Dan Buchanan: Welcome to the latest in our Aberdeen Standard Investments Closed-End Fund podcast series, where we catch up with our closed-end portfolio managers and gain some perspective on these complex market conditions. Today, we are focusing on the high yield fixed income space with a co-manager of the Aberdeen Income Credit Strategies Fund, ticker ACP, Mr. Adam Tabor. Welcome Adam.
Adam Tabor: Hi Dan.
Dan Buchanan: Adam, thanks for joining us from the UK. Let's begin with your view of the high yield bond market and bank loan markets if you will. And particularly can you speak to the current economic cycle related to credit markets?
Adam Tabor: Yes. Well, pretty constructive from our perspective. Now, hopefully, you know an end to the COVID lockdown is in sight now. And now as vaccines get rolled out across the globe, so long that we don't have a new vaccine resistant variant, which would tend to be a good setback, we should see economic activity continue to recover. And that kind of reopening and reflation story has been a big support for high yield markets.
A lot of companies, most impacted by the COVID lockdown, were either high yield rated already with vulnerable balance sheets, or found themselves downgraded to high yield as a consequence of the pandemic. So the flip side of that is that a recovery, and really a much faster recovery than we had anticipated, is having a much bigger positive impact on those companies now. And lower-rated credit is outperforming. Just to give you a sense, and this is Bank of America Global High Yield Index data in the year-to-date, till the end of May BBs have returned 1.1%, Bs 2.5%, and CCCs have returned 7.6%. So quite a significant difference in outperformance. And then linked to that is that default rates have remained very low, and, much lower than had been expected at this time last year.
So according to Moody's, who put together a trailing last 12-month default rate for the global high yield, that was at 4.9% at the end of May, down from 5.6% in April. And that was forecast to be close to 11% this time last year. So we've seen about half of the defaults have been cleared [PH]. And Moody's now forecast that to dropping to just 1.8% by the end of ‘21. So yeah, so obviously that's very, very supportive for high yield performance.
Dan Buchanan: I’m really surprised Adam how low the default rates are and what they are prophesized to be. I'm curious for our listeners, how does your team assess risk when you're constructing and managing a portfolio like ACP?
Adam Tabor: Yeah. So we need to make it clear that ACP is investing in the higher yielding end of the high yield market, so that the fund itself has an average rating of B today. That's B flat on a best rating basis, or B minus on a worst rating basis. We're just under, or just over, a third of the fund invested in CCC rated securities. So that's again in the context of a global high yield market with an average rating of BB-minus, so a couple of notches higher than where we are, and about 10% in CCCs. So yeah, clearly we are taking a lot more credit risk in the market.
Worth mentioning here that we don't necessarily consider all of that CCC risk. The third of the fund has pure CCC risk, which might sound a bit odd. But many of those positions are in very high coupon bonds that both we and the market expect to get refinanced soon, as yields and rates have fallen. And they might be subordinated or junior bonds in businesses that are otherwise quite defensive, and cash generative, or they could be in companies that have been downgraded, downgraded because of COVID, where we expect those businesses to recover and then get upgraded again when we come out the other side.
Regardless of that, we clearly are taking on more credit risk. So it's very important that we're on top of every company that we invest in. And our ability to do that really is down to the great team of analysts that we have here at Aberdeen. So we do have a truly global footprint, that we're fortunate to have. We've got credit teams in the US, in London and Singapore, covering all the major credit markets. So we really can kind of pick and choose from a global opportunity set with the local analysts on the ground covering these companies and meeting management and helping us understand the risks.
Dan Buchanan: Adam, we've had a recent successful REITs offering, adding new assets to the portfolio to make it more efficient, and bring scale to the fund. How do you foresee reshaping the portfolio, if at all, in light of these changes?
Adam Tabor: Yeah. So the major shift we made was kind of during the sell-off from kind of March to June-July last year, where we rotated out of lot of the higher rated defensive names that had held up well, telecoms and health care being examples, and rotating that into lower rated names that we thought had bowled [PH] off too aggressively and would recover. So really kind of [inaudible 00:05:59] a bit into that sell-off. And that's obviously worked out very well for us, and that's been a big source of outperformance in the 12 months of [inaudible 00:06:07].
Aside from that we haven't really made huge changes to the fund. Well, we have gradually been increasing our emerging market exposure lately, and that's one area that we think will have a bit of opportunity having kind of slightly lagged the strong performance in the European and US high yield markets. And again, that's an area where we can really leverage off of a very strong emerging kind of corporate franchise that we have here at Aberdeen and a lot of good work that they do.
I guess, lastly, it's worth mentioning that the new issue markets have been incredibly strong. We're seeing record new supply on both sides of the Atlantic, and that's the function first with a bit of a backlog as markets were more or less closed for a big chunk of last year. And secondly, the strong performance, and the kind of declining yields that we've seen, which means the companies can borrow very cheaply. A healthy and busy new issue pipeline is good for us because that's a source of new ideas and we can pick and choose bonds that we think in this price. If we can find a 6% or 7% coupon bond that’s mispriced and trades off a couple of points, that can be a much lower risk way of generating the double digit returns that we're looking for, as opposed to let's say, a par bond with a 10% coupon. So that new issue market is something that we've been taking advantage of lately as well.
Dan Buchanan: And Adam, I would ask you the fund currently is trading at a slight premium, very successful. What is the mood among companies and management that you and the analysts have been speaking with as of late, in the high yield bond market?
Adam Tabor: Yeah. Generally very positive at the moment. I mean, especially compared to this point last year where we were having some quite tense and frank conversations with management and were reappraising a lot of business models in the light of the pandemic. Most industries have proven incredibly resilient and much more resilient than perhaps have been expected. And many have even kind of been forced to modernize and digitize and really improve as a result of the pandemic, and that really shows increased margins over time and profitability in that phase that they might not have done otherwise. So yeah, I would say definitely the kind of general term is optimism.
Dan Buchanan: Excellent. Thank you. I'm going to switch gears for a moment, Adam, and talk about ACP, the Aberdeen Income and Credit Strategies Fund, which is a closed-end fund vehicle. So I'm curious from a portfolio manager's perspective, how does the closed-end fund structure help you to effectively manage a high yield portfolio in today's environment?
Adam Tabor: Yeah. So the biggest benefit is that we don't have to manage daily flows. That was a real problem for open-ended high yield funds in March-April last year, as everyone headed to the exit at the same time. A lot of open-ended funds were forced to sell bonds at some pretty low levels to fund outflows. Yeah, so the closed-ended nature of our capital, the capital at ACP, means that we can be, and we were, much better positioned in those scenarios and could even step in as a buyer.
We should mention that we're not totally unconstrained. The fund is levered, and we do have to work on the debt to equity covenant in our credit facility. So we do have to watch that. But we have just, and this is a month ago, we have just issued $14 million of preferred shares, which do provide additional buffer against those covenants. So very helpful for us and investors we think, having issued that, and for anyone who might be interested in those, we [inaudible 00:10:28] at 5.25%, and they came with an A2 rating from Moody’s.
Dan Buchanan: Very constructive and very helpful for investors. Adam, finally, I'll ask you and put you on the spot here. What would you say to a new investor today that's reallocating their portfolio, why they should invest in high yield bonds at this part of the cycle?
Adam Tabor: Yeah. Well, in terms of ACP, the ACP shows yield just over 10 today, which obviously we think is attractive, versus the high yield market yielding closer to 4%, 4.5%. The shares have obviously had a good run, but we still think that lower-rated credit should continue to outperform as economies reopen. And then lastly, which I guess we haven't really mentioned at all, is that we feel the fund is relatively well insulated from rising inflation, which is something that's at the top of a lot of investors’ minds at the moment. So the fund has a duration of about two and a half years, versus a broader high yield market at just under four years. And kind of as we discussed earlier, it's credit risk that’s paramount for us, whereas you know, a much lower yielding BB or investment grade bond will be much more vulnerable to inflation and rising rates. So yeah, so that combination of higher credit risk and low duration, we think is a good place to be at the moment.
Dan Buchanan: Thank you Adam for your insights today, and thank you to our listeners for tuning in. You can find out more about the fund at www.aberdeenacp.com. I'm Dan Buchanan with Aberdeen Standard Investments. Do look out for future episodes.
