For individual investors in the UK

Henderson Diversified Income Trust Fund Manager Commentary – Q2 2022

Financial professionals need to rethink stress
Jenna Barnard, CFA

Jenna Barnard, CFA

Co-Head of Strategic Fixed Income | Portfolio Manager


John Pattullo

John Pattullo

Co-Head of Strategic Fixed Income | Portfolio Manager


15 Jul 2022
3 minute read

Key takeaways:

John Pattullo, Jenna Barnard and Nicholas Ware, Portfolio Managers of Henderson Diversified Income Trust, provide an update on the Trust highlighting the key drivers of performance over the quarter, the challenges fixed income investors are facing, recent portfolio activity, and provide their outlook for bond markets over the coming months.

Macro backdrop

It has been a tough first half of the year for financial markets. The second quarter saw a pivot away from higher inflation to weaker global growth and imminent recession risk as the dominant market driver. Developed world government bonds were hit as markets priced in significant additional increases in interest rates. Markets are now expecting interest rates to rise to 3.3% in the US, 3% in the UK and 1.6% in the eurozone. This also impacted equities and credit markets and by the end of the quarter it was only the US dollar and some commodities (such as oil) that had done well.

The central bank interest rate hike trajectory remained one of the dominant market narratives, helped by US Consumer Price Index (CPI) data which delivered yet another surprise in May as it rose to a new 40-year high of 8.6%.¹ Hopes of peak inflation and peak central bank hawkishness faded and gave way to a calls for a more aggressive rate hiking path from the US Federal Reserve (Fed). The Fed duly delivered with a 75 basis point (bps) rate hike in June. The Swiss national bank followed with a surprise rate hike of 50bps, and the market tried to take on the Bank of Japan's yield curve control in a historic week for the rates market. The second week of June saw the US 10-year government bond yield peak at 3.47%. It subsequently fell during the second half of the month to 3.01%, as growth fears intensified.²

The worry for investors is that the cumulative effect of all these rate increases will be enough to push the economy into a recession. We have also seen a spate of disappointing data releases towards the end of the quarter, further fuelling the recession narrative.

The issue perplexing central banks is the cause of the inflation – is it due to the one-off, large fiscal and monetary stimulus during Covid-19 while supply chains were broken, or has the market fundamentally changed due to de-globalisation and a lack of workers due to demographics and lack of immigration. At the moment the central banks seem confused and panicked, but they are certain that the overall inflation number is too high and that they need to reassert credibility and assert price stability over growth. Both US Core Personal Consumption Expenditures (PCE) and CPI have peaked and have begun declining, but it seems the Fed is looking at the headline number, which is subject to vagaries of the oil price (destroying demand will affect this with a lag). The risk of an accident therefore remains high in our view, and the path to a recession seems quite likely unless headline inflation can make a meaningful move lower.

Trust performance and activity

The company's net asset value (NAV) fell by 12.2% during the quarter, underperforming the benchmark which fell by 9.1%. The share total return was -11.8%.²

To generate the income required, we need to be invested and to be moderately geared. We continued buying back shares in the quarter and will look to continue to do so in the market if we consider it be accretive for the shareholders.

In terms of the credit, market we saw European investment grade spreads widen by 83bps and deliver -7.3%, US investment grade bonds widen 42bps and deliver -6.7%, European high yield widen 241bps and deliver -10.8%, and US high yield widen 244ps and deliver -10.0%. The widening happened predominately in June, which marked the second worst month for US and European high yield bonds since 2008.²

In terms of primary activity during the period, we have seen reduced primary issuance in both the European and US investment grade markets, as well as very little issuance in either Europe or US high yield markets as issuers and arrangers were contending with highly volatile markets. We have seen a pick-up in distressed debt with the total now $26.9 billion, split between $15 billion for bonds and $11.9 billion for loans,over the first six months of the year in the US. The US high yield bond default rate stood at 1.08% and European high yield bonds at 0.5% at the end of the quarter.² The overall level of distress in the market has begun picking up from a low base.

Outlook/strategy

We have been buying more investment grade bonds during the quarter as we get more defensive in light of our rate of change model, which has correctly picked up a rapidly decelerating growth cycle. We have also been reducing positions in B-rated and CCC-rated credit and reduced the company's high yield bond holdings by 4.6% (adding 3.9% to investment grade). We remain fully invested in what we see as "reason to exist" large cap credit around what we see as the BB and BBB-rated sweet spot. Our focus on providing a relatively consistent and attractive income stream to investors means that the company's investments are naturally skewed to lower-rated issuers in fairly defensive sectors.

HDIV Q2

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

 

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 

The information in this article does not qualify as an investment recommendation.

 

Marketing Communication.

 

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Important information

Please read the following important information regarding funds related to this article.

Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. This is a marketing communication. Please refer to the AIFMD Disclosure document and Annual Report of the AIF before making any final investment decisions.
    Specific risks
  • If a trust's portfolio is concentrated towards a particular country or geographical region, the investment carries greater risk than a portfolio diversified across more countries.
  • Higher yieldings bonds are issued by companies that may have greater difficulty in repaying their financial obligations. High yield bonds are not traded as frequently as government bonds and therefore may be more difficult to trade in distressed markets.
  • This trust is suitable to be used as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this trust.
  • Active management techniques that have worked well in normal market conditions could prove ineffective or detrimental at other times.
  • The trust could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the trust.
  • The return on your investment is directly related to the prevailing market price of the trust’s shares, which will trade at a varying discount (or premium) relative to the value of the underlying assets of the trust. As a result losses (or gains) may be higher or lower than those of the trust’s assets.
  • The trust may use gearing as part of its investment strategy. If the trust utilises its ability to gear, the profits and losses incured by the trust can be greater than those of a trust that does not use gearing.
  • All or part of the trust's management fee is taken from its capital. While this allows more income to be paid, it may also restrict capital growth or even result in capital erosion over time.