Core Trade Alert: Update And Sell Call On Barings Corporate Investors (MCI)

Summary:

  • The NAV for the fourth quarter will be released on the 25th of this month

  • We estimate it will be down 8.7%

  • Given the run in price, we think the premium will be too high putting pressure on the price.

  • We recommend selling the position ahead of the release

  • Please read the "concluding thoughts" and "important" sections below.

Barings Corporate Investors (MCI)

With the quarterly NAV release coming up in a couple of weeks, we wanted to review this popular fund.  We've owned this fund for over two years now with the original buy alert going out December 21, 2016.  Since then, the shares are up 17.5% with relatively low volatility, even on price.  (This is skewed slightly as the last distribution has been taken out but not yet paid)

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First a quick overview of the fund:

Fund Strategy

MCI invests principally in privately placed, below-investment grade, long-term debt obligations and often accompanied by equity features, purchased directly from their issuers and sourced through Barings extensive deal network of private equity sponsors.   MCI’s principal investments are in the privately placed, below-investment grade, long-term debt obligations of companies primarily domiciled in the U.S. These direct placement securities may in some cases be accompanied by equity features such as warrants, conversion rights and occasionally preferred stocks. We typically purchase these investments directly from their issuers, who tend to be smaller companies, and may also temporarily invest in marketable investment-grade and other debt securities (including high yield) and common stocks. MCI is managed on a total return basis, and distributes substantially all of its net income each year in the form of quarterly dividends. 

(Source:  Barings.com)

Characteristics:

  • Total net assets:  $306M

  • Number of holdings:  208

  • Avg daily volume:  21,000

  • Leverage:  9%

  • Allocation:

    • 75.0% Private placement (144a)

    • 9.8% Restricted equity 

    • 5.3% Bank loans

    • 5.0% Public high yield debt 

    • 4.6% Cash and equivalents

    • 0.7% equity

For most of the history of the fund, it has traded at a premium to NAV.   But the real analysis must be done with the NAV.  The NAV is only reported on a quarterly basis (which is the minimum required reporting) as much of their holdings are not publicly traded.  Thus a third party valuation firm must mark the private placement to a value as of December 31st.  

The current yield is right on 8% with a quarterly $0.30 payout.  They announced the most recent distribution in mid-December payable January 11th- we are also passed the ex-distribution date.   The fund has an odd distribution date system with no distribution in the first three months of the year, one in the second, one in the third, and two in the fourth (second one payable in the first quarter).  

NAV Calculation

We sought to find out whether MCI’s NAV total return for Q4 could be predicted by analyzing other funds who, because they publish NAV daily, have already posted their Q4 returns. If we could use them to accurately predict MCI's Q4 NAV return, we could back into MCI's NAV value, as we already know MCI's committed dividends.

We tested almost two dozen similar funds (individually and in groups) to see which ones had predictive value vis-a-vis MCI over the past 8 quarters. The best correlations were to non-investment-grade bond funds and specifically to Barings Global Short Duration High Yield (BGH), Wells Fargo Adv Income Opp (EAD), PGIM Short Duration High Yield (ISD), and the Proshares Global Listed Private Equity ETF (PEX).

We then used multi-variable regression analysis to find the coefficients (weights) of these 4 benchmarks. With a ~99% R-squared, which is extremely tight, the multiple regression model spits out an equation for the last 8 quarters that looks like this:

MCI quarterly NAV total return = 0.56061 + (1.35047*EAD) - (0.89222*BGH) + (0.99528*ISD) + (0.22224*PEX)

In the “best-fit” formula above, the ticker symbols represent the quarterly NAV total return for those funds. Since they have all already reported for Q4, we can solve as follows:

MCI NAV total return for Q4 = 0.56061 + (1.35047*-5.28) - (0.89222*-9.72) + (0.99528*-3.45) + (0.22224*-15.49)

MCI EXPECTED NAV total return for Q4 = -4.77%

(Note that all 4 benchmark funds had negative NAV total returns in Q4.)

Now “knowing" the total return and the dividends, we can solve for the NAV value. The answer is $13.96. Thus our prediction is that the NAV value is going to fall by -8.7% from the last reported $15.29 value.

If our prediction is correct, the lower NAV (when announced) will translate into the premium jumping up to the 10% level, assuming the latest share price. At that level, the fund is a clear SELL.

Important: while these 4 funds taken as a group have had predictive value vis-a-vis MCI over the last 8 quarters, none of these past 8 quarters were negative total return quarters for MCI. In fact for the most part, the 4 fund benchmarks all had a very good run over the past 2 years, with no individual quarters down much more than -1%. So we are in fact betting that the relationships that held between these funds in good times will be maintained in the difficult 4th quarter of 2018.

There is another thing we also need to consider. In their November press release, MCI noted that they refinanced their fixed rate bonds used for leverage, which is fairly unique. Their leverage amount is relatively small at 9% but the refinancing should reduce expenses and thus improve net investment income.

Concluding Thoughts / Action:

We believe the fund is likely to see a share price reduction when the NAV comes out in two weeks. Of course, we do not expect to see an immediate market reaction as most investors will not even know about it right away. The fund trades about 21K shares a day which is fairly low -- a reason why it never made it above a 2% Core holding.

Since the end of 2018, the HY and equity markets have seen a rebound which could be supportive of the current price on MCI.  In other words, if the NAV were priced daily like other funds, the 12/31 price would be $13.96 but the current January 11th NAV price could be back above $14-$14.25 at which level the premium would be lower and perhaps justified. 

The price is up sharply in the last few weeks which we thing adds to our 'sell' thesis.  

If you decide to sell at some point over the next week, we would advocate STRONGLY to use limited orders and to watch your position closely. It will be interesting to see if the shares can be shorted.  Remember, when shorting, you are responsible for paying the distributions!

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