Honeycomb Investment Trust 14 July 2021

Honeycomb Investment Trust (LON:HONY) generates a high yield by investing in asset-backed loans. This is a specialist strategy with high barriers to entry, and therefore the returns on offer are high. HONY yields 8.4% at the time of writing, having paid a 20p dividend every quarter since launch (2016) without fail.

HONY’s portfolio is very diverse, as discussed under Portfolio. It provides loans to non-bank lenders, secured against their assets, with the majority of the portfolio (70%) senior in the capital structure and having generated a high and stable investment return. The non-bank lenders themselves typically lend to consumers, SMEs and property investors, with the manager looking for investments which have a positive impact on society, for example by providing affordable housing (see ESG). HONY’s managers undertake detailed ongoing monitoring of the borrowers’ lending to assess the security of their loans. The short-dated nature of the underlying loan portfolios means books can ordinarily be quickly run down when trouble hits, as was the case in 2020.

Helped by this feature, HONY has not missed a beat during the pandemic, maintaining its 80p a year dividend with only a minor contribution from reserves (see Dividend). As it makes loans there are no capital gains expected, with NAV returns serving as a good proxy for the cash available for distribution. The NAV returns in 2021 to date have been very strong, more than covering the dividend. In the four months to 30 April, the portfolio delivered an annualised NAV return of 8.4%.

HONY employs gearing to help it generate its high returns and is currently around 70% debt to equity geared on a net basis, close to the limit of its expected 50-75% range. The discount has narrowed in recent months, and is presently 5.7%.

HONY’s portfolio has shown welcome resilience during the pandemic. It would be natural for investors to worry how exposure to consumers and SMEs would cope with a recession and lockdowns. To some extent, we think this has been a proof of concept: providing finance to lenders secured on their loan portfolios with a cushion provided by being senior in the capital structure has meant there have been no monthly falls in NAV during the pandemic (alongside the hard work of the managers with existing investments, and finding new deals to increase the proportion of secured loans). Of course, government support schemes played their part too, and no recession is like the last.

Furthermore, it is important to recognise that buybacks worth c. 10% of the market cap had a significant effect on NAV returns in 2020 (and therefore cash available for redistribution). The managers have been able to maintain net returns partly by increasing the gearing levels. Although gearing is still within the range expected, that lever is no longer available to be pulled, so investment returns will need to remain high for the current level of distributions to be met without running down reserves. The momentum behind the portfolio in early 2021 is highly promising in our opinion, with annualised net returns of 8.4% in the first four months running at a rate high enough to replenish the reserves used in 2020 and provide a cushion for the 20p a quarter dividend, which we think looks secure in the immediate future.