As we have highlighted on many previous occasions, the extraordinarily low interest rates around the world are forcing investors to take on more risk just to sustain (rather than grow) their income each year. Now, this is all well and good if these investors have undertaken due diligence and understand what it is they are investing in. Unfortunately, this isn’t always the case. With this mind, we wanted to take a closer look at the very popular Neuberger Berman Global Corporate Income Trust. We have broken our analysis down into a few simple sections:
Who is Neuberger?
Neuberger is a New York based fund manager with expertise across most sectors of the market including equities, fixed income and alternatives. They were established in 1939 and have over $455bn under management globally with closer to $7bn under management in Australia, primarily with institutions. It’s important that investors do not confuse size with security, as whilst the manager itself is extremely successful and huge by Australian standards, they do not control the performance of the underlying investments.
What is the fund?
The Corporate Income Fund is a specialist income focused fund that invests solely into senior bonds issued by global listed companies. This includes secured and unsecured senior debt which are both positioned at the top of the capital structure and first in line in the event that an issuer defaults on their obligations or moved into bankruptcy.
What does it invest in?
The Corporate Income Fund invests into what is commonly referred to as ‘junk bonds’, ‘high yield’ bonds or unrated credit. At present, the portfolio holds less than 1% in what are considered investment grade bonds, with a rating above BBB with the remainder allocated as follows:
The fund is managed according to a number of overriding allocation restrictions with the primary one being an asset allocation of 60% to the US, 20% to Europe and 20% to emerging markets. Management aim to hold between 250 to 350 individual bonds with an external rating by one of the majors of BB or B. The geographic and sector allocations are as follows:
What are the risks?
In our view, the risks of this investment are substantially higher than many of both its investors and the financial planners who recommended it truly understand. The fund invests bonds issued by institutions that fall many rungs below the likes of the Commonwealth Bank on the credit ratings scale. For instance, the largest current holding is Petrobras bond, lending money to the Government-backed Brazilian gas and oil producer.
More importantly investors are exposed to an immensely higher risk of default on the loans made through this fund than through the likes of a Bond Fund issued by PIMCO or Schroder’s. Yet the managers are extremely clear with this fact in all their publications reporting that essentially none of the underlying investments would pass the investment grade requirement. This represents a substantial risk to investors for many reasons, but primarily, the risk of default is substantially higher. The table below shows the probability of default for various bonds rated by market-leader Standard and Poor’s (S&P) over many decades. As you can see, the CCC rated bonds, which makeup 11% of fund today, have a 26% probability of defaulting in the first year of their issue, which increased to 50% (yes 50%) after just 8 more years. This is substantially higher than the .08% probability of one of Australia’s banks going bankrupt.
The managers rely on a substantial amount of diversification to reduce the impact of any one issuer defaulting, however, in many cases this sector of the bond markets is already highly leveraged. For instance, the largest exposures are to cyclical or struggling sectors including energy and media all of which are being disrupted on a daily basis.
Be careful what you wish for. To be honest, we don’t believe an investment of this risk level is suited to the majority of superannuants, pensions and mum and dad investors that make up its share register. The fund was opportunistically listed at a time when Australian investors were seeking alternatives to fully franked dividends under the threat of a Labor Government; to this we say well done. The managers were able to leverage off this concern to raise close to $1bn in ‘forever capital’. If you were not aware, the benefit of an LIC or LIT (listed investment trust) for managers is that the capital raised will remain forever, there are no redemptions or purchases, the units are simply traded on the stock exchange. So Neuberger have effectively locked in 0.85% of management fees on $1bn in perpetuity.