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Henderson Diversified cut high yield exposure and outperformed

Over the six months to the end of April 2016, Henderson Diversified Income achieved a return on net assets of 2.4% and a return to shareholders of 1.3%. this compares to a return on the company’s benchmark, the total return over three month sterling Libor plus 2.00%, of 1.3%. A first interim dividend of 1.25p per ordinary share for the year ended 31 October 2016 was paid to shareholders on 31 March 2016 and a second interim dividend of 1.25p per ordinary share was declared on 24 May 2016 which will be paid on 30 June 2016 to shareholders on the register on 3 June 2016.

From last summer the managers, John Pattullo and Jenna Barnard, have materially reduced the portfolio’s high yield exposure primarily in US healthcare and select European and US telecom names.  This calendar year they reduced some of the high yield banking bonds.  This included some of the few capital contingent convertible bonds they held.  The timing of this was fortuitous as they sold before the meltdown in risk assets in early February.  They allocated some of the sales proceeds to US investment grade bonds.  This asset class had sold off significantly given the late cycle nature of credit markets but was trading at valuations reflective of a recession.  They decided to invest in large cap, non-cyclical sectors in companies which have recently taken on debt, and hence issued bonds, to finance acquisitions but which have stated deleveraging targets.  Such names include Verizon, AT&T, Walgreen Boots, Reynolds and Kraft Heinz.  They believe this has helped to lower the default risk of the Company without giving up yield.  They have extended interest rate sensitivity (duration) a little as these investment grade bonds tend to be of much longer maturity than the shorter dated high yield bonds we sold.  They have approximately a third of the Company’s assets in each of secured loans, investment grade bonds and high yield bonds. (ignoring the modest exposure the portfolio has to high yielding equities).  They say that, given a somewhat uncertain economic outlook, this “thirding” strategy seems sensible to them.  It is the first time since 2007 the assets have been roughly equally split.

The managers say that the European secured loan market had a mixed six months through to 30 April 2016. Returns for the first 4 months of the period were negative in line with broader uncertainty across credit markets, before rebounding strongly through March and April. Overall the asset class delivered a 2.08% return for the 6 months (measured by the Credit Suisse Western European Leveraged Loan Index hedged to GBP). Despite the March/April recovery in prices, the asset class did deliver a below coupon return.

The volatility seen through the period did result in spreads widening on new loan issues. As a result they think the new issue market for loans continues to look attractive with the majority of borrowers pricing their senior secured loans with coupons in the LIBOR + 4.5-5.5% range.

New names added to the secured loans portfolio over the period include Telecolumbus (Cable TV, Germany), Keurig (Food & Beverage, US) and Equinix (Real Estate, US). Given broader economic concerns they have continued to focus on maintaining the credit quality of the underlying portfolio. They have therefore reduced position sizes or exited certain loans, where the borrower’s financial performance has fallen short of their expectations. Loans removed from the portfolio include ERM (Services, UK) due to exposure to the oil and gas sector and BMC Software (IT, US). They added to existing positions in Pret a Manger (Retail, UK) and Kloekner Pentaplast (Packaging, Germany) given the strong performance of both businesses.

The average price of the loans in the portfolio as at the end of the period stood very close to par and the overall loan component of the portfolio is delivering a running yield of 5.2%.

HDIV : Henderson Diversified cut high yield exposure and outperformed

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