Sequoia Econ Infra - Interim Results 30 September 2023
24/11/2023 07:01
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RNS Number : 5322U Sequoia Economic Infra Inc Fd Ld 24 November 2023
RNS number:5322U
23 November 2023
Sequoia Economic Infrastructure Income Fund Limited
(the "Company")
Interim Results for the six months ended 30 September 2023
KEY HIGHLIGHTS
· Resilient portfolio generating substantial cash despite
macroeconomic challenges, outperforming wider credit markets
o Stable NAV, at 92.88 pence per ordinary share (31 March 2023: 93.26)
o Total return on NAV of 3.3% for the period in line with long term returns
expectations of 7-8%
§ This substantially outperformed Gilts over the same period (-7.7% total
return) and consistent with leveraged loans and high yield bonds
o Sustained income and cash flow supports decision taken in November 2022 to
raise the dividend by 10% with effect from February 2023
· Maintaining credit quality of the portfolio while still
maintaining an attractive yield
o Well diversified portfolio of private debt investments secured by
infrastructure assets in low risk-jurisdiction with no single investment
accounting for more than 3.9% of NAV
o 59.4% of the portfolio in defensive sectors including telecommunications,
accommodation, utilities and renewables
o 53.5% of the portfolio in senior and 45.6% in mezzanine ranked secured
loans
o Improved the portfolio's overall ESG by allocating capital to higher-rated
opportunities and selling off legacy investments
· Portfolio income expected to grow
o Short weighted-average life loan life of 3.6 years enables timely
redeployment of capital into higher yielding opportunities
o 54.4% floating rate investments, capturing short-term rate rises and
reducing interest rate sensitivity
o Enhanced lending margins and more favourable credit terms contributing to
the overall performance have arisen from challenging market conditions
reducing options for raising capital
· Strong pipeline of investment opportunities, focused on
resilience and credit quality
o Diverse array of attractive potential investments currently under
consideration
o Commitment to maintaining selective approach to new investments, favouring
highly defensive sectors with high barriers to entry that provide essential
services and that are expected to benefit from an improving economic backdrop
o Focused on senior secured loans that also maintain or improve portfolio
diversification
· Proactive approach to share price and discount management
o Increase in rating of the shares improved to a 10.4% discount (31 March
2023: 13.8%), driven by share price growth to 83.20p (31 March 2023: 80.40p)
o Significant strategic share buy-back programme
o Directors and Investment Adviser team members participated in share
purchases during the period reflecting their confidence in the Company
Robert Jennings, Chair, commented:
"I am delighted to announce another robust performance despite a challenging
economic backdrop over the last six months. Through the actions that the team
has taken, the business enjoys considerable flexibility in facing future
challenges and opportunities. The substantial amount of cash generated by the
portfolio has enabled the Company to continue its balanced approach to capital
deployment. All Fund leverage has been repaid; the share buy-back has
continued; and the Investment Adviser has been able to deploy capital
selectively in a good number of new, high-quality investments.
"This is my last set of results as Chairman of SEQI before I step down at the
end of December. I do so confident that SEQI is well positioned for the
future."
Randall Sandstrom, Director and CEO/CIO, Sequoia Investment Management Company
said:
"Whilst the global outlook remains uncertain, there are reasons to be
cautiously optimistic that we are closer to entering a less malign economic
environment. The portfolio is well positioned to continue to provide security
with our ongoing commitment to prioritising quality, diversity, and cash
generation. Inflation is falling in the US, UK and Europe and consumer
spending in the US is driving strong economic growth. However, our investment
strategy remains focused on positioning the portfolio against potential
further downturns through investments in economic infrastructure assets with
highly defensive characteristics, maintaining credit quality and delivering
attractive and sustainable returns."
INVESTOR PRESENTATION
The Investment Adviser will host a presentation on the annual results for
investors and analysts today at 10:00am GMT. 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://brrmedia.news/SEQI_HYR
(https://protect.mimecast-offshore.com/s/vwH1CyrylrCYNXvzFZBAsO?domain=brrmedia.news)
The presentation will be hosted by Randall Sandstrom, Matt Dimond and Reem
ElAshmawy. Steve Cook is currently on medical leave.
Copies of the Interim Report will shortly be available on the Company's
website www.seqifund.com and on the National Storage Mechanism.
For further information, please contact:
Sequoia Investment Management Company Limited +44 (0)20 7079 0480
Steve Cook
Dolf Kohnhorst
Randall Sandstrom
Greg Taylor
Anurag Gupta
Matt Dimond
Jefferies International Limited +44 (0)20 7029 8000
Gaudi le Roux
Stuart Klein
Teneo (Financial PR) +44 (0)20 7260 2700
Martin Pengelley sequoia@teneo.com
Elizabeth Snow
Sanne Fund Services (Guernsey) Limited (Company Secretary) +44 (0)20 3530 3667
Matt Falla
Lisa Garnham
About Sequoia Economic Infrastructure Income Fund Limited
The Company seeks to provide investors with regular, sustained, long-term
distributions and capital appreciation from a diversified portfolio of senior
and subordinated economic infrastructure debt investments. The Company is
advised by Sequoia Investment Management Company Limited.
Chair's statement
"Our business has emerged in good shape and through the actions that the team
has taken, enjoys considerable flexibility in facing future challenges and
opportunities."
It is my pleasure to present to you Sequoia Economic Infrastructure Income
Fund Limited's (the "Company" or "SEQI") Interim Report for the six‑month
period ended 30 September 2023.
Overall, the portfolio remains resilient, and continues to generate
substantial amounts of cash despite ongoing macroeconomic challenges.
Inflation was high during the period, interest rates rose, and economic growth
remained sluggish. Our robust performance against this backdrop is evidence of
our key portfolio attributes, including wide diversification, with the average
loan only representing about 2% of the portfolio, and a relatively short
average maturity, which allows loan repayments to be redeployed into higher
yielding opportunities. The Company has maintained its "balanced" approach to
capital deployment: all fund leverage has been repaid; the share buy-back has
continued; and the Investment Adviser has been able to deploy capital
selectively in a number of high-quality new investments. We strongly believe
that this is a sensible approach and delivers flexibility in a period of
uncertainty and elevated volatility. Our solid results for this half year, and
the increase in our dividend with effect from the payment in February 2023,
bear this out.
NAV and share price performance
Over the first half of this financial year, the Company's NAV per ordinary
share fell by approximately 0.4%, from 93.26 to 92.88. Over the same period,
the Company paid dividends of 3.4375p per ordinary share, consistent with our
increased full year target dividend of 6.875p, resulting in a total NAV return
of 3.3% (not annualised).
Total return over the six-month period
SEQI share price 7.9%
SEQI NAV 3.3%
Leveraged loans 3.3%
High yield bonds 3.8%
Gilts -7.7%
This performance was a much better return than Gilts over the same period and
is comparable to the returns seen on other types of debt investments such as
leveraged loans and high yield bonds. Since its IPO the Company has
outperformed comparable asset classes by a significant margin. For example,
£100 invested in high yield bonds at the time of the Company's IPO would now
be worth £121.33; £100 invested in a 10-year Gilt would now be worth
£110.95; while the same amount of money invested by the Company would now be
worth £137.55 (in all cases assuming that income is reinvested).
During the half year, the Company's share price improved from 80.40p to
83.20p, reflecting a narrowing of the discount to NAV from 13.8% to 10.4%.
After taking account of dividends, this resulted in a total return(2) over the
six months to 30 September 2023 on the ordinary shares of 7.9% (not
annualised).
While the share price clearly reflects the wider malaise in the UK listed fund
sector (and especially so for alternative assets such as private debt,
infrastructure and renewable energy), the Company has continued to support NAV
per share through the buy-back programme. Commencing in July 2022 we have
strategically bought back shares in the market, and the Directors and certain
members of our advisory team have demonstrated their faith in the business by
purchasing shares in their own capacity. Over the half year, the Company
bought back 53,649,927 shares, making it one of the largest buy-back
programmes across listed alternative assets on the LSE.
We do not believe that the levels of discount to NAV that we have seen reflect
the Company's long-term prospects, the resilience of its investment portfolio,
or its ability to generate attractive returns for our shareholders, and we
anticipate that if unwarranted levels of discount occur, we will continue to
buy shares in the market as appropriate.
The Board also notes the potential for a positive shift, as we move into 2024,
in the external capital market dynamics which have impacted on SEQI and the
broader investment company market over the last 18 months, and which have
contributed to this unusual period of share price discounts to NAV. We would
expect that, as the interest rate cycle peaks in our target markets, this will
result in some reversal of investment capital outflows - which have generally
been moving away from liquid alternatives and into government bonds and money
market instruments.
Portfolio performance
As explained above, the NAV over the period was approximately flat, which
reflects the resilience of our portfolio in the context of a challenging
economic environment where rising interest rates have been a persistent
headwind.
One significant advantage we have over many funds in the alternative funds
sector is the flexibility embedded in our portfolio: our investments are
typically of short duration, with a weighted average life of less than four
years. As a consequence, our portfolio is highly cash generative, which has
allowed us to support our share buy-back programme, to repay all the Fund's
leverage and to reinvest capital into new, attractive investment
opportunities. This is a significant differentiator of our Fund relative to
other illiquid alternatives in the market.
Regarding credit risk, there are a few notable points that should be borne in
mind. Firstly, the portfolio is highly diversified, with the average loan only
representing about 2% of the total portfolio and the largest 4.3%. This means
that if a loan goes bad, at worst it has only a limited impact. Nonetheless,
as with any portfolio of sub-investment grade loans, there will inevitably be
some borrowers who experience financial difficulties.
Secondly, the historical experience is that, when loans to infrastructure
projects default, lenders on average enjoy a high level of recovery, compared
to other forms of corporate credit. The combined effect of these two factors
is that the financial impact of bad debts on portfolio performance has been
limited: the "loss rate" for the portfolio (being credit losses, annualised
and expressed as a percentage of the amount lent) is only 0.58%. This compares
to an estimated 1.6% annual loos rate for broader corporate bonds of a similar
credit quality.
At our half year end, only 3.1% of the portfolio is in a full restructuring,
with a further 8.5% subject to a higher-than-normal level of scrutiny. These
levels are only marginally higher than at the end of the previous financial
year.
When a loan defaults or the borrower gets into difficulty, our Investment
Adviser works diligently to ensure that the Company maximises its recovery.
Investment market outlook
The economic outlook in the US, UK and other developed economies where the
portfolio is invested remains challenging, but there are reasons to be
cautiously optimistic. Inflation is now falling quite rapidly in the US, UK
and Europe. Interest rates set by Central Banks may have peaked in most of the
jurisdictions where the Company invests. In the US, consumer spending is
driving strong economic growth. Without wanting to sound falsely optimistic,
these trends give hope that we may be close to entering a less challenging
economic environment.
However, we have not invested on the basis of such optimism. In fact, our
strategy has been to find investments which will be resilient even if things
do not improve. For a significant period now the Investment Adviser has
focused on making senior secured - rather than subordinated - loans, and has
favoured sectors of the infrastructure market with defensive characteristics
rather than cyclical sectors.
We are of the view that the time is now right to lock in some of the high
rates currently being earned on our floating rate loan portfolio, and shortly
after the period end the Company entered into our first fixed floating swap
transaction. The effect of this transaction will be to enhance our dividend
cover ratio over the next seven years if policy interest rates fall from their
current levels.
Dividend
Portfolio interest income has grown strongly over recent years, as the
interest earned on our floating rate loans has increased, and income from our
recent investments reflects today's higher interest rate environment. This
enabled the Company to increase its dividend with effect from January 2023 by
10% to 6.875p per ordinary share. In this half year, our dividend remains
fully cash covered by a factor of 1.08x. This is within the range of
historical levels of circa 1.05x to 1.10x, despite lower returns from the
Company's net cash, and the absence of accretion from any leverage.
Our expectation is that portfolio income will continue to grow, as existing
loans mature, and proceeds are redeployed in today's higher rate environment.
If this transpires, the Board will reflect again on how best to return value
to Shareholders. For the time being though, with our share price
disappointingly continuing to languish at a significant discount to NAV, we
believe it is appropriate to focus surplus income on our share buy-back
programme.
Governance matters
a. Environmental, social and governance ("ESG")
We remain focused on and committed to our ESG strategy, despite recent market
volatility and ongoing economic uncertainty. Investing our Shareholders'
capital in a responsible way and engaging on ESG topics with the companies
that we lend to remain core parts of our investment philosophy. We continue
to use our proprietary methodology to assess carefully a number of E, S and G
metrics to produce an ESG score for every portfolio asset and potential
investment in our pipeline. We aim to use this part of our due diligence
process to target higher-scoring assets and avoid or dispose of assets that we
deem to be less sustainable. However, we recognise the importance of
transition assets and borrowers who themselves have a transition strategy,
which can result in lower ESG scores at the point of investment but should
result in a score increase over time. This, in combination with our other ESG
initiatives, should result in an increasing ESG score for our portfolio of
assets. Noting factors that are outside of the Fund's control, such as
exchange rates and early unanticipated repayments, we have generally been
successful in doing so consistently since the methodology was adopted. This
period marks another gradual increase in our average ESG score across the
portfolio. This principally stemmed from the disposal of low-scoring assets
and an active and accelerating step-up in our engagement efforts with
borrowers in this half year. We seek to continually evolve our approach to ESG
in a fast-moving backdrop. This period, we updated our ESG scoring framework
to keep abreast with best practices and latest thinking - most notably this
meant reassessing the sustainability profile of the nuclear sector, as
described in the sustainability report below.
In the most recent Annual Report, we published our second Task Force on
Climate-Related Financial Disclosures ("TCFD") report as well as our first
periodic disclosure under the Sustainable Finance Disclosure Regulation
("SFDR") as an Article 8 fund. Over the coming years, we will see an
increasing level of disclosure and reporting on ESG matters under a range of
different frameworks. We believe that transparent and reliable reporting plays
a significant role in the progression of responsible investing, but it is not
without challenges for a debt fund. We invest internationally and are
discovering that the quality of ESG reporting is not consistent across
different geographies. In addition, smaller borrowers especially lack the
resources needed to be able to measure certain datapoints. However, we are
working with our borrowers to gather the necessary quantitative data that will
be required in the future. We aspire to be a pioneer in the listed debt fund
sector with regard to the quality and accuracy of our ESG reporting to
investors.
b. Risk
Over recent months we have undertaken a review of how we monitor risks
internally. As a result of this review, we have made improvements to the
Company's Risk Register. Better defined risk classifications, finer
definitions of risk levels, and indications on direction of travel make the
document easier to use and more informative. In the future, we will modify the
format and expand the information contained in the principal risks sections of
our Annual and Interim reports. We believe that these changes will facilitate
and benefit risk management of our operations and will provide Shareholders
with a better understanding of the Company's risk profile.
c. Shareholder information
Another significant initiative which the Company has recently undertaken has
been to improve the quality of its dialogue with current and prospective
Shareholders. In respect of this, we were delighted to win the AIC award for
the Best Investor Factsheet. It has always been a strength of our
communications programme that we update NAV on a monthly basis following a
rigorous process of review by our external valuation agent, PwC. In times when
interest rates and the conditions in credit markets are changing rapidly, we
believe the emphasis that we place on providing timely and accurate updates is
of great value to the market as a whole and, for that matter, to the Board.
d. Board
We have announced that James Stewart, who joined our Board two years ago, will
take over from me as Chair of the Board with effect from the start of 2024,
and that I will be stepping down at that time. This development has been
planned for a while and I am delighted that James is to be my successor as he
is ideally suited to the role.
As previously reported, we have undertaken an extensive external search to
recruit an additional Director. This process attracted a number of high
calibre applicants and we are now close to finalising this appointment.
Concluding comments
It has been a great privilege to serve as inaugural Chair of SEQI for the last
nine years. In that time, I have witnessed a talented group of people within
our Investment Adviser and other key service providers come together to plan,
form and manage the first (and still the only) exclusively debt-backed
infrastructure fund listed on the London market. On several occasions in
earlier reports, I noted how impressed I was by how well and effectively the
key individuals at a number of disparate organisations who support your
Company have pulled together as a team. To all of you, thank you for the vital
contributions you have made.
I also wish to thank my fellow Board colleagues, both past and present, and
our consultants for the support and contributions they have all made over the
years, which have allowed our Board to function well and effectively.
Over the past three years, with the combination of the pandemic, followed by
the sharp rise of sovereign interest rates, our investment thesis, processes,
portfolio and service providers have been thoroughly stress-tested. Our
business has emerged in good shape and through the actions that the team has
taken enjoys considerable flexibility in facing future challenges and
opportunities. The basis for improving shareholder returns as markets recover
is, I believe, fully in place by virtue of the well-balanced and diversified
portfolio, exceptional and experienced team across all critical disciplines
and balance sheet strength. I am confident that in due course this will allow
you, our Shareholders, who have supported us through the last nine years and
most particularly through the recent tough period, to reap the rewards of your
patience and loyalty.
Robert Jennings
Chair
23 November 2023
Investment Adviser's report
"While the global outlook remains uncertain, the portfolio is
well-positioned… There are reasons to be cautiously optimistic that we are
closer to entering a more benign economic environment."
The Investment Adviser's objectives for the year
Over the course of the first half of the financial year, Sequoia Investment
Management Company Limited ("Sequoia" or the "Investment Adviser") has had the
following objectives for the Company:
Goal Commentary
Gross portfolio return of 8-9% The Company is fully invested with a portfolio that currently yields in excess
of 10%(4), due to continued increases in long-term interest rates over the
period
Manage the portfolio responsibly through an inflationary and rising interest The Fund has previously positioned its portfolio beneficially to take
rate environment advantage of the rise in interest rates and is now locking in these higher
rates, reflected by a decrease in the floating rate proportion of its
portfolio from 58.4% at 31 March 2023 to 54.4% at 30 September 2023
Follow a sustainable investment strategy The Fund has improved the overall ESG score of its portfolio from 62.29 to
62.84 by reducing its exposure to low-scoring investments, and also by
increased ESG engagement with the companies that it lends to.
Timely and transparent investor reporting The Company's Factsheet (which was awarded the AIC's 2023 Shareholder
Communication Award for Best Factsheet), commentaries, and full portfolios
have been provided monthly for full transparency, and investor engagement has
continued over the first half of the financial year
Continue to improve the ESG profile of the Company and the portfolio The Fund reviewed and updated its ESG framework, given the continually
evolving nature of ESG, to ensure it remains up to date and best reflects
current thinking and the future direction of travel
Dividend target of 6.875p per ordinary share per annum The Company paid two quarterly dividends of 1.71875p per ordinary share in
line with its dividend target, amounting to a total of 3.4375p
Economic infrastructure is a diverse and highly cash‑generative asset class
Economic infrastructure debt is a type of investment that is widely
acknowledged for its stability and dependability. This asset class exhibits a
set of key characteristics that makes it appealing to investors. Firstly, it
is characterised by high barriers to entry, making it challenging for new
entrants to penetrate the market, which, in turn, provides a protective shield
for existing investors. Secondly, the cash flows generated by economic
infrastructure debt are typically steady and foreseeable, ensuring a reliable
income stream for investors. This is primarily attributed to the essential
nature of the services, which ensures a constant level of demand. Finally, the
physical assets supporting economic infrastructure debt serve as tangible
collateral, providing a means to secure the investment.
These features have resulted in economic infrastructure debt becoming an
increasingly sought-after asset class for investors seeking a stable income
source and a trustworthy long-term investment.
Economic infrastructure debt spans sectors like transportation, utilities,
power, telecommunications, and renewables. These sectors often rely on
long-term concessions or licenses, with revenues tied to demand, usage, or
volume. In contrast, social infrastructure, like parks and hospitals, receives
compensation merely for the availability of physical assets.
To mitigate demand risk, economic infrastructure projects are typically less
leveraged than social infrastructure, maintain higher equity buffers,
conservative credit ratios, robust loan covenants, and more significant asset
backing for lenders. This principle has held steady throughout the first half
of the financial year, guiding the Fund's investment strategies.
Despite market volatility during the period, the Fund proactively positioned
its portfolio defensively against potential downturns. Measures taken include
a focus on senior debt and on non-cyclical industries. These actions have
helped to mitigate risks from the current inflationary market conditions and
other global uncertainties, such as the ongoing war in Ukraine and the
conflict in the Middle East.
Furthermore, as sustainability remains a prominent investment focus, the Fund
recognises that investing in new economic infrastructure is often pivotal for
implementing the latest technologies and manufacturing processes into
established industries. This opens the door to an array of ESG-incorporating
investment opportunities, benefiting not only the Fund's portfolio but also
the modernisation of sectors traditionally marked by formidable barriers to
entry.
The market environment during the period
While infrastructure debt benefits from inherent revenue stability, the Fund's
valuations are not unaffected by the record movements observed in the
financial markets over the last six months, particularly the rapid decline in
government bond prices. For context, the FTSE All-Share Index, representing
the overall London equity market, increased by 1.2% over the last six months,
while the FTSE 250, tracking mid-cap companies, declined by 1.5% during the
period. 10-year Gilts (UK government bonds) decreased by 7.7%, leveraged loans
increased by 3.3%, and high yield bonds rose by 3.8%. These figures include
dividends or interest income, providing annualised total returns for the
period.
The US, UK, and Europe have seen their respective inflation figures fall
further in the last six months from the peaks observed in the last fiscal
year. However, the current narrative driving the underperformance of
government bonds is no longer a continuation of interest rate hikes from
central banks, as these are assumed to have reached, or be close to, their
terminal value. Instead, the focus has shifted to the sustainability of a
high-interest rate environment given each region's respective economies, and
the timing of any fall in rates.
The performance of the Fund's private debt portfolio is sensitive to
fluctuations in interest rates and credit spreads within liquid markets. On
the one hand, the valuation of the Fund's investment holdings may be adversely
impacted by downturns in government debt, high yield bond or leveraged loan
markets - in general though, such fluctuations are unrealised mark-to-market
changes that will reverse as our loans approach their maturity date. On the
other hand, the Fund derives real advantages from these adverse market
conditions. Infrastructure businesses have faced limited options for capital
raising, which increased the Fund's pricing power. This, in turn, resulted in
enhanced lending margins, more favourable credit terms, or a combination of
both, ultimately contributing to the Fund's overall performance. Therefore,
despite market challenges, the Fund's infrastructure debt investments continue
to offer investors an appealing risk-return profile.
Market backdrop
Inflation
What is happening?
Inflation is past its peak levels in all of the Fund's investment
jurisdictions, as disinflation takes hold in most developed markets globally.
Why this matters to SEQI?
As inflation drops, term interest rates would be expected to fall, which makes
alternative investments such as infrastructure more attractive compared to
liquid credit. Also, lower inflation leads to less cost pressure during the
construction of a project, decreasing construction risk, all else being equal.
Interest Rates
What is happening?
Short-term interest rates are expected to have reached their peak rates in the
US, UK and Europe.
Why this matters to SEQI?
The portfolio's floating rate investments will start to de-risk as their
borrowing costs peak. A lower interest rate environment is also supportive of
fixed rate loans and bonds, which would be expected to help the pull-to-par of
our fixed rate assets. Further, as short-term rates begin to fall, yield
curves will become less inverted or turn positive again, supporting a bid for
risk in the market.
Commodity prices
What is happening?
The Commodity Research Bureau Index has peaked ahead of inflation rates in the
US due to built-up demand during the Covid pandemic.
Why this matters to SEQI?
Goods make up a large portion of inflation, and as commodity prices cool,
inflation can be expected to soften, lowering the cost of construction and
taking pressure off interest rates, all else being equal.
Portfolio overview
During the first six months of the financial year, our continuing strategic
approach revolved around the ongoing construction and management of a
well-diversified portfolio of private debt investments secured by
infrastructure assets situated in low-risk jurisdictions. Our primary
objective has been to uphold our targeted returns while placing a strong
emphasis on mitigating undue credit and ESG risk. Throughout this timeframe,
we remained committed to the prudent investment strategies established in
2019. These strategies encompass retaining a significant portion of the
portfolio in defensive sectors, giving precedence to senior debt over
mezzanine debt, and either maintaining or incrementally enhancing the credit
quality of the portfolio.
In response to the market challenges, our diversified approach to private debt
investment has proven effective in delivering robust returns and adeptly
managing risk. Consequently, we have been able to capitalise on fresh
opportunities for financing high-quality infrastructure projects. By
steadfastly adhering to this strategy, we maintain a high level of confidence
in our capacity to consistently provide attractive returns to our investors
while skilfully mitigating risk in this demanding market. Current portfolio
highlights reflecting the impact of these efforts include:
· 59.4% 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.
· 32.5% of the portfolio in the telecommunications sector that
continues to perform as previous PIK assets become cash-paying and the
appetite for infrastructure such as data centres grows.
· 53.5% of the portfolio in senior and 45.6% in mezzanine ranked
secured loans, as opposed to more of a 50-50 blend to position the portfolio
for a slow-growth environment.
· Improved credit quality of the portfolio over the last 12 months
without a reduction in targeted yields. Our policy not to invest in CCC
profile loans remains in place.
· Continued low modified duration of 1.5, with 54.4% of the
portfolio in floating rate deals and 45.6% in short-term fixed rate assets and
a current low portfolio weighted-average life of 3.6 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 Fund maintains a distinct emphasis on investing in regions characterised
by stability and minimal risk, in alignment with its established investment
criteria. This leads the Fund to restrict its investment activities to
countries meeting established standards, such as being classified as
investment-grade. The Fund's investment strategy revolves around the
identification of opportunities offering favourable risk-adjusted returns
while prudently avoiding potential obstacles, notably regulatory and legal
risks.
At the core of the Fund's strategy is a primary focus on private debt, which
constitutes almost all of its portfolio. This strategic approach is driven by
the fact that private debt typically offers an "illiquidity premium", i.e. a
higher return compared to liquid bonds with similar characteristics. Given the
Fund's predominant "buy and hold" investment approach, capturing this
illiquidity premium is deemed a prudent strategy. Research from the Investment
Adviser confirms the existence of this additional premium, suggesting that
infrastructure private debt instruments tend to yield 1-2% more than similar
publicly rated bonds.
NAV and Fund performance
The Fund adopts a prudent stance in its investment endeavours, particularly
with regard to the risk associated with greenfield construction projects.
Although the Fund is open to allocating up to 20% of its NAV for lending to
such ventures, its actual exposure to assets under construction as of 30
September 2023 stood at 11.2% of its overall portfolio. The Fund exercises
careful discretion in project selection, exclusively investing in those where
it perceives that it is adequately compensated for the moderate
construction-related risks it undertakes. Additionally, the Fund maintains
stringent criteria for evaluating the inherent strength of the borrower's
business or project to ensure effective risk mitigation.
Over the last six months, the Company's NAV per share decreased from 93.26p
per share to 92.88p per share ex-dividend, driven by the following effects:
Factor NAV effect
Interest income on the Company's investments 5.17p
Gains on foreign exchange movements, net of the effect of hedging 0.15p
Portfolio valuation movements (1.98)p
IFRS adjustment from mid-price at acquisition to bid price (0.06)p
Operating costs (0.66)p
Gains from buying back shares at a discount to NAV 0.44p
Gross increase in NAV 3.06p
Less: Dividends paid (3.44)p
Net decrease in NAV after payment of dividends (0.38)p
The total return on the NAV was equal to 3.3% over the period, equivalent to
6.6% p.a. This is broadly in line with the Company's long-term return
expectations of 7-8% p.a. Once again, the portfolio has outperformed other
investments over the period including the FTSE All-Share Index by 2.1%, the
FTSE 250 by 4.8% and 10-year Gilts by 11.0%, while performing in line with
leveraged loans and falling slightly behind high-yield bonds by 0.5%.
As evident from the table provided above, the principal factor that positively
influenced NAV performance was the interest income derived from investments.
Slightly offsetting some of this income, the Company's investments suffered a
small decline in values, mostly as a result of rising discount rates, with
only a third of the portfolio valuation movements being attributable to the
Company's non-performing loans. It is worth noting that such mark-to-market
price declines represent unrealised losses and are anticipated to gradually
reverse over time, as loans approach their maturity date (the "pull-to-par"
effect).
The Investment Adviser believes that the portfolio is well positioned to
continue to outperform the liquid credit markets for the following reasons:
· private debt has higher yields than liquid credit, for a
like-for-like credit quality;
· debt supported by infrastructure exhibits resilience due to
higher asset backing. This resilience is evident in the Fund's lower loss
rates compared to broader liquid credit, again, when considering equivalent
credit quality.
· mitigation of interest rate sensitivity through a significant
proportion of floating rate debt in the portfolio (54%), resulting in a low
level of sensitivity to changes in interest rates;
· relatively short debt maturities, allowing the fund to rapidly
recycle capital in the currently attractive lending markets; and
· a high level of portfolio diversification by sector, sub-sector
and jurisdiction, thereby minimising the impact of single asset-, sector- and
country-specific political and economic risks.
Share performance
As at 30 September 2023, the Company had 1,681,169,626 ordinary shares in
issue (31 March 2023: 1,734,819,553). The closing share price on that day was
83.2p per share (31 March 2023: 80.40p per share), implying a market
capitalisation for the Company of approximately £1.4 billion, a slight
increase of circa £3.9 million compared to six months ago.
After taking account of the two quarterly dividends amounting to 3.4375p per
ordinary share, the share price total return over the period was 7.9%,
equivalent to an annualised total return of 15.8%. The observed 2.8p increase
in the share price over the first two quarters of the year was driven by two
factors:
· the change in NAV as discussed above; and
· an improvement in the rating of the shares
from a 13.8% discount to a 10.4% discount.
A significant contributing factor to the share price discount is the negative
market sentiment surrounding alternative assets, including debt funds. This,
in the opinion of the Investment Adviser, arises in part from concerns around
persistent inflation and low growth, combined with some loss of trust in the
accuracy of alternative fund valuations generally. The Investment Adviser
wishes to reassure investors that the Fund's valuations are performed
independently and reflect the true value of its assets, and unlike the
majority of private equity, infrastructure equity and real estate equity
funds, are published on a monthly basis. However, outflows of capital from
investors, reallocating from liquid alternatives into government bonds and
money market instruments which offer recently increased levels of yield, have
exacerbated the problem, as 'forced sellers' have driven share prices across
the sector lower; although we see some recent stabilisation in this effect as
policy interest rates across key markets seem to have peaked.
Both the Investment Adviser and the Company's Directors view the current share
price discount to NAV as disproportionate. They are of the opinion that it
fails to reflect the investment portfolio's potential to deliver attractive
risk-adjusted returns during uncertain economic periods, its shorter
investment duration and robust NAV approach. With this belief, the Fund
continues to repurchase its ordinary shares, considering them undervalued,
which provides NAV accretion for current shareholders. Within the last six
months alone, the Company has repurchased 53,649,927 shares. The share
buy-back programme was first announced to Shareholders in July 2022, and the
Company has since bought back a total of 87,069,372 shares, close to 5% of its
total outstanding shares, as at 30 September 2023. This has provided
Shareholders with an increase in NAV per share of 0.6p since the buy-back
programme was implemented.
Dividend cover
The Company has paid 3.4375p in dividends during the last six months in
accordance with its target.
The Company's dividend cash cover was 1.08x for the first half of the
financial year. This is lower than in the previous year, for the following
reasons:
· The Company has crystalised less capitalised interest compared to
last year, namely around £5 million in the period compared to £20 million in
the prior year. However, this non-materialised PIK interest will be received
at a later date as investments repay;
· The Company has increased its dividend target from last year as
the Board was confident in the level of income produced by the portfolio.
Given that the Company's dividend remains comfortably cash-covered, the
portfolio's floating rate assets have successfully offset the higher dividend
payments; and
· The Company has repaid its Revolving Credit Facility ("RCF")
balance in full whilst building up increased levels of liquidity. As a result,
the income generated by the spread between RCF utilisation cost and yield on
investments funded by such drawings has not been captured in the period.
Overall, the above-mentioned factors are either transient, or the result of
other positive developments for the Company.
Fund performance
30 September 2023 31 March 2023 30 September 2022
Net asset value per ordinary share 92.88p 93.26p 93.64p
£ million 1,561.5 1,617.9 1,634.9
Cash held (including in the Subsidiaries) £ million 141.7 68.7 38.2
Drawings on RCF £ million 0.0 181.8 193.0
Invested portfolio(1) percentage of net asset value 90.3% 106.5% 116.0%
Total portfolio including investments in settlement 92.2% 109.6% 121.3%
1. Relates to the portfolio of investments held in the Subsidiaries
Portfolio characteristics
30 September 2023 31 March 2023 30 September 2022
Number of investments 57 68 72
Valuation of investments £ million 1,410.2 1,723.5 1,924.5
Single largest investment £ million 60.2 61.0 64.3
percentage of NAV 4.3% 3.8% 3.9%
Average investment size £ million 23.5 25.3 25.0
Sectors by number of invested assets 8 8 8
Sub-sectors 27 26 28
Jurisdictions 10 12 11
Private debt percentage of invested assets 97.3% 98.1% 96.3%
Senior debt 53.5% 57.2% 59.2%
Floating rate 54.4% 58.4% 56.9%
Construction risk 11.2% 14.2% 12.3%
Weighted average maturity years 4.2 4.1 4.6
Weighted average life years 3.6 3.5 3.9
Yield-to-maturity 10.9% 11.9% 11.2%
Modified duration 1.5 1.5 1.6
As can be seen in the table above, the Fund has reduced its number of
investments from 68 to 57 within the last six months. The Investment Adviser
has selectively decided not to redeploy some of the capital received from
maturing assets, instead using these proceeds to de-lever the Fund, increase
the liquidity available to the Company and buy back shares while they are
trading at a discount. The decrease in investments has been actively managed
so as not to impact the diversification the Fund provides to its investors;
the portfolio remains invested in 8 different sectors and has increased its
sub-sector count to 27 from 26 at the prior year end. Furthermore, some of the
exited positions were construction assets, which has allowed the Company to
de-risk the portfolio even further.
Credit performance
Looking at the overall portfolio, the credit performance remained positive
over the course of the last six months. Given that the portfolio is comprised
of high-yielding debt instruments, one would expect a small portion of
investments to encounter some credit challenges over the course of their
lifespan. The Company's experience to date is that credit losses have only
been a modest drag on investment returns, contributing to a loss rate of
approximately 0.58% per annum. This compares well to non-financial corporate
debt of a similar credit rating, where the historical annual loss rate is
approximately 1.6%.
Lenders have a duty of confidentiality to the companies that they lend to, and
so it is the Company's policy not to discuss underperforming loans by name,
other than where the borrower has entered into an insolvency process (such as
administration in the UK, or Chapter 11 in the US). It is easy to see how a
public discussion of an underperforming business could exacerbate its
problems, for example by making it harder to retain employees or secure new
contracts.
Progress continues to be made on managing the Company's loans in restructuring
or receiving enhanced scrutiny. Overall we do not foresee that the NAV will be
materially impacted by these ongoing discussions.
However, although the current economic environment has its challenges,
infrastructure has been resilient and the overall credit quality of the
Company's investment portfolio remains high. Inflation is falling (especially
in the US), energy markets are normalising and interest rates appear to be at
or near their peak levels. These stabilising macro-economic themes provide a
foundation for steadier credit markets and are further explored in the "Market
backdrop" section.
Balance sheet management
Over the six months following the end of the previous financial year, the Fund
has successfully repaid all of its outstanding revolving credit facility
loans. Initially, it had a net leverage position of £113.1 million, which
included a £181.8 million draw on the Company's revolving credit facility and
a cash reserve (including cash held in the Subsidiaries) of £68.7 million as
at 31 March 2023. This position has since transitioned to an undrawn revolving
credit facility and a cash balance of £141.7 million. While the Fund has
actively been building its liquidity, it does not intend to maintain these
high cash levels, in order to avoid unnecessary cash drag. The increased cash
balance was largely due to the complete repayment of a significant loan on the
final business day of the period. The current high liquidity position offers
the Fund the flexibility to allocate capital as needed while also reducing
volatility related to its financial obligations. The Investment Adviser
therefore continues to originate deals in the credit market on a daily basis
and currently manages a dynamic pipeline of potential deals that have been
pre-screened for suitability of over £400 million. Given the current
portfolio composition, the Fund is actively originating in sectors that would
benefit from increased exposure such as Transport Systems and Transport
Vehicles. Further details can be found in the "Strong pipeline of
opportunities" section of the Investment Adviser's Report.
Portfolio valuation
Currently, the average single B or higher-rated loan in the portfolio is
marked at a price of about 95 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 loans marked down due to the above-mentioned effects approach
their repayment dates, we will see their valuations 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 do 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 over the next three years:
Pull-to-par Pull-to-par
Period (£m) (pence per share)
1 October 2023 to 30 September 2024 17.2 1.0
1 October 2024 to 30 September 2025 15.8 0.9
1 October 2025 to 30 September 2026 13.6 0.8
1 October 2026 and after 26.4 1.6
Origination activities
The Fund's investment strategy targets assets in both the primary and
secondary debt markets, with each offering unique advantages. Investing in the
primary market allows the Fund to earn upfront lending fees and tailor its
investments to meet specific requirements. Acquiring assets in the secondary
market facilitates the rapid deployment of capital into seasoned assets with
proven performance records.
Primary market origination
The Fund maintains its focus on the primary loan markets, which continue to
present significant opportunities. The Investment Adviser actively sources
bilateral loans and participates in "club" deals where a small group of
lenders collaborates. In addition, the Fund has engaged in more widely
syndicated infrastructure loans.
Primary market loans are appealing due to their favourable economics. As the
lender, the Fund benefits from upfront lending fees and increased flexibility
in negotiating terms. As the Fund has grown, its primary market investment
activity has expanded and now accounts for the vast majority (82.9%) of the
portfolio.
Secondary market origination
While the primary market remains a focal point, the Fund also acquires certain
investments from banks or other lenders in the secondary markets. This
approach allows for the swift deployment of capital, as primary market
transactions in infrastructure debt can often be time-consuming to execute. It
also provides the Fund with more liquid assets, offering flexibility when
there's a need for increased liquidity.
Furthermore, secondary market loans come with a performance history that
enables credit analysis based on actual results rather than financial
forecasts. Research indicates that infrastructure loans typically see
improvements in credit quality over time. Therefore, in many cases, secondary
loans have enhanced credit quality since their initial origination.
Strong pipeline of opportunities
While the Investment Adviser has primarily concentrated on monitoring existing
positions, it also has a diverse array of appealing potential investments,
some of which are currently under consideration. The conjunction of weak high
yield bond and leveraged loan markets, combined with the prevailing risk
aversion in bank lending, has resulted in borrowers being more receptive to
the enhanced pricing power wielded by alternative debt providers. This
environment allows for more advantageous terms to be negotiated compared to
what is typically available during periods of abundant bank lending. These
favourable conditions translate into benefits for investors, including higher
interest rates, fees, improved covenants, and enhanced collateral provision.
Our strategy revolves around capitalising on these advantageous lending
conditions while adhering to the late-cycle strategies previously mentioned.
This approach, in the current market climate, offers higher yields for assets
of the same quality compared to the previous year or similar yields with
improved asset quality. In line with this approach, we are considering a
diverse pool of investments in our pipeline with yields ranging from 8% to
12%.The Investment Adviser is content with the current yield composition of
the portfolio, and has a predominant focus on enhancing asset quality.
Preference is therefore given to assets with the following characteristics:
· Senior debt, as it offers additional security through collateral
backing.
· Defensive sectors, or borrowers with a high degree of contractual
or predictable income, as opposed to businesses sensitive to economic cycles.
· Assets that maintain or improve portfolio diversification.
· Operational projects, as they provide better visibility into cash
flows compared to construction projects.
· BB-rated or better implied credit quality.
Given this selective approach to new investments, we find ourselves declining
over 90% of the lending opportunities we encounter. Nonetheless, our portfolio
is well-positioned to provide security in the face of volatile markets ahead,
with our ongoing commitment to prioritising quality, diversity, and cash
generation.
Allocation of capital in today's market
Since the end of the last financial year, several loans have been sold or
redeemed, the proceeds of which the Fund has used to fully repay drawings on
its RCF. We plan to utilise the resulting strong balance sheet to explore new
lending opportunities that align with the previously mentioned criteria.
Additionally, we aim to continue our share buy-back program, especially in
light of the continuing discount of our share price to NAV.
Sequoia Investment Management Company Limited
Investment Adviser
23 November 2023
Unaudited condensed interim statement of comprehensive income
For the period from 1 April 2023 to 30 September 2023
Period ended Period ended
30 September 2023 30 September 2022
(unaudited) (unaudited)
£ £
Income
Net gains on non-derivative financial assets at fair value 17,186,265 212,896,981
through profit or loss
Net losses on derivative financial assets at fair value (201,704) (187,934,965)
through profit or loss
Investment income/(deficit) 35,188,198 (67,620,134)
Net foreign exchange gains/(losses) 4,231,846 (12,011,438)
Total income/(deficit) 56,404,605 (54,669,556)
Expenses
Investment Adviser's fees 4,763,410 6,176,304
Investment Manager's fees 199,851 183,668
Directors' fees and expenses 177,806 189,726
Administration fees 201,326 212,125
Custodian fees 113,769 129,013
Audit and related non-audit fees 92,757 97,452
Legal and professional fees 756,445 1,304,816
Valuation fees 345,400 397,400
Listing and regulatory fees 67,623 42,067
Other expenses 228,047 191,039
Total operating expenses 6,946,434 8,923,610
Loan finance costs 3,784,731 3,806,112
Total expenses 10,731,165 12,729,722
Profit/(loss) and total comprehensive income/(loss) for the period 45,673,440 (67,399,278)
Basic and diluted earnings/(loss) per ordinary share 2.68p (3.82)p
All items in the above statement derive from continuing operations.
Unaudited condensed interim statement of changes in Shareholders' equity
For the period from 1 April 2023 to 30 September 2023
Share capital Retained losses Total
For the period from 1 April 2023 to 30 September 2023 (unaudited) £ £ £
At 1 April 2023 1,808,622,511 (190,769,209) 1,617,853,302
Total comprehensive income for the period - 45,673,440 45,673,440
Share buy-backs (43,270,931) - (43,270,931)
Dividends paid during the period - (58,803,088) (58,803,088)
At 30 September 2023 1,765,351,580 (203,898,857) 1,564,452,723
For the period from 1 April 2022 to 30 September 2022 (unaudited) Share capital Retained losses Total
£ £ £
At 1 April 2022 1,837,390,531 (60,347,699) 1,777,042,832
Total comprehensive loss for the period - (67,399,278) (67,399,278)
Share buy-backs (19,552,003) - (19,552,003)
Dividends paid during the period - (55,181,915) (55,181,915)
At 30 September 2022 1,817,838,528 (182,928,892) 1,634,909,636
Unaudited condensed interim statement of financial position
At 30 September 2023
30 September 2023 31 March
2023
(unaudited) (audited)
£ £
Non-current assets
Non-derivative financial assets at fair value through profit or loss 1,656,388,517 1,861,431,678
Current assets
Cash and cash equivalents 22,343,725 7,363,120
Trade and other receivables 1,129,019 1,605,043
Derivative financial assets at fair value through profit or loss 9,637,161 23,254,199
Total current assets 33,109,905 32,222,362
Total assets 1,689,498,422 1,893,654,040
Current liabilities
Trade and other payables 105,112,786 62,951,554
Derivative financial liabilities at fair value through profit or loss 22,932,913 31,060,322
Total current liabilities 128,045,699 94,011,876
Non-current liabilities
Loan payable - 181,788,862
Total liabilities 128,045,699 275,800,738
Net assets 1,561,452,723 1,617,853,302
Equity
Share capital 1,765,351,580 1,808,622,511
Retained losses (203,898,857) (190,769,209)
Total equity 1,561,452,723 1,617,853,302
Number of ordinary shares 1,681,169,626 1,734,819,553
Net asset value per ordinary share 92.88p 93.26p
The Unaudited Condensed Interim Financial Statements were approved and
authorised for issue by the Board of Directors on 23 November 2023 and signed
on its behalf by:
Fiona Le Poidevin
Director
Unaudited condensed interim statement of cash flows
For the period from 1 April 2023 to 30 September 2023
Period ended Period ended
30 September 2023 30 September 2022
(unaudited) (unaudited)
£ £
Cash flows from operating activities
Profit/(loss) for the period 45,673,440 (67,399,278)
Adjustments for:
Net gains on non-derivative financial assets at fair value through profit or (17,186,265) (212,896,981)
loss
Net losses on derivative financial assets at fair value through profit or loss 201,704 187,934,965
Investment (income)/deficit (35,188,198) 67,620,134
Net foreign exchange (gains)/losses (4,231,846) 12,011,438
Loan finance costs 3,784,731 3,806,112
Increase in trade and other receivables (excluding prepaid finance costs and (45,731) (1,896,623)
investment income)
(Decrease)/increase in trade and other payables (excluding accrued finance (632,698) 92,721
costs, investment income and ordinary share buy-backs)
(7,624,863) (10,727,512)
Cash received on settled forward contracts 22,177,540 12,016,690
Cash paid on settled forward contracts (16,889,615) (84,890,282)
Cash investment income received 78,497,163 55,914,115
Purchases of investments (212,348,197) (227,862,945)
Sales of investments 434,577,623 272,540,771
Net cash inflow from operating activities 298,389,651 16,990,837
Cash flows from financing activities
Proceeds from loan drawdowns - 118,712,919
Loan repayments (179,836,032) (60,000,000)
Payments of loan finance costs (3,090,540) (2,695,376)
Share buy-backs (43,953,088) (19,552,003)
Dividends paid(1) (58,803,088) (55,181,915)
Net cash outflow from financing activities (285,682,748) (18,716,375)
Net increase/(decrease) in cash and cash equivalents 12,706,903 (1,725,538)
Cash and cash equivalents at beginning of period 7,363,120 8,759,040
Effect of foreign exchange rate changes on cash and cash equivalents during 2,273,702 887,298
the period
Cash and cash equivalents at end of period 22,343,725 7,920,800
1. Excludes non-cash transactions.
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