CQS New City High Yield "cherry picks" smaller cos

In March the trust completed a share placing of £16.2m, which it is using to pay back some gearing (debt). The gearing increased to about 10 per cent earlier this year so it could invest in high-yield bonds while they were cheap, following a pullback in this market. In December the trust replaced its £20m loan facility with a £30m loan facility via Scotiabank at a rate of 1.42 per cent, which it says is significantly cheaper than the previous one.

The share issue has also helped reduce the trust's premium to net asset value (NAV): a couple of months ago this was just under 10 per cent, whereas now it is 1.4 per cent.

Investment strategy

"The high-yield market has expanded significantly over the last four to five years," says Craig Cleland, head of corporate development, investment trusts at CQS. "Bank finance has dried up so smaller- and mid-sized companies are issuing bonds."

He says larger fund managers are not as interested in bonds from small- and mid-cap companies, leaving a good choice for smaller funds such as CQS New City High Yield. This allows them to "cherry pick" the ones they want, and they turn down many of the pitches they receive. CQS New City High Yield has 12 companies on its investment watchlist.

The trust has invested in Greencoat UK Wind (UKW) and NextEnergy Solar Fund (NESF), investment trusts that focus on renewables. Although these are equities Mr Cleland says they have bond- like characteristics, in that they offer a stable income stream, and wind and solar have long-term contracts of 20 to 25 years.

Read our interview with Greencoat UK Wind's manager

Greencoat UK Wind offers a yield of 5.7 per cent, while Next Energy Solar offers 5.5 per cent, and they both trade at premiums to NAV. However, New City High Yield added to these trusts when they did equity placings. It bought Greencoat UK Wind in October at 107p per share, in contrast to the mid-market value of 108.25p, meaning it got in at a lower premium to NAV.

CQS New City High Yield's managers also like real estate investment trusts (Reits) for their bond-like characteristics. The trust recently topped up on Standard Life Investments Property Income Trust (SLI), and at the end of last year added to NewRiver Retail (NRR). These offer yields of 5.22 per cent and 5.26 per cent, respectively.

CQS New City High Yield Fund has more than 130 holdings across many sectors and aims to mitigate risk by increasing its diversity. A quarter of its assets are alternatives to corporate bonds such as convertible bonds, equities and floating rate notes. Rising interest rates are a concern for fixed-income investments and the primary risk for this trust, but about 20 per cent of its assets are floating rate instruments which move up with interest rates.

Its portfolio also has a low duration of just over three years. When rates rise the prices of bonds with longer durations tend to decline, but shorter duration ones tend to be less affected.

Read more on this in this week's big theme

A weak economy presents risks as defaults could rise, but the trust tends to buy securities higher up the repayment priority scale, increasing the likelihood that it will be paid back.

Dividend prospects

Over its half year to 31 December, CQS New City High Yield Fund declared interim dividends of 0.94p and 0.96p. The payment of 0.96 pence per share was a 4.3 per cent increase on the 0.92 pence per share paid in the same period last year.

The trust has been paying three interim dividends at the same rate and a larger fourth one, but this financial year the third one will be at least equal to the second, and the fourth one will be maintained at last year's level.

New City High Yield Fund has raised its dividend every year since 2007, and has indicated that it should be able to continue to do this as the "portfolio is very sound" and it has nearly a year's dividend in its revenue reserve. The trust yields 6.8 per cent.

Performance issues

New City High Yield underperformed the Association of Investment Companies UK Equity & Bond Income sector over one, three and five years, although it beat it over 10 in terms of share price performance.

The trust's managers compare performance to the Investment Association (IA) Global Bond sector. Although the trust has underperformed this sector over one year in terms of share price performance, it has beaten it over three, five and 10 years by quite a margin.

The trust made positive share price returns in nine out of 10 of the last calendar years. When it fell 15 per cent in 2008 this was considerably less than equity indices such as the FTSE All-Share and Morningstar's benchmark, FTSE 350 High Yield, which respectively fell about 30 per cent and 27 per cent.

This is in line with New City High Yield's absolute return approach: to grow the portfolio income while preserving capital.

Source: Morningstar & *CQS, as at 10 April 2015

Performance (%)

Note: *Cumulative share price return. Source: Morningstar, as at 10 April 2015

Top 10 holdings (as at 28 February 2015)

Sector breakdown (as at 31 January 2015)

Source: Cantor Fitzgerald