Are investors overlooking the opportunity in floating rate bond funds on high dividend yields? That’s the implication from a market update from TwentyFour Income Fund (TFIF ), a 9%-yielder whose shares briefly slipped to a small discount last week. 

TFIF, a £733m closed-end Guernsey fund that has just passed its tenth birthday, says its strategy of investing in loans and asset-backed securities whose coupons rise and fall with interest rates saw it declare its highest ever quarterly dividend of 4.46p this month. This produced a total payout of 9.46p per share in the year to 31 March, up 2.69p from the 6.77p paid in the previous year. 

The 25% leap in the distribution in 2022/23 reflected the high yields the investment company’s six-strong team at TwentyFour Asset Management were able to pick up last year as interest rates surged, either reinvesting money from maturing bonds or deploying the proceeds of shares issues when its stock traded at a premium.

In March last year Sonia, the inter-bank lending rate benchmark, stood at just 0.14% but jumped to 2.26% 12 months later. This additional 2.12% generated the bulk of the increased dividends from its sterling-hedged debt portfolio.

While the turmoil caused by the war in Ukraine and Kwasi Kwarteng’s notorious ‘mini’ Budget knocked 8.8% off net asset value last year, the managers say income prospects are good given market expectations for two or three more 0.25% interest rate hikes from the Bank of England after last week’s disappointing 10.1% inflation reading. 

And while the market has priced in a moderate recession after the recent stressful trading in banks after the Credit Suisse and SVB collapses which will cause some fundamental deterioration in loan performance over the next 12 months, they reiterate that mortgage arrears and leveraged loan defaults are still at historically low levels. 

‘Drivers of performance such as unemployment and house price declines are expected to remain significantly lower than during previous recessions, and well within levels for which the bonds in the portfolio have been stress tested,’ the managers say.

The team, which includes portfolio managers Aza Teeuwen, Douglas Charleston and Elena Rinaldi, see the best value in BBB, BB and B rated secured assets in mortgages and senior secured corporate loans. They have less conviction in unsecured consumer debt and commercial real estate debt. 

With market volatility expected to continue, the management team cut gearing, or borrowing, from 10.6% to 5.4% in the first quarter. 

In the first three months of 2023, the portfolio’s underlying NAV has recovered 6.8% and could continue to do well as investor demand narrows the spreads - or yield gap - between asset-backed securities and government bonds. 

The scope for this is seen in the huge double-digit yields the portfolio is generating. On a purchase basis, measuring the return on TFIF’s loans against the price at which they were bought, the portfolio yields a record 11.3% at 31 March. Marked to market, the portfolio yields close to 15%. The average term to maturity of its loans is 3.4 years.

TFIF shares closed last week at just over 100p, back at their March 2013 launch price, and a 2.7% premium above NAV, according to Numis Securities data. Today they dipped 0.3p to 99.9p. Over 10 years to Friday the shares have generated a total return of 78.4%. According to TFIF, at 31 March that represented an annual underlying investment return of 6.4%.

TFIF is the mostly highly-rated investment company in the structured finance sub-sector, according to Numis data. Marble Point Loan Financing (MPLF ), launched in 2018, is the second mostly highly rated: its 17%-yielding shares, which trade at close to ‘par’ or NAV, have lost shareholders just over 2% in total returns in the past five years. 

Among the more lower-rated, Blackstone Loan Financing (BGLP ) offers a 16% yield on a 20% discount, having delivered a total 37% total shareholder return over five years. 

Fair Oaks Income (FAIR ), which last week reported a resilient set of 2022 results with NAV down 0.9%, yields 16% and trails on a 16% discount to NAV. Over three years it has generated an impressive 95% total return but over five years this falls to a 1.9% loss. It said investor sentiment had swung back towards the highly leveraged CLO corporate loan bundles in which it invests.

Columnist James Carthew recently looked at opportunities in debt funds here.