The managers of Henderson Diversified Income Trust (HDIV ), a £130m bonds and loans fund, have positioned their portfolio more defensively as they anticipate falling inflation and a possible hard landing of the global economy this year.

Interim results for the six months to 31 October show fund managers John Pattullo, Jenna Barnard and Nicholas Ware reduced the 6%-yielder’s weighting to high-yield bonds, which will face increased credit risks and defaults in a recession or downturn. In tandem with this, they put more money into investment-grade bonds, which were hit by last year’s hikes in global interest rates but which could face easier conditions as central banks near the end of their monetary tightening. 

‘It has been an unusual cycle in terms of inflation proving to be a more important factor driving market returns this year than growth. However, we expect this to correct itself in the coming financial year with inflation falling and think the portfolio is well set up for that,’ the managers said as the investment trust reported a 10.4% drop in net asset value (NAV), trailing the 6.9% fall of its composite bond market benchmark.

High-yield bonds dropped to 52.1% of the £130m portfolio at the end of October, down from 65.3% a year earlier, while investment-grade bonds rose to 36.1% from 24.9%.

The managers continued this shift in November cutting high-yield or ‘junk’ bonds to 41.3%, while lifting investment-grade to 48.8%, or nearly half. They also held 7.6% in loans and 2.3% in preference shares.

Having cautiously lowered gearing, or borrowing, over the summer, the trio added more in the autumn as credit markets rallied from a selloff exacerbated in the UK by former chancellor Kwasi Kwarteng’s botched ‘mini’-Budget.

With gearing back to 11% in November, they indicated in their comments last week that they would be prepared to buy back into high-yield if they were to sell off again. 

‘If we were to experience increased risk aversion, which we do expect, we would be well positioned to add more high-yield bonds at more attractive yields going forwards,’ they said.

Uncovered dividend

The board announced last year that its quarterly dividends could be paid in part from reserves rather than current year income to give the managers greater flexibility to reduce gearing and invest in lower-risk, lower-yielding assets. As a result, dividends for the full year to 30 April are not expected to be fully covered by investment income.

The interims showed the managers added short-dated, less interest rate sensitive debt in banks such as JPMorgan, Lloyds and Barclays in the half-year period. They also bought investment grade bonds in US drugs giant AbbVie, US mobile phone operator T-Mobile and Belgian brewer AB InBev to the portfolio.

‘This more defensive positioning, we think, will benefit holders; whilst 2022 saw both rates and spreads sell-off in unison, in 2023 we foresee a more traditional relationship will ensue where rates and spreads [the yield gap between government bonds and corporate bonds] may move in opposite directions but the carry [income] from investment grade will ensure a decent cushion to generate a positive return,’ they said in their outlook statement.

During the period the trust bought back 3.8m shares to prevent their price from dropping too far below NAV. The share price discount averaged 6.6% in the half year and has narrowed to 2.5% today. The past three years have been difficult for the income fund which, even with dividends included, has delivered a total loss of nearly 13% over three years. Only over 10 years to the end of November does HDIV beat its benchmark with a total return of 42.4% against its 35.6%.