ACP - Fund Update September 2023

In this episode we focus on income credit strategies with a manager of the abrdn Income Credit Strategies Fund, ticker ACP. 

Transcript

MT: Welcome to the latest instalment of our abrdn Closed End Fund podcast series, where, along with our portfolio managers, we review what's happening in a particular fund and its underlying markets. I'm Mike Taggart of abrdn, today we are focusing on the global high yield fixed income market with Adam Tabor, portfolio Manager on the abrdn Income Credit Strategies Fund, ticker ACP.

Hello, Adam, thank you for taking the time to speak with us today. 

AT: Hi, Mike. 

MT: So if you would, let's begin with your current view on the state of the global high yield credit markets. 

AT: Yeah, well, we've been quite cautious all year. You know, we've seen a very fast hiking cycle from the Fed and other central banks, which is kind of close to being over now, maybe one or two more hikes to go. But the US economy has been much more resilient than we expected. Inflation's falling, employment has remained robust and the possibility that we might get this nice soft landing has increased. 

We kind of still err on the side of caution. We still worry about the lagged effect of the rate hikes and the abrdn house view is that there will at some point be a mild recession in the US.  So we think growth could disappoint and we think that there is scope for spread widening and high yield. 

Now the global high yield spreads, so the spread over treasuries is about for 470, 480 basis points today, which is more or less the average of where it's traded over the last ten years. And that spread has moved wider in the last few weeks, troughed at 425 in mid-September. So 60 basis points of widening since then and we think there could be more widening to come on a bit of a weakening growth outlook. 

Despite that, given the fact that Treasury yields have risen so sharply, that spread at 480 translates into a much higher yield today. So so the yield, the worst of the global high yield index is running at over 9% now versus a ten-year average of 6.3.

So at the same time, we're mindful that we have to balance our outlook with that high absolute yield on offer today. And even though we feel that compensation for default risk is quite attractive at these levels, we still think that, that a cautious approach is the right one in the near term and we want to have room to add risk if spreads do widen.

MT: Okay. Thank you. And you know, you just mentioned it. So a key component to high yield investing is risk management. How does your team assess risk in modifying the portfolio and in the current market? 

AT: Yeah, well, there are two main ways we can manage risk in the fund. Firstly, we can decide how much credit risk we want to take in terms of our positioning. And the second is how much leverage we want to add to the fund. And given the cautious outlook that I've just described, we've taken both of those down over the last year or so.

In terms of credit risk. The easiest way to demonstrate that is through the rating profile of the fund. And we have reduced our triple C exposure, which is the kind of lowest quality, highest risk part of the credit spectrum. And we've taken that down to just over 20% of the fund today - when it has been as high as 40% plus a couple of years ago. And we have around half of the fund in single B rated bonds today. And that is where we feel that you find the best balance between generating the yield that we need without taking too much default risk.

 And then with regards to the fund leverage, we have reduced drawing on our credit facility by around a third this year. And that's partly because as interest rates have risen, the cost of that leverage has increased, but also because we think spreads will widen and we want to retain the ability to re lever the fund when we think that valuations are more attractive.

MT: Okay, excellent. And if it's not enough to manage a portfolio in these exceptionally tumultuous times, right, back in March, the former Delaware High Income Opportunities Fund was merged into ACP. Would you share an update on the integration of that portfolio and how you've done it? How you've integrated that portfolio kind of given the market conditions? 

AT: So, the merger with IVH - IVH is the ticker that the Delaware High Income Fund was listed under -  like you said, closed in March this year. So we've been managing the combined assets for just over six months. And just to remind listeners, it was roughly the same size as ACP, so it doubled the size of the fund to around $500 million.

And there has naturally been a period of integration and some switching of holdings from what they owned to what we would like to own in the fund. But that's mostly complete now. One or two things that that we are still working on and we continue to manage ACP in the same way. So no change in our approach and the distribution that ACP shareholders receive has stayed the same. So, no change to the yield that investors receive on their shares. 

MT: Excellent. And then, you know, another key element to high yield investing is sector exposure. Would you provide us with an update on any particularly vulnerable or resilient sectors in the high yield space year to date? 

AT: Yeah, we think we think telecoms lends itself quite well to the high yield market. You know, when you when you take out a new broadband or mobile phone plan, you normally lock yourself in for up to two years. So these are businesses with long term contracts, predictable revenues and cash flow streams and importantly, pricing power. You know, a good broadband connection is essential, especially with more people working from home now. So one thing we are mindful of is that is that that sector is going through a big investment cycle at the moment. So lots of capital being deployed to build out fiber and 5G networks. So we are careful in identifying which operators are best able to cope with that funding requirement. But once these networks are built, you know, the winners should start seeing significant cash flow generation. 

And then on the other side, you know, one of the sectors that we've cut back on again, particularly in Europe, has been consumer financials. So this is lenders, mortgage providers and debt collectors, which is quite a big industry in Europe as a lot of that function was carved out of banks that aren't allowed to hold non-performing loans on their balance sheets anymore. And many of these debt collection businesses are set up with a lot of leverage and high yield debt that was issued when rates were a lot lower. So we see that as a prime example of a sector that that might find it tough going, you know, as and when they do have to refinance. And many of those businesses do have debt coming due in the next 2 to 3 years or so. So, yeah, a sector that we've cut back on quite materially over the last 12 to 18 months.

MT: And, you know, from your perspective, Adam, does the closed end funds structure actively managing a portfolio of high yield bonds within a closed end fund - does that offer you any benefits as a portfolio manager in these volatile times? 

AT: Yeah, I mean, we've said this before, but the main benefit is not having to manage flows. So, inflows or outflows to and from the fund and in an open-ended fund they can often come at the worst time when the market has been selling off and the market's at its cheapest.

So yes, having closed ended capital means that, you know, we can try and steer the fund to take advantages, take advantage of opportunities when we think the market is cheap. And what we're doing at the moment is as a good example of that.

MT: And finally, Adam, what would you say to investors who have allocated capital or are considering allocating capital to global high yield in today's market?

AT: Yeah, well, like I said earlier, you know, we do think that absolute yields of 9% do look quite attractive at an index level. And one of the things that we spend a lot of time thinking about is future default risk. And we're in an environment now where there is a lot of concern over future default risk. There's a significant amount of high yield debt maturing in the next 2 to 3 years that companies will have to refinance that much higher coupons. And some of them may not be able to afford that. 

We're relatively sanguine on the default outlook. Moody's, for example, the rating agency, they have, the 12-month trailing default rates running at 4.3% at the end of August. And they forecast that it will peak to 4.7% in Q1 next year before tailing off. So the default risks should be quite contained and at 9%, a lot of that is already priced in. And you are quite well compensated for that default risk today. So, you know, and in addition to that, clearly it's part of our job to try and identify where the default risks are and avoid them. So, yeah, despite the kind of near-term cautious outlook that we have, we do think that that defaults should remain contained and we do think that yields are attractive on a longer-term view.

All right. Thank you, Adam, for providing us with that update on ACP, the Aberdeen Income Credit Strategies Fund. And thank you, everyone for listening to this podcast. 

There are three convenient ways to learn more about ACP; on the Internet you can visit abrdnacp.com; you can email us at investor.relations@abrdn.com or give us a call at one 800 5225465.

I'm Mike Taggart of abrdn. Thank you for listening.

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