SQN Secured Income 22 January 2020
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by SQN Secured Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
To provide shareholders with attractive risk-adjusted returns by investing in a range of secured loans mainly through wholesale secured lending opportunities, secured trade, and receivable finance and other collateralised lending opportunities
SQN Secured Income
SQN Capital Management, LLC
Association of Investment Companies (AIC) Sector
Debt - Direct Lending
12 Mo Yield
Dividend Distribution Frequency
Latest Market Capitalisation
Latest Net Gearing (Cum Fair)
Latest Ongoing Charge Ex Perf Fee
(Discount)/ Premium (Cum Fair)
Daily Closing Price
SQN Secured Income Fund (SSIF) lends to small businesses, paying a fully covered 7p annual dividend in monthly instalments. SSIF has been transformed under manager Dawn Kendall, of SQN Asset Management, who took over in August 2017. A portfolio of senior secured direct loans has been built up and legacy investments in troubled peer-to-peer platforms sold down. Dividend cover has been achieved under the new asset mix, which generates an underlying portfolio yield of 10%, more than enough potential to meet the target of a net 8% total return per annum.
The company is designed to take advantage of a gap in the market created by banks’ low levels of lending in the £1m-to-£20m loan size bracket due to regulatory capital requirements and the complexity of the deals. SQN tells us that this means SSIF can be highly selective and generate yields of 9%–12% on its loans.
Thanks to a historic dividend cut when the manager changed (since reversed), as well as an overhang of stock held by an investor associated with the previous management, the company has slipped onto a discount (currently 7.7%). The company therefore decided to conduct a continuation vote if net assets were less than £250m on 31 December 2019. With net assets of c. £50m at the time of writing, the company is exploring options for its future.
We understand that the managers have tabled two options for shareholders at this point. One option is that investors could choose to allow the manager to continue with the current strategy, selling down the remainder of the legacy portfolio and completing the transformation into a direct lending proposition. This could include taking advantage of the 35% gearing allowed, which could boost the dividend to up to 9.5p and, were the discount to then close, the trust could seek to scale up with further share issuance. Alternatively, if shareholders wanted the company to wind up and return cash to shareholders, the managers have estimated this would take two to three years to execute.
A related party to the previous manager, Somerston, retains 28% of the shares and so any decision will likely require Somerston’s agreement. We understand SQN is in discussion with Somerston and other shareholders to gauge their opinions on the best route forward.
Dawn has done a good job in completely overhauling the portfolio since taking over, and the current direct lending investments appear to offer an exceptional yield and the potential to be uncorrelated to major equity and bond indices. The challenge now is to get the trust up to scale, which first requires a positive continuation vote. The outcome remains uncertain, however, with the views of Somerston likely to be crucial.
We think it would be a shame were investors to choose to wind up, as the level of yield the company could potentially provide is quite considerable compared to mainstream sectors. Moreover, it pays a monthly dividend, rare amongst investment companies and prized by investors living off their income. We also note that the direct lending sector has seen a number of trusts run into trouble, while SSIF’s experience, thanks to the work done by Dawn on restructuring the fund, is in marked contrast. The covered dividend is one piece of evidence, as is the fact the trust has suffered no losses yet on the loans made under SQN’s tenure, although this remains a relatively risky area to invest. In our view, the discount of 7.7% reflects the large shareholding owned by Somerston and the sector as a whole being out of favour.
|A highly attractive yield with a fully covered dividend||Stock overhang needs to be cleared for the discount to narrow|
|A broad opportunity set which lends itself to scaling up||UK exposure brings with it 'Brexit risk'|
|Strategy is uncorrelated to other markets such as equity, bonds and real estate||Lending to smaller businesses brings higher risks of default|