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$4b Fixed Income LIT sector capitulates in Coronavirus Crash

Only a few short months ago the burgeoning Fixed Income Listed Investment Trust (LIT) space was the shining light of the LIC/LIT market. As many equity based funds fell to large discounts to their underlying Net Asset Value (NAV), fixed income LITs largely stayed true to their underlying NAV and delivered on their promised performance…

By ETF Watch - Apr 02, 2020

Only a few short months ago the burgeoning Fixed Income Listed Investment Trust (LIT) space was the shining light of the LIC/LIT market. As many equity based funds fell to large discounts to their underlying Net Asset Value (NAV), fixed income LITs largely stayed true to their underlying NAV and delivered on their promised performance goals.

Things have changed… fast. We take a look below.

The birth of the fixed income LIT

Go back to 2017 and the LIC market was predominantly an equity focused market. Most of the oldest LICs were focused on domestic shares, whilst a number of the new LICs had a more global focus.

In 2016 the first of the Listed Investment Trusts (LITs) were born. These operated the same as a traditional LIC, with a fixed pool of capital, however had one important difference, that being they operated as a trust structure rather than a company structure, paying no tax themselves, and passing all income earnings to investors. The preferred structure of a fixed income style investment.

In October 2017, the first of the Fixed Income LITs was launched, MCP Master Income Trust (MXT). Raising well in excess of its target, it raised over $500m in its IPO, a figure previously only hit by the largest household name fund managers. Clearly investors were looking for yield, or at least the clients of the brokers paid to push these products.

Retirees with ever shrinking cash and term deposit rates, looking for capital security and high yield. These products were tailor made for them. What could go wrong?

Fast forward to 2020 and there’s been 8 Fixed Income LIT IPOs since 2017, raising over $4 billion in funds through their IPOs and rights issues. The sector was booming. Even those arguing against the abolition of stamping fees on LICs and LITs were pointing to the success of the Fixed Income LITs in meeting investor demand.

Then Coronavirus hit.

What has happened to these bonds in the Corona Crash?

It’s taught in University Economics that bonds tend to have an inverse relationship to shares. When share markets are falling, bond markets are rising and vice versa. This in theory makes Bonds a useful hedge against share price falls.

Then a financial crisis hits and all bets are off. A selloff of the magnitude we’ve seen over the last 6 weeks means all bets are off and then some.

Liquidity in bond markets essentially dried up overnight. Without active exchanges to trade on (like stock exchanges), liquidity can be a huge issue for bond markets in market panic. They’re plenty of sellers but simply no buyers. This caused bond prices to fall off a cliff. The selloff was across the entire bond spectrum (government all the way down to junk bonds), with junk bonds clearly the most impacted do to the market perceiving a large amount of defaults in the unknowns of the early days of the crisis.

Somewhat of a floor has been placed under bonds now, with the US Federal Reserve’s ‘QE infinity’ announcement, and their commitment to buy bonds, including corporate bonds and even Bond ETFs.

How has this impacted Australia’s fixed income LITs?

The steady as she goes performance of Australia’s 8 fixed income LITs took a nose dive from 20 Feb, when share markets peaked. Below we show the performance of Fixed Income LIT share prices from 20 Feb to 31 March:

23 March was the day of peak panic, with some LITs falling by over 50% from their peak. Since then the US has announced their new Quantitative Easing, and most Western countries have thrown the kitchen sink at the crisis in order to save their economies. Since then the prices of most of the Fixed Income LITs have partially recovered to be somewhere between 20% – 40% from their peaks.

What about the Net Asset Values of these LITs

Net Asset Values (NAVs) of most of these LITs fell along with their share price value during the first stage of the crisis. Bond market liquidity quickly dried up and pricing bond portfolios become near on impossible.

However, the Fed’s QE measures have put some stability back in the market. As a result, we’ve seen bond prices quickly bounce back. The table below shows the NAVs prior to the crisis beginning and the latest NAV.

TickerNAV 20 FebLatest NAVNAV DateNAV Discount @ 31/03
GCI$2.01$2.0031/03/2020-17.30%
KKCUnknown$1.9827/03/2020-24.67%
MOT$2.02$2.0131/03/2020-26.37%
MXT$2.01$2.0031/03/2020-15.55%
NBI$2.07$1.6631/03/2020-9.64%
PCI$1.11$1.0531/03/2020-14.53%
PGG$2.01$1.3425/03/2020-4.48%
QRIUnknownUnknownTBCTBC

For many of the LITs, the NAV has rebounded almost completely to pre-crisis levels. For those focused on the more risky end of the market, NAV is still down, but has materially recovered.

However the market remains sceptical. Whilst pre crisis, most LITs traded roughly in line with their underlying NAV, today discounts range from 5% to about 25%. It’s clear the market is treading with caution as the crisis onfolds.

Does this provide a great buying opportunity for this beaten down sector? Time will tell. Until then we’ll be keeping a close eye on these LITs as the crisis continues to unfold.

 

 

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