NCYF is set to become the only bond fund to be an AIC Dividend Hero.

Kepler Overview

CQS New City High Yield Fund (NCYF) delivers an exceptionally high yield, 8.9% at the time of writing, having grown its dividend for 19 consecutive years. One more year will qualify it for AIC Dividend Hero status.

Managers Darren Toner and Ian ‘Franco’ Francis invest in the smaller, more complex and less liquid issues in the high yield bond market to generate this income. NCYF uses the closed-ended structure to the full, taking advantage of its ability to handle illiquidity, gearing up the portfolio and managing a revenue reserve which supports payments in times of volatility. The appeal to income investors is obvious, and the trust has mostly traded on a premium for a number of years, regularly issuing shares to grow.

Current expectations are for interest rates to rise in the coming quarters in the key jurisdictions of the UK, US and EU, and this would play into the managers’ hands. Higher rates are likely to feed through into higher absolute yields on offer, and make it easier for the managers to reinvest maturing bonds into those paying higher coupons. The portfolio has a low duration, having a high yield and short average time to maturity, and so the impact on portfolio values should be small.

Darren and Franco continue to find plenty of opportunities in the market. They note any stress from volatility in energy markets, from higher rates and from the impact of AI should lead to differentiation in company performance and outlook and therefore opportunities for active investors.

Franco is set to retire next May, but has worked with Darren, head of the global high yield and financials teams at CQS, for 16 years and the specialist team of analysts remains in place, so there will be no change to the approach.

Analyst’s View

NCYF employs a relatively straightforward strategy to generate an exceptionally high yield. Darren, Franco and their team specialise in a naturally inefficient part of the market which is too small for most investors and which often lacks external credit ratings or analyst coverage. They can do this thanks to the closed-ended structure, which means they can own relatively illiquid securities and hold them to maturity. The ability to gear up structurally and set aside income in a revenue reserve are other key factors behind the trust’s success in growing the income year on year from such a high base.

Franco has managed the trust successfully for almost 20 years, but we are confident that there shouldn’t be any disruption from his retirement. Darren has led the team which generates the analysis and stock-picking ideas Franco has employed, and spoken daily with Franco for 16 years, implementing the team’s ideas in different mandates. The bedrock of the approach is devoting the resources to an inefficient part of the market many investors don’t cover, with an experienced analyst team.

We think NCYF is an outstanding option for investors who want a high yield and have a long-term time horizon. Capital growth is unlikely to be a significant part of the investment case given the income-first mandate and could be negative for periods, while the premium rating increases the importance of having a longer-term time horizon.

Bull

  • Exceptional income offering, both yield and dividend growth
  • Highly experienced and specialist managers working poorly-covered niches
  • Healthy revenue reserves

Bear

  • Significant premium could deliver losses to newer shareholders if it deflates
  • Issue and issuer specific risks have to be borne in mind with a concentrated and illiquid portfolio
  • Continued growth would hamper ability to invest in the same way, albeit this is not likely for some years