The global response to the COVID-19 pandemic has created an economic slowdown unparalleled in steepness and severity since the Great Depression, if ever. One consequence of this has been that corporates have been eliminating dividend payments at the fastest recorded pace. According to the Financial Times, over £3.5bn of UK dividends were cancelled in the week of March 23-27 alone and some analysts are warning that over 33% of the FTSE 100’s projected 2020 dividend may ultimately be cancelled.
Given this backdrop and given that income is a key investment objective of the Polar Capital Global Convertible Fund, we felt it appropriate to update investors on the Fund’s yield and our medium-term distribution outlook.
First, it is important to remind investors of the structure of convertibles. The vast majority of convertibles rank as senior unsecured claims which means that cashflows are contractually obligated, senior, and are not deferrable. In other words, just as with straight corporate debt, convertible issuers must continue to pay coupons in all instances except where bankruptcy has been declared. This is why convertible cash flows are extremely stable – a principle driver of the Fund’s ability to provide the consistency of its distribution, as shown below.
Polar Capital Global Convertible Fund Income Generation
Source: Polar Capital, 31 December 2019. Income is based on the Polar Capital Global Convertibles Fund USD I Dist share class. Past performance is not indicative or a guarantee of future results.
Going forward, we believe the Fund remains very well placed to maintain this distribution. The recent widening of credit spreads has resulted in a marked increase in yields available. Moreover, as often happens in periods of excess volatility, many bonds from high-quality creditors have fallen by significantly more than warranted, leaving them at prices that offer compelling risk/reward. In particular, the Fund has in recent days purchased a bond from an A-rated quasi-sovereign issuer at over 6% yield for 10 months as well as a bond from a BB- equivalent healthcare issuer at nearly 9% for three years. These yields are exclusive of any potential gains the Fund may make from a rebound in their respective share prices.
As a result of opportunities such as these, the Fund has been active in recycling its investments in order to maximize the risk/reward of the portfolio. Indeed, over time the end result may be a higher yielding portfolio with lower risk.
Moreover, we remain confident in the stability of these distributions. Overall not only has the Fund’s portfolio remained investment grade (BBB-)1, but ever since early in the COVID-19 outbreak we also sought to ensure that the Fund’s investments were in extremely liquid companies. We stress-tested the portfolio and made changes where warranted with the result being that 84%2 of the portfolio is now in companies that can cover all their financial obligations over the coming year from cash on the balance sheet alone. In other words, no matter what impacts the COVID-19 crisis has on operating conditions, these companies should remain able to repay all debt and pay coupons throughout 2020 and are not reliant upon any income to meet their financial obligations.
As a result, we continue to remain extremely comfortable with the Fund’s ability to meet or exceed its 1% quarterly distribution target, regardless of the on-going COVID-19 distribution.
1 Polar Capital, as at 31 March 2020.
2 Polar Capital, as at 31 March 2020, underlying data gathered from S&P Capital IQ.
Past performance is not a reliable indicator of future returns. Investors should note that historic yield does not measure the overall performance of a fund. It is possible for a fund to lose money overall but to have a positive historic yield. Historic yield cannot be considered as being similar to the interest rate an investor would earn on a savings account.