The board of NBLS is proposing a radical overhaul of the fund’s strategy which would see its mandate widened extensively in order to generate a high monthly income. In order to reflect the new mandate, the name of the fund would be changed to Neuberger Berman Global Monthly High Income Fund.
NBLS currently exclusively invests in floating-rate loans. Under the proposals the investment mandate would broaden to also include conventional fixed income (both investment grade and high yield), as well as CLOs, mezzanine debt and even private corporate loans arranged exclusively for Neuberger Berman via its extensive industry contacts. By investing in more esoteric segments of the fixed-income markets typically available mainly to institutional investors, the intention is to harvest the illiquidity premium to generate 150 to 200 more basis points of yield than that available on NBLS’s current portfolio – i.e. a gross yield of c. 6.6% at current levels.
NBLS would pay a monthly dividend under the proposals, with a target distribution set by the board at the start of each year based on its outlook for rates. The monthly distributions would start in October, with the first target set in January. It is expected to take four months to fully invest the less liquid alternative allocations.
Current shareholders will be offered a cash exit for up to 40% of their shares in a redemption offer as an alternative to participating in the new structure. An enhanced discount-management policy would see a tender offer of 25% at a 2% discount to NAV twice yearly. Should NBLS’s NAV fall below £150m as a result, wind-up proposals will be put forward.
The board’s proposals for NBLS would create one of the most flexible fixed-income offerings on the market. In our view the Neuberger Berman Global Monthly High Income Fund would be a true strategic-bond fund which would use the advantages of the closed-ended structure to reach into esoteric and illiquid areas of the fixed-income market. We think only a group with the size and reach of Neuberger Berman would be capable of offering such a product, which allows the managers to cherry-pick from a global marketplace of credits and even participate in private loan deals. These can offer highly attractive yields relative to those available in the public markets.
With the rates environment likely to be low for some time to come, we think the flexibility is particularly attractive. Some investors might prefer a more defined dividend target, but we think the planned flexible approach and annual review is sensible. At the same time, tightening spreads could see the managers forced to take more credit risk or more liquidity risk, both of which bring their own dangers.
We also think it worth noting the discount-management plans. A 25% biannual tender offer should reduce discount risk and also, coupled with the intention to wind up if NAV falls below £150m, should reassure investors that they will be able to exit their investment close to NAV in future.
|Attractive yield potentially on offer, given low-interest-rate environment
||Low-growth and low-rate environment means absolute yields could fall in coming months
|Deep resources across the fixed-income teams should give advantage in such a broad and flexible mandate
||Hedging costs can vary depending on interest-rate differentials
|Would offer access to sectors rarely available to the retail market
||To generate high yield would need to take credit risk which brings economic sensitivity
The board’s proposals for NBLS would see it aim to take advantage of Neuberger Berman’s deep expertise in all sectors of fixed income in order to generate a higher yield, pay it out more frequently and be able to prosper in a wider set of economic environments. By investing in less liquid areas of the market the portfolio should be able to generate 150bps to 200bps more in income (over the course of a year) with a modest rise in credit risk. The model portfolio has an average credit rating of B, compared to B+ for the current loans portfolio, but generates a gross yield of 6.6% compared to 4.6%.
The planned asset allocation would see 50% to 70% of the portfolio invested in traditional credit. This includes investment-grade debt, high-yield debt and floating-rate loans issued by large, global companies. The remainder would be invested in alternative-credit markets. These include CLOs, special situations and private loans arranged exclusively for Neuberger Berman. Investments will be mainly in the dollar, euro and sterling markets, hedged back into sterling. The USD share class of NBLS has been rolled into the GBP share class, and going forward there will be a single share-class structure. While the traditional credit portfolio could be invested in on day one, the alternative-credit investments could take longer to get up to their full allocations. This could take up to four months, although even in the less liquid private loans space the managers tell us there is a pipeline of loans already identified which the team consider to be appropriate investments.
Unlike NBLS, much of the portfolio would be invested in fixed-rate debt. However, interest-rate sensitivity should still be relatively low thanks to the short maturity of the instruments and the loan components. The current model portfolio has a duration of just 1.7 years, for example. The portfolio should therefore still display some resilience in a rising interest-rate environment, while having the flexibility to prosper in a bullish environment for rates through taking modest interest-rate risk and rotating between sectors.
The investment in private corporate loans is one of the key differentiating factors of the proposed offering. Neuberger Berman has strong links with a number of European banks lending into continental economies where companies prefer to seek bank funding rather than tapping the bond markets. These relationships lead to privately arranged bilateral loans at attractive rates. Historically participation in these deals has been largely restricted to institutional investors, but NBLS would offer a rare path into the space for smaller investors. Neuberger Berman employs independent agencies to provide a credit rating to the issuers, which are typically medium-sized enterprises raising relatively small amounts of capital. The current size of NBLS, £366m in net assets, means it is small enough to take a meaningful slice of these deals, and large enough to do so while remaining highly diversified. These private loans are expected to total 5% to 10% of the portfolio allocation at any one time.
The investment process would remain identical under the new regime, but with the expanded management team able to cherry-pick the best ideas from across Neuberger Berman’s $120bn of fixed-income investments. The credit analysts seek to i¬dentify attractive credits in terms of yield, downside risk and ESG impact (see the ESG section). The managers favour those in non-cyclical sectors which should be more resilient to the cycle, and aim to build a portfolio diversified by issuer, sector, rating and geography. Under the new proposals, attention will be paid to make sure there is no doubling up of exposures between traditional and alternative credit so the same underlying risk factors, such as industry or country, dominate an apparently diverse portfolio. Dedicated risk-management teams support this analysis on an ongoing basis, ensuring that liquidity, credit risk and factor exposure remain within desirable limits. Key for NBLS will be building a portfolio which satisfies these requirements while generating enough income through the year to pay a monthly dividend and a sufficiently high yield.
In addition to the private loans, the alternative bucket would include syndicated CLO tranches. NBLS would focus on the BBB/BB tranches and the managers would have oversight of the individual loans in each transaction (as is usual with CLOs). Given the huge footprint of Neuberger Berman in the fixed-income market, its own analysts should have ratings and views on the underlying issuers which should help identify the superior pools of loans. We think this is likely to be especially important in the fallout from the coronavirus pandemic, as certain issuers and sectors will have their solvency called into question. The managers would also be able to participate in syndicated private loan deals involving a number of lenders as well as being able to participate in second-lien and mezzanine loan deals. In short, there would be an extensive universe available to the managers and they would be able to cherry-pick the most attractive from a risk/reward perspective.
We see two obvious closed-ended comparators: M&G Credit Income (MGCI) and TwentyFour Select Monthly Income Fund (SMIF). MGCI is committed to investing 70% in investment grade, which will limit it from a yield point of view. It aims to generate LIBOR plus 4% when fully invested, with an interim target of LIBOR plus 2.75% until it is fully invested. Dividends are paid quarterly. SMIF on the other hand does not invest in private debt but is otherwise fairly unconstrained. Its portfolio has a gross purchase yield of 6.9%, close to the indicative gross yield of 6.6% on NBLS’s model portfolio. SMIF has strong biases to asset-backed securities and to subordinated financial debt, where the managers have particular expertise, so we would judge it is likely to be less diversified in risk exposures. The vast majority of the portfolio is invested in Europe (incl. UK), and this is another point of distinction: NBLS is intended to have a broad developed-markets remit, with extensive investments in the much larger US debt markets. Under these proposals NBLS would therefore seem to us to be the most unrestricted as to mandate, offering the broadest spread of exposures to developed-world fixed-income markets with all the flexibility to generate income and respond to the economic developments that brings.
NBLS does not currently use gearing to fund investments and under the proposals would not do so either. The directors would be allowed to permit borrowing up to 20% of NAV in theory, but expect the portfolio to be managed on an ungeared basis. Derivatives would potentially be used for hedging and for efficient portfolio management, including hedging investments back to sterling.
NBLS has generated NAV total returns of 12.6% over the past five years according to Morningstar data. The S&P/LSTA Leveraged Loan Index is up 19.3% over the same period. It is worth noting that this index is US-only, however, and makes up 85% of the global loan market and of NBLS’s universe, so it is not a perfect comparator.
There are also no hedging costs on the index, and these have eaten away at NBLS’s returns in recent years. Following the Brexit referendum, UK rates were substantially lower than US rates until the current crisis. This led to the fund giving up some of the yield on its US investments as it hedged them back into sterling (in the larger GBP share class). The current rate differential between the US and the UK is much tighter, and so this should not be such a drag in the near future under either the old or the new strategy, both of which require the managers to hedge investments back into sterling. Indeed, were UK rates to rise higher than US rates it could even become accretive to returns.
The chief difference between the current portfolio and the proposed portfolio would be the addition of fixed-rate debt. This would bring with it greater, if still modest, interest-rate exposure, although given the managers’ mandate they would be able to rotate between sectors in order to alter their exposure. It would also bring with it greater potential for capital growth as fixed-rate bonds pull to par, a dimension that is more limited in the current floating-rate portfolio.
Under the proposals, the board of NBLS would set a target dividend at the start of each financial year reflecting their expectations for rates and credit spreads. Crucially this would be paid monthly, making NBLS one of a small number of investment trusts to distribute on this basis. The intention and expectation is for the team to be able to generate 150bps to 200bps of extra yield over the yield on the current loans portfolio, although in absolute terms this will depend on base rates and credit spreads at any one time. Currently we understand the portfolio of NBLS is yielding 4.6% gross, and the dummy portfolio of the new strategy 6.6% gross, which would amount to a 5.5% net yield on NAV should ongoing charges remain the same.
The pandemic has led to another step down in base rates as central banks attempt to offset the reduction in economic activity by encouraging investment up the risk curve. When we met with manager Vivek Bommi recently he told us he expects the outcome of this crisis to be a prolonged period of low rates (a Japanification of the US in other words) to follow the slump in rates in Europe we have seen since the 2008 crisis. This would reduce the absolute level of yield available across all fixed-income sectors, but in our view would clearly increase the attractions of a flexible mandate such as that proposed for NBLS. The proposed mandate should be able to harvest the illiquidity premium from areas of the market otherwise hard to access, and be able to invest selectively in the higher credit-risk segments of the market. In a true Japanification scenario, low inflation would also make lower nominal yields correspondingly attractive in real terms.
Under the board’s proposals, the existing management team of NBLS would remain and be strengthened by the addition of senior professionals in the multi-asset credit and European private loans teams. The managers would draw on the work of over 40 investment professionals across research, trading and risk management. Neuberger Berman’s non-investment-grade credit team run c. $40bn of assets, and the fixed-income team c. $120bn. The Neuberger Berman Global Monthly High Income Fund would aim to cherry-pick the best ideas from the investment-grade, non-investment-grade, public and private loans teams. The size of the research team at Neuberger Berman and their reach into all areas of the debt markets would therefore be a huge advantage.
NBLS is currently managed by Joseph P. Lynch, Stephen J. Casey, Vivek Bommi and Simon Matthews, each of whom have 20 years or more of investment experience. Joseph and Stephen have managed the strategy since inception. Joseph is head of global non-investment-grade credit, and Stephen is senior portfolio manager for non-investment-grade credit focussing on loan portfolios. They were joined by Vivek in May 2018. Vivek is a senior portfolio manager for global and European high-yield bonds and senior floating-rate loans. Simon joined Neuberger Berman in 2019 as senior portfolio manager for non-investment-grade credit focussing on global and European non-investment-grade portfolios. Under the new proposals, the new members of the team would be Norman Milner, head of multi-asset credit portfolios, and Pieter D’Hoore, head of the European private loans team based in the Hague.
When NBLS launched in 2011 it seemed that rates were likely to rise in the coming years, and potentially rise fast. NBLS’s current strategy was designed for such a scenario, whereby the floating-rate component would see yields rise with rates. As the outlook has softened and the likelihood of a prolonged period of low rates has increased, demand for the shares of NBLS has weakened. The board has conducted regular buybacks which have therefore steadily shrunk the market cap, and the board has also been committed to a non-discretionary redemption offer. This requires the board to offer to buy back up to 50% of the shares in issue if the discount to NAV is wider than 5% for the last three months of a financial year.
As the below graph indicates, since the pandemic hit the discount has drifted considerably wider than 5% despite regular buybacks. These halted in early July and the board believes the current proposals should increase demand for the shares and thereby lead to a narrower discount if approved. There is a tender offer as a part of the proposals which allows shareholders to receive NAV minus 2% for 40% of their shares. The board intends to propose a wind-up of the trust should NAV fall below £150m, although we note that if the entire 40% were tendered, NBLS would have net assets remaining of c. £220m, so that would not be a potential consequence of the intended offer. However, under the proposals an enhanced discount-management policy would see a biannual tender offer of 25% at a 2% discount to NAV, so should there remain significant shareholder dissatisfaction with the outcome of the new policy an exit would potentially be available.
The proposal would see the management fee move from a flat fee of 0.65% of NAV to a tiered fee. This would be 0.75% on the first £500m and then fall by 0.05% on each £250m band, with net assets above £1bn charged at 0.6%. The proposal is therefore a slight increase, which we think is justified given the extra resources to be devoted to management, including the more specialised private loan investments. The last ongoing charges figure for NBLS was 1.1%, with 0.45% of other expenses on top of the management fee. There is no performance fee and none is proposed. The latest KID RIY was 1.68%, although we note that calculation methodologies can vary.
Neuberger Berman believes that environmental, social and governance (ESG) factors are an important driver of long-term investment returns from both a return and a risk-mitigation perspective. The fixed-income teams have incorporated an ESG assessment into their internal credit ratings in order to consider the valuation implications of ESG risks and opportunities alongside traditional factors, and also to focus on companies or themes which are judged to be ‘better’ according to environmental, social and governance characteristics. Additionally, investment in tobacco, firearms, private prisons, certain areas of the fossil fuel industries and controversial weapons is banned.
Neuberger Berman is a signatory to the UN’s Principles for Responsible Investment (PRI) and reports extensively on the evolution of its approach, decisions made and voting record. All signatories to the PRI are assessed by the UN, graded on various aspects of policy and compared to peers. In 2019 Neuberger Berman received top scores (A+) across all six categories for the first time – peer-group median scores were A, A, B, B, B and B.