than social infrastructure and have higher equity buffers, more
conservative credit ratios, stronger loan covenants, and higher levels of
asset backing for lenders. This has remained true during the financial year,
and SEQI's investment opportunities continue to be based and analysed on these
characteristics.
Despite market volatility during the period, the Fund took pre‑emptive
actions to position its portfolio defensively for potential downturns, such as
targeting mainly floating rate assets, focusing on senior debt, and favouring
non-cyclical industries. These measures helped mitigate risks from the
lingering effects of the COVID-19 pandemic, the current inflationary market
and opposing rate hikes, and other global uncertainties, such as Russia's war
with Ukraine.
Overall, economic infrastructure debt remains an attractive asset class with
stable cash flows and high barriers to entry. As sustainability continues to
be a key investment topic, SEQI notes that investing in new economic
infrastructure is often necessary for the implementation of the latest
technologies and manufacturing processes into existing industries. This
creates an abundance of ESG‑incorporating investment opportunities,
benefiting not only SEQI's portfolio but also the modernisation of otherwise
high barrier-to-entry sectors.
The market environment during the year
Despite the fundamental stability of infrastructure debt as an asset class,
the broader financial markets experienced significant turbulence over the
year, which has inevitably impacted the valuations of the Fund's investments.
For instance, the FTSE All-Share Index, representing the overall London equity
market, increased by 2.5%, while the FTSE 250, tracking mid-cap companies,
declined by 8.1% during the period. 10-year Gilts (UK government bonds)
decreased by 11.0%, leveraged loans declined by 4.2%, and high yield bonds
fell by 4.7%. These figures include dividends or interest income, providing a
total return for the period.
The deterioration in financial markets resulted from several factors, such as
high inflation, global supply chain disruptions and rising interest rates. The
COVID-19 pandemic continued to impact economies worldwide, and investors
displayed a high level of risk aversion, requiring higher interest rates and
credit spreads as compensation for elevated risk. Some markets, such as high
yield bonds, experienced significant volatility, with year-on-year new
issuance declining.
The Fund's portfolio of private debt is impacted by interest rates and credit
spreads in liquid markets. While weakness in high yield bond markets
negatively affects in the valuation of the Fund's investments, the Fund also
benefited from weak markets, as infrastructure businesses had fewer options
for raising capital, and the pricing power enjoyed by the Fund increased. This
translated to higher lending margins, better credit terms, or both, which
benefited the Fund's overall performance. Despite the challenges, the Fund's
investments in infrastructure debt continue to provide investors with an
attractive risk-return profile.
Portfolio overview
Our strategy for the period has been to continue building and managing a
diversified portfolio of private debt investments backed by infrastructure
assets in low-risk jurisdictions. We aim to maintain our target returns with a
focus on avoiding excessive credit risk. Throughout this period, we continued
to employ cautious investment strategies that were put into place in 2019.
These strategies involve maintaining a large portion of the portfolio in
defensive sectors, prioritising senior debt over mezzanine debt, and
maintaining or gradually improving the portfolio's credit quality.
The economic outlook for the period ahead remains uncertain, with concerns
over inflation and the impact of rising interest rates on global growth.
Despite these challenges, our diversified approach to private debt investing
has helped us to achieve solid returns and manage risk effectively. As a
result, we have been able to take advantage of new opportunities to lend to
high-quality infrastructure projects. Following this strategy, we believe that
we can continue to generate attractive returns for our investors while
mitigating risk in a challenging market.
· We have 57.6% of the portfolio in defensive sectors. These include
telecommunications, accommodation, utilities and renewables, which are viewed
as defensive because they provide essential services, often operate within a
regulated framework and have high barriers to entry.
· Our telecommunications sector, which stands at 28.8% of the
portfolio, continues to perform as previous PIK assets become cash-paying and
the appetite for infrastructure such as data centres grows.
· We have 57.2% of the portfolio in senior and 42.8% in mezzanine as
opposed to more of a 50-50 blend to position the portfolio better for a
slow-growth environment.
· We have maintained the credit quality of the portfolio over the last
12 months while still achieving our target yield. We have continued our
policy, instituted shortly after SEQI's launch in March 2015, not to invest in
CCC profile names.
· We have maintained a low modified duration(1) of 1.5 with 58.4% of
the portfolio in floating rate deals and investing in short-term fixed rate
assets, which currently have a low weighted-average life of 3.5 years.
The Fund's investment portfolio is diversified by borrower, jurisdiction,
sector and sub-sector, with strict investment limits in place to ensure that
this remains the case. The chart below shows portfolio sectors and sub-sectors
on 31 March 2023:
The Fund has a clear focus on investing in stable and low-risk regions, which
is in line with its investment criteria. As a result, it limits its investment
activities to countries that meet certain standards, such as being classified
as investment-grade. The Fund's investment philosophy is centred around
identifying opportunities that offer attractive risk-adjusted returns while
avoiding potential pitfalls, such as regulatory and legal risks. While the
Fund is exploring potential investments in Spain, it has decided not to pursue
investment opportunities in Portugal or Italy, as these markets are perceived
to be more challenging due to a combination of economic, regulatory and legal
risks. The Fund may revisit this opinion in the future.
The Fund's investment strategy is primarily focused on private debt, which is
the largest asset class in its portfolio. This approach is driven by the fact
that private debt typically offers an illiquidity premium, which means it
yields higher returns than liquid bonds with similar characteristics. Since
the Fund's main investment strategy is a "buy and hold" approach, it makes
sense to capture this illiquidity premium. This is supported by Sequoia's
research, which indicates that infrastructure private debt instruments
typically yield about 1% more than public, rated bonds.
Despite its focus on private debt, the Fund also considers bonds as an
attractive investment option in certain situations. For example, some bonds
may be structured as "private placements", offering attractive yields that are
comparable to loans. Additionally, some sectors, such as US transportation,
primarily borrow through the bond markets, which means having an allocation to
bonds can improve the diversification of the portfolio. Lastly, having some
liquid assets in the portfolio enables the Fund to take advantage of future
opportunities while avoiding the costs associated with holding cash.
NAV and Fund performance
The Fund takes a cautious approach to its investment activities, particularly
when it comes to greenfield construction risk. While the Fund is willing to
allocate up to 20% of its NAV to lending for such projects, its actual
exposure to assets in construction(1) as at 31 March 2023 was 14.2% of its
portfolio. The Fund selects projects carefully and only invests in those where
it believes it is well-compensated for the moderate level of construction risk
taken. Furthermore, the Fund has strict criteria when judging the underlying
strength of the borrower's business or project to ensure that the potential
risk is mitigated.
Over the financial year, the Company's NAV per share(1) decreased from 100.5p
per share to 93.26p per share ex-dividend, driven by the following effects:
Factor NAV effect
Interest income on the Fund's investments 10.61p
Gains on foreign exchange movements, net of the effect of hedging 0.19p
Negative market movements (9.86)p
IFRS adjustment from mid-price at acquisition to bid price (0.24)p
Operating costs (1.71)p
Gains from buying back shares at a discount to NAV 0.18p
Gross decrease in NAV (0.83)p
Less: Dividends paid during the year (6.41)p
Net decrease in NAV after payments of dividends (7.24)p
The total return on the NAV(1) was equal to -0.9% over the period. Whilst this
is a disappointing outcome, it ought to be analysed in the context of the
wider market. The portfolio has outperformed leveraged loans by 3.3%,
high-yield bonds by 3.8%, the FTSE 250 by 7.2% and 10-year Gilts by 10.1%.
As it has been a volatile year for asset valuations, it would be sensible to
compare the performance between the first and second half of the financial
year. It is important to note that given the continuous increase in interest
rates and credit spreads, the Investment Adviser is not expecting a complete
reversal of negative movements in asset valuations but is more focused on a
slowing trend and a stabilising portfolio.
To capture these characteristics, the portfolio has been split into two
categories, namely cashflow-based valuations and recovery-based valuations.
Cashflow-based valuations
Cashflow-based asset valuations constitute investments whose cashflows are
reasonably predictable and can therefore be analysed using a discounted
cashflow model. Valuation decreases for assets that are marked via this
methodology are predominantly driven by systematic inputs such as the
previously mentioned increase in long-term rates and credit spreads. As these
do not represent underlying underperformances of the assets, the Investment
Adviser expects the majority of unrealised losses to be recovered as the
investments reach maturity.
Of the 9.86p per share total loss due to market movements over the financial
year, a valuation loss of 6.42p can be attributed to cash-flow based
valuations. Further decomposing the negative movement, almost the entirety of
this negative movement, 6.41p, was recognised in the first half of the year,
while a minimal further loss of 0.01p has been recorded for the second half.
The explanation for this substantial improvement is a stabilising of long-term
interest rate forecasts towards the end of the year, which allowed credit
spread tightening and the natural pull-to-par of the portfolio's asset to
counter the loss of valuation due to risk-free rate adjustments. While a 6.42p
loss in valuations for the full year remains, the Investment Advisor expects
further price appreciation of these assets as they pull-to-par and eventually
get repaid at their maturity.
Recovery-based valuations
Whilst cashflow models may still be used to value assets in this category, the
Investment Adviser tracks their development more closely and uses additional
valuation methodologies to assess idiosyncratic risks and eventual
recoverability of these assets. This category therefore contains investments
with an above-average degree of uncertainty on future price appreciation.
The remaining 3.44p loss in valuation of the total 9.86p decline due to market
movements falls into this category. In the first half of the financial year, a
loss of 2.18p was due to these investments, of which 1.47p was attributable to
Bulb, Salt Lake Potash and Whittle Schools. An additional decline of 1.26p was
recognised in the second half of the year, with a 0.35p loss due to the
remaining non-performing loans. While this indicates that progress has been
made on this category of assets, systemic factors such as long-term interest
rates and credit spreads evidently play a lesser role in the valuation
recovery than for cashflow‑based valuations. Therefore, the potential
reversal of negative market movements for these investments may be slower and
less predictable.
Given that the portfolio has outperformed the FTSE 250, leveraged loans and
high-yield bonds, and supports evidence of future NAV appreciation, the
Investment Adviser wishes to reiterate why such outperformance can be
achieved:
· resilience of infrastructure debt by leveraging the inherent
defensive attributes of infrastructure assets and the strong asset backing
typically associated with our loans;
· mitigation of interest rate sensitivity through a significant
proportion of floating rate debt in the portfolio (58%), resulting in a low
level of sensitivity to changes in interest rates; and
· enhanced portfolio diversification by investing across various
sectors, sub-sectors and jurisdictions, thereby minimising the impact of
country-specific political and economic risks.
Share performance
As at 31 March 2023, the Company had 1,734,819,553 Ordinary Shares in issue.
The closing share price on that day was 80.4p per share, implying a market
capitalisation for the Company of approximately £1.4 billion, compared to
£1.8 billion a year previously.
After taking account of dividends paid during the year of 6.40625p, the share
price total return over the period was -16.1%. This decline in the share price
is driven by two factors:
· the decline in NAV as discussed above; and
· a decrease in the rating of the shares from a 2.3% premium(1) to a
13.8% discount(1).
The rating decrease of the Fund is due to negative market sentiment towards
debt funds, which has also affected the majority of alternative income
vehicles listed on the LSE. The concerns over inflation and increasing
interest rates have contributed to this sentiment, which is further compounded
by long-term economic prospects. Both the Investment Adviser and the Company's
Directors consider the current share price discount as disproportionate. They
believe that it does not reflect the investment portfolio's potential for
generating attractive risk-adjusted returns during uncertain periods or its
long-term prospects. With this conviction the Fund has been repurchasing
Ordinary Shares, as it considers the shares to be undervalued, and such
repurchases are accretive to our NAV.
Dividend cover
The Company has paid 6.40625p in dividends during the last 12 months in
accordance with its target. It is worth noting any declared quarterly dividend
is paid out to investors in the following quarter. Therefore, this financial
year consisted of three annualised 6.25p per Ordinary Share dividends and one
increased annualised 6.875p per Ordinary Share dividend. The fourth quarter
dividend payment will be accounted for in the first quarter of the financial
year 2023/24.
The level of dividend cash cover(1) has been increasing and has reached 1.21x
for the financial year 2022/23, which is a significant improvement from 1.06x
for the prior year. The increase is due to a combination of rising short-term
rates, as reflected in the uplift in the yield-to-maturity(1) from 8.4% to
11.9%, and interest being received in cash that was previously capitalised,
known as "PIK interest". The Investment Adviser expects further PIK interest
to materialise as loans repay.
Fund performance
31 March 2023 30 September 2022 31 March 2022
Net asset value per Ordinary Share 93.26p 93.64p 100.50p
£ million 1,617.9 1,634.9 1,777.0
Cash held (including in the Subsidiary) £ million 68.7 38.2 94.1
Balance of RCF £ million 181.8 193.0 121.4
Invested portfolio(1) percentage of NAV 106.5% 116.0% 95.0%
Total portfolio(1) including investments in settlement 109.6% 121.3% 101.5%
Portfolio characteristics(1)
31 March 30 September 31 March
2023 2022 2022
Number of investments 68 72 76
Valuation of investments 1,723.5 1,924.5 1,804.5
ESG score 62.29 61.59 61.88
Single largest investment £ million 61.0 64.3 64.7
percentage of NAV 3.8% 3.9% 3.6%
Average investment size £ million 25.3 25.0 23.7
Sectors by number of invested assets 8 8 8
Sub-sectors 26 28 29
Jurisdictions 12 11 12
Private debt percentage of invested assets 98.1% 96.3% 94.7%
Senior debt 57.2% 59.2% 53.6%
Floating rate 58.4% 56.9% 50.1%
Construction risk(1) 14.2% 12.3% 13.1%
Weighted-average maturity years 4.1 4.6 5.2
Weighted-average life years 3.5 3.9 4.1
Yield-to-maturity(1) 11.9% 11.2% 8.4%
Modified duration(1) 1.5 1.6 2.1
1. Relates to the portfolio of investments held in the Subsidiary.
Credit performance
At an overall portfolio level, the credit performance over the year remained
positive, except for the aviation sector which was still affected by the
COVID-19 pandemic. However, higher energy prices, even when combined with
volatility, had a positive impact on the power generation, renewable energy
and midstream sectors.
The current inflationary environment could also prove beneficial to
infrastructure assets, as businesses can increase their revenues by linking
the cost of the product or service provided to inflation while maintaining a
constant level of leverage. However, this is a double-edged sword that could
hit borrowers by increasing their internal costs as well, leading to an
unexpected increase in expenses. In particular, investments exposed to
construction risk are particularly affected, as projected budgets might be
overrun. Continued monitoring of such exposed assets to ensure debt
serviceability is maintained is an essential part of analysing the portfolio's
credit performance.
In the Company's 2022 Annual Report, we highlighted three investments that
were facing significant credit issues, namely a private school in Washington
DC, a UK energy supply business, and a potash project in Australia. We have
since exited most of the potash project, with only a small residual facility
remaining, and the profit share on the project has been valued at nil. The
non-performing loans incurred a net cost of 1.82p per Ordinary Share during
the period, the majority of which can be attributed to the potash facility.
The status of the two remaining non‑performing loans is as follows:
1. US private school
A loan secured on a large building in a prime area in Washington D.C.,
originally occupied by a private school under a long-term lease agreement.
Mostly as a consequence of the COVID-19 pandemic, enrolments at the school
declined to the point where it could not cover its operating costs, which
ultimately led to its insolvency. The loan was amended and extended in May
2022 to allow the borrower to deliver on its business plan after the COVID-19
pandemic but the school failed to recover and was then formally evicted from
the property on 19 October 2022. The owner of the property continues to market
it to other potential tenants, predominantly in the education sector, with an
encouraging early response from a number of educational and governmental
entities. However, the commercial real-estate market continues to suffer
globally as a result of reduced demand, remote work, economic uncertainty, and
shifts in consumer behaviour. All these factors have contributed to a
valuation decline during the year. As at 31 March 2023, the value of this loan
is 2.2% of the portfolio.
2. UK energy supply company
The Investment Adviser has made substantial progress on recovering value from
the Fund's loan to Bulb Energy, a UK energy supply company. During the year,
the Company became the majority shareholder, through a partial
debt‑for‑equity swap, of Zoa, a newly formed business set up to market
Bulb's best-in-class software to energy supply companies in the UK and
elsewhere. The Fund still maintains a claim on the assets of Bulb and its
parent Simple Energy and has recovered c.£14 million in cash since Bulb went
into administration. The combined value of the Fund's shares in Zoa and its
loan to Bulb is 1.1% of the portfolio.
Net leverage
The net debt of the Fund has increased from £27.3 million to £113.1 million
as a result of an increase in drawings on the Company's revolving credit
facility from £121.4 million to £181.8 million and a decrease in cash
holdings from £94.1 million to £68.7 million. This increase in net leverage
is mainly due to the volatility and devaluation of Sterling currency
experienced over the financial year. As Sterling lost value, the Fund's
non-Sterling assets gained value in Sterling terms. However, the Fund remains
currency-hedged, and hence the value of its hedging book falls by roughly the
same amount. Eventually, as the Fund's currency hedges approach their maturity
dates, the Fund needs to settle them by paying cash, a factor which caused the
increase in net leverage during the year.
The Company has repaid a portion of the revolving credit facility with the
capital repayments it has received, resulting in additional capacity to manage
future volatility in exchange rates, while simultaneously reducing cash drag
on non‑invested capital.
Portfolio valuation
Currently, the average loan in the portfolio is marked at a price of about 88
pence in the pound; this mostly reflects the higher interest rates and credit
margins used to value the loan, compared to those available in the market at
the time the loan was made.
Over time, as these loans approach their repayment dates, their valuations
will accrete back up to 100 pence in the pound - this is the so-called
"pull-to-par" effect.
These NAV estimates are calculated on the basis that interest rates and bond
yields remain constant and does not take into account NAV-accretive mechanisms
other than the pull-to-par; the only variable is the passage of time.
Non-performing loans are excluded from the calculation.
In monetary terms, the pull to par is expected to be material:
Pull to par Pull to par
Period (£m) (pence per share)
1 April 2023 to 31 March 2024 38.4 2.2
1 April 2024 to 31 March 2025 28.0 1.6
1 April 2025 to 31 March 2026 16.3 0.9
1 April 2026 onwards 37.6 2.2
Origination activities
The investment strategy of the Fund involves investing in both primary and
secondary debt markets. This approach offers several advantages: investing in
the primary market enables the Fund to earn upfront lending fees and customise
its investments to align with its requirements, while purchasing assets in the
secondary market facilitates the swift deployment of capital into seasoned
assets with demonstrable performance.
Primary market origination
The Fund continues with its focus on the primary loan markets, which remain an
important opportunity. The Investment Adviser has been able to source
bilateral loans and participate in "club" deals, where a small group of
lenders join together. Additionally, the Fund has participated in more widely
syndicated infrastructure loans.
Primary market loans are appealing since they often come with favourable
economics. As the lender, the Fund benefits from upfront lending fees and
improved term negotiability. With the growth of the Fund, its primary market
investment activity has increased and has now surpassed secondary market
investments. As at 31 March 2023, 87.5% of the portfolio consists of primary
investments.
Secondary market origination
Although the Company has been focusing on primary market investments, it
continues to acquire some of its investments from banks or other lenders in
the secondary markets. This has allowed not only for faster deployment of
capital, as primary market transactions in infrastructure debt can often take
a considerable amount of time to execute, but also provides the Fund with more
liquid assets, providing optionality when times require more cash at hand.
Furthermore, secondary market loans have a performance history that allows for
credit analysis based on actual results rather than financial forecasts.
Research indicates that infrastructure loans tend to improve in credit quality
over time, so in many cases, secondary loans have improved in credit quality
from the time of their initial origination.
Strengthening the team at Sequoia Investment Management Company
Within the past year, the Investment Adviser has expanded its team by hiring
two new team members.
Matt Dimond, who has joined as Head of Client Capital, will be working with
investors, evaluating strategies, and has expertise in real asset investments.
Matt previously held senior roles at InfraRed Capital Partners and Swiss Life.
Leah Dean joined as a new Associate and will focus on ESG matters. Leah has
previously worked as a Language and Behaviour Analyst at AKO Capital before
starting her role at the Investment Adviser. The Fund is committed to
sustainable investing and is dedicated to complying with regulatory
requirements while engaging with borrowers on ESG topics. With Leah's addition
to the team, the Fund will be better equipped to stay up to date with the
constantly evolving ESG landscape, assess the current portfolio for possible
enhancements, and offer assistance to investors with any enquiries they may
have.
Strong pipeline of opportunities
While the Investment Adviser has been largely focusing on monitoring existing
positions, it is also seeing a wide range of attractive potential investments
which are being considered. With weak high yield bond and leveraged loan
markets coinciding with the current risk aversion dominating bank lending,
borrowers are more willing to accept the additional pricing power enjoyed by
alternative debt providers. As such, improved terms can be negotiated than
those typically available in times of abundant bank lending, which feeds
through to favourable conditions for investors such as higher interest rates,
fees, covenants and collateral provision.
Our strategy is to take advantage of these attractive lending conditions while
adhering to our previously mentioned late cycle strategies, which in the
current market provides us with higher yields for the same quality of assets
compared to last year or similar yields with improved asset quality. As the
Investment Manager is satisfied with the current yield composition of the
portfolio, the focus has been primarily on improved asset quality. Preference
is therefore given to assets with the following characteristics:
· senior debt, as opposed to mezzanine or holdco lending, which
provides additional security over collaterals;
· defensive sectors, or borrowers with a high degree of contractual or
predictable income, as opposed to businesses exposed to the economic cycle;
· assets that will maintain or improve portfolio diversification;
· operational projects, as opposed to construction projects, as these
have improved visibility over cash flows; and
· BB or better implied credit quality.
With this selective approach to new investments and limited funds, we are
turning down over 90% of the lending opportunities we come across.
Nonetheless, our portfolio provides security for the volatile markets ahead as
we continue to prioritise quality, diversity and cash generation.
Sequoia Investment Management Company Limited
Investment Adviser
28 June 2023
STATEMENT OF COMPREHENSIVE INCOME
For the year ended 31 March 2023
Year ended Year ended
31 March 2023 31 March 2022
£ £
Revenue
Net gains/(losses) on non-derivative financial assets at fair value 26,891,111 (27,520,112)
through profit or loss
Net losses on derivative financial assets at fair value
through profit or loss (96,628,102) (39,932,471)
Investment income 80,814,469 151,920,575
Net foreign exchange losses (1,513,107) (1,023,582)
Total revenue 9,564,371 83,444,410
Expenses
Investment Adviser fees 11,989,220 11,836,201
Investment Manager fees 369,422 349,634
Directors' fees and expenses 366,699 305,202
Administration fees 440,937 453,630
Auditor's fees 201,990 188,598
Legal and professional fees(1) 2,973,313 1,327,377
Valuation fees 741,000 821,400
Custodian fees 255,108 255,221
Listing, regulatory and statutory fees 143,257 168,318
Other expenses 497,307 497,617
Total operating expenses 17,978,253 16,203,198
Loan finance costs 9,534,772 4,522,522
Total expenses 27,513,025 20,725,720
Profit and total comprehensive (loss)/income for the year (17,948,654) 62,718,690
Basic and diluted (loss)/earnings per Ordinary Share (1.02)p 3.55p
1. Legal and professional fees includes an amount of £2,218,093 (2022:
£666,019) in respect of fees relating to the Fund's investment in Bulb
Energy.
All items in the above statement are from continuing operations.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the year ended 31 March 2023
Share capital Retained losses Total
Year ended 31 March 2023 £ £ £
At 1 April 2022 1,837,390,531 (60,347,699) 1,777,042,832
Ordinary Shares buy-backs during the year (28,768,020) - (28,768,020)
Total comprehensive loss for the year - (17,948,654) (17,948,654)
Dividends paid during the year - (112,472,856) (112,472,856)
At 31 March 2023 1,808,622,511 (190,769,209) 1,617,853,302
Share capital Retained (losses)/earnings Total
Year ended 31 March 2022 £ £ £
At 1 April 2021 1,831,856,145 (12,725,764) 1,819,130,381
Issue of Ordinary Shares during the year, net of issue costs 5,534,386 - 5,534,386
Total comprehensive income for the year - 62,718,690 62,718,690
Dividends paid during the year - (110,340,625) (110,340,625)
At 31 March 2022 1,837,390,531 (60,347,699) 1,777,042,832
STATEMENT OF FINANCIAL POSITION
At 31 March 2023
31 March 2023 31 March 2022
£ £
Non-current assets
Non-derivative financial assets at fair value through profit or loss 1,704,493,932 1,770,022,999
Current assets
Cash and cash equivalents 7,363,120 8,759,040
Trade and other receivables 100,122,134 143,092,101
Derivative financial assets at fair value through profit or loss 23,254,199 17,536,684
Total current assets 130,739,453 169,387,825
Total assets 1,835,233,385 1,939,410,824
Current liabilities
Trade and other payables 4,530,899 3,855,430
Derivative financial liabilities at fair value through profit or loss 31,060,322 37,143,642
Total current liabilities 35,591,221 40,999,072
Non-current liabilities
Loan payable 181,788,862 121,368,920
Total liabilities 217,380,083 162,367,992
Net assets 1,617,853,302 1,777,042,832
Equity
Share capital 1,808,622,511 1,837,390,531
Retained losses (190,769,209) (60,347,699)
Total equity 1,617,853,302 1,777,042,832
Number of Ordinary Shares 1,734,819,553 1,768,238,998
Net asset value per Ordinary Share 93.26p 100.50p
The Financial Statements were approved and authorised for issue by the Board
of Directors on
28 June 2023 and signed on its behalf by:
Sarika Patel
Director
STATEMENT OF CASH FLOWS
For the year ended 31 March 2023
31 March 2023 31 March 2022
£ £
Cash flows from operating activities
(Loss)/profit for the year (17,948,654) 62,718,690
Adjusted for:
Net (gains)/losses on non-derivative financial assets at fair value through (26,891,111) 27,520,112
profit or loss
Net losses on derivative financial assets at fair value through profit or loss 96,628,102 39,932,471
VFN capitalised interest - (7,309,761)
Investment Adviser fees settled through issue of Ordinary Shares - 878,100
Net foreign exchange losses 1,513,107 1,023,582
Loan finance costs 9,534,772 4,522,522
Decrease/(increase) in trade and other receivables 42,063,321 (33,004,700)
(excluding prepaid finance costs)
Increase in trade and other payables 67,578 45,287
(excluding accrued finance costs and Ordinary Share buy-backs)
104,967,115 96,326,303
Cash received on settled forward contracts 16,174,078 43,775,627
Cash paid on settled forward contracts (124,603,014) (16,124,456)
Purchases of investments (302,102,305) (399,588,003)
Sales of investments 394,522,483 339,810,204
Net cash inflow from operating activities 88,958,357 64,199,675
Cash flows from financing activities
Proceeds from loan drawdowns 138,712,919 36,023,268
Loan repayments (80,000,000) -
Payment of loan finance costs (9,058,791) (5,772,304)
Ordinary Share buy-backs(1) (27,770,733) -
Dividends paid (excluding scrip dividends) (1) (112,472,856) (105,684,339)
Net cash outflow from financing activities (90,589,461) (75,433,375)
Net decrease in cash and cash equivalents (1,631,104) (11,233,700)
Cash and cash equivalents at beginning of year 8,759,040 20,018,189
Effect of foreign exchange rate changes on cash 235,184 (25,449)
and cash equivalents during the year
Cash and cash equivalents at end of year 7,363,120 8,759,040
1. Excludes non-cash transactions.
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