NB Global Floating Rate Income faces downside risks

NB Global Floating Rate Income launched in April 2011 and targets income generation, while seeking to preserve investors' capital and give protection against rising interest rates. It aims to provide shareholders with regular dividends, at levels that are sustainable, while growing the capital value of its investment portfolio over the long term by mainly investing in floating rate senior secured loans.

Senior loans are floating-rate instruments and therefore provide a level of protection in a rising interest rate environment that may not be available from bonds with a fixed coupon. Senior loans allow investors to potentially attain relatively high rates of income. Loans are usually secured by a security package over a substantial proportion of the borrower's assets, often rank first in terms of the priority of payment, and are therefore senior to bonds in a company's capital structure. That means they are less sensitive to changes in credit fundamentals and can offer a greater level of capital and income security.

When we reported on the NB Global Floating Rate Income Fund in May 2013, it held assets of just £400m. It is now one of the largest investment companies with assets of £1,243m.

We included it in the IC Top 100 Funds as an alternative source of income that investors could use as part of their higher-risk fixed income allocation.

The main risk is default among the underlying loan issuers, and NBLS has reported no defaults so far. However, the asset class is not without risks and investors need to be aware of the potential threats, which analysts say now include limited NAV upside combined with potential meaningful downside.

A recent portfolio update highlighted that loans are now priced fractionally above par, and that future performance will be driven by coupon returns. In the December quarterly commentary, the fund's managers said: "The average bid of the Loan Index ended the year at 98.29 and an even higher 100.05 if you remove all issuers rated below B-. As such, we believe price gains for 2014 will primarily be limited to CCC and D rated issuers, which make up only 8 per cent of the Loan Index. Therefore, performance is likely to be driven primarily by coupon returns and the most likely downside risk is an exogenous shock that leads to a 'risk-off' environment which causes outflows from the asset class."

This has led Alan Brierley, director of investment companies at Canaccord Genuity, to conclude that "NAV progression is likely to be de minimis".

He says: "NBLS has trebled in size since July and is now one of the largest investment companies. This growth mirrors phenomenal cash flows into the asset class in the US as investors look to protect against rising interest rates. This unprecedented level of demand introduced a degree of caution. We wonder if the risks are fully appreciated."

He also points out that the dividends paid in 2013 were 16 per cent lower than 2012, the fund's assets face "obvious economic risks" and the histoircal experience of alternative assets and DCMs has not been pretty.

Canaccord Genuity has issued a 'sell' recommendation on this fund, indicating that it expects the company to underperform its peer group or its benchmark over the next 12 months.

Source: NBLS and Morningstar

Source: Morningstar

TOP TEN HOLDINGS (as at 31 January 2014)

Rating Breakdown (as at 31 January 2014)

*Source: Standard & Poor's