Annual Financial Report

Sequoia Economic Infra Inc Fd Ld

29 June 2023

 

29 June 2023

SEQUOIA ECONOMIC INFRASTRUCTURE INCOME FUND LIMITED

(the "Company" or "SEQI")

RESULTS FOR THE YEAR ENDED 31 MARCH 2023

The Directors of SEQI, the specialist investor in economic infrastructure debt, are pleased to announce the Company's results for the year ended 31 March 2023.

RESILIENT PERFORMANCE DESPITE VOLATILE MARKET

ROBERT JENNINGS, CHAIR, COMMENTED:

"The Company has remained resilient against a backdrop of an increase in credit spreads and tighter lending conditions globally, driven by interest rates which rose at almost unprecedented speed in FY23. Our income for the year increased due to the high proportion of floating rate investments in our diversified portfolio which has allowed us to increase our annual dividend by 10% to 6.875p per Ordinary Share, starting with the February 2023 dividend payment in respect of the quarter ended 31 December 2022.

The Board and the Investment Adviser are very mindful of the wide discount to Net Asset Value per share which our shares currently trade on. In that context, SEQI's shorter duration is beneficial and allows us to take a flexible approach to capital allocation in optimising the balance between share buy backs, leverage and attractively yielding portfolio investments."

We believe our economic infrastructure portfolio is well positioned in the current high interest rate environment and are taking advantage of credit markets that are favourable to debt providers. We have demonstrated our resilience throughout the challenges of the last eight years and, our well-diversified portfolio, growing interest income and disciplined approach to capital deployment gives us confidence for our future."

HIGHLIGHTS

·      Annualised portfolio yield-to-maturity of 11.9% (2022: 8.4%) as at 31 March 2023

·      Dividends totalling 6.5625p per Ordinary Share (2022: 6.25p) paid in respect of the year in line with annual dividend targets

·      Strong dividend cash cover of 1.21x (2022: 1.06x)

·      Defensive, diversified portfolio of 68 investments across 8 sectors, 26 sub-sectors and 12 mature jurisdictions

o  98% of investments in private debt (2022: 95%)

o  58% floating rate investments (2022: 50%), capturing short-term rate rises

o  Short weighted average life of 3.5 years (2022: 4.1 years) creating reinvestment opportunities

o  Weighted average equity cushion of 34% (2022: 33%)

·      NAV per Ordinary Share cum-dividend of 93.26p (31 March 2022: 100.50p) mostly reflecting the mark-to-market effect of higher interest rates and credit spreads

·      NAV total return of -0.9% (2022: 3.5%) in the year

·      Share price total return of -16.1% (2022: 4.5%) in the year

·      Ongoing charges ratio of 0.96% (2022: 0.87%) (calculated in accordance with AIC guidance)

·      ESG score of the portfolio is on a long-term and sustainable upward trend

ANNUAL REPORT

A copy of the annual report has been submitted to the National Storage Mechanism and will be shortly available at https://data.fca.org.uk/#/nsm/nationalstoragemechanism. The annual report is also available on the Company's website at https://www.seqi.fund/investors/results/ where further information on SEQI can be found.

INVESTOR PRESENTATION

The Investment Adviser will host a presentation on the annual results for investors and analysts today at 10:00am BST. There will be the opportunity for participants to ask questions at the end of the presentation. Those wishing to attend should register via the following link:

https://stream.brrmedia.co.uk/broadcast/648c3fe1cdb8783915128cb1

For further information, please contact:

Sequoia Investment Management Company Steve Cook Dolf Kohnhorst Randall Sandstrom Greg Taylor Anurag Gupta	[phone]
Jefferies International Limited (Corporate Broker & Financial Adviser) Gaudi Le Roux Stuart Klein	[phone]
Teneo (Communications Adviser) Martin Pengelley Faye Calow	[phone]
Sanne Fund Services (Guernsey) Limited (Company Secretary) Matt Falla Lisa Garnham	[phone]

LEI: 2138006OW12FQHJ6PX91

CHAIR'S STATEMENT

Dear Shareholder,

It is my pleasure to present to you the Annual Report and Audited Financial Statements of the Company for the financial year of operations ended 31 March 2023. In the absence of unforeseen circumstances, this will be my final report to you as your Chair, as I am now in my ninth year.

The financial year saw interest rates rise at almost unprecedented speed, as central banks strove to tame rapidly rising inflation. This led to an increase in credit spreads and tighter lending conditions globally.

This environment has resulted in mixed fortunes for the Company, as our NAV declined on the back of higher rates, but our income increased due to the high proportion of floating rate investments in the portfolio - this enabled us to increase its dividend by 10%, to 6.875p per Ordinary Share, starting in January 2023. Less pleasingly, our share price fell to below its NAV - this is an unwelcome development, largely driven we believe by sentiment towards the wider alternative income sector rather than a specific reflection of the attractiveness of the Company. Nonetheless, we have taken a number of measures to limit the discount to NAV.

NAV and share price performance

Over the financial year, the Company's NAV per Ordinary Share¹ decreased from 100.50p to 93.26p, after paying dividends of approximately 6.41p, producing a NAV total return¹ of -0.9% (2022: +3.5%), compared to our target return of 7-8%.

The decline in the NAV is mostly down to the mark-to-market effect of higher interest rates and credit spreads, which rectifies itself as loans move closer to repayment. If we were to hypothetically disregard this effect, the NAV total return for the year¹ would have been over 6%. It could be argued that this 6% return represents the true underlying performance, since this decline in marks is an unrealised loss, much of which should substantially reverse itself over time through the pull-to-par effect. In other words, as our loans approach their maturity date, their marks will inevitably (absent any credit event) rise towards their par value. As interest rates start to plateau gradually, this represents a helpful tailwind to our NAV in the years ahead.

Moreover, we have once again outperformed the liquid credit markets, with high yield bonds generating total returns of -4.7%, and leveraged loans -4.2%, over the same period, compared to -0.9% in our case.

The Company's share price also declined over the year, from 102.80p to 80.40p, a share price total return¹ of -16.1% (2022: +4.5%), once dividends are taken into account. This was almost entirely a result of the decline in the rating of the shares, from a premium¹ of 2.3% at the beginning, to a discount¹ of 13.8% by the end of the year.

We are disappointed in this fall in our share price, which we believe is predominantly a result of investors' concerns over rising interest rates, high inflation, a sluggish global economy and geopolitical risks, as well as technical factors specific to investors but unrelated to the Company, such as the consequences of redemptions from their own funds. We do not believe it is a reflection of the fundamental attractiveness of the Company - all our peers in the infrastructure and debt sectors also trade at a discount. However, we are not complacent and the following measures were put in place from an early stage to address this issue:

·    an active buy-back programme, with 33.4 million Shares repurchased over the financial year, which we have continued since the year end. Not only does this partly address the excess supply of shares in the market, but most notably the purchases are accretive to NAV;

·    ongoing Share purchases by the Directors of the Company and Sequoia Investment Management Company Limited (the "Investment Adviser") and its directors. In total, 1,609,258 Shares were bought by insiders during the year;

·    a 10% increase in the dividend, keeping pace with UK inflation, which should improve the attractiveness of the Company to investors looking for strong income; and

·    enhanced investor communication including a revamped website (www.seqi.fund), a well-attended investor capital markets day and numerous meetings with individual investors.

1.  See Appendix for Alternative Performance Measures ("APMs").

Dividend

As noted above, on the back of higher short-term interest rates, which has resulted in increased income from the Fund's investments in floating rate loans, we were able to increase our dividend by 10%, from 6.25p per Ordinary Share to 6.875p per Ordinary Share. This increase took effect from January 2023. As in previous years, the dividend remains fully cash-covered.

For the time being, we intend to hold the payout at its current level. However if, as we anticipate, our interest income continues to increase, further strengthening in our dividend cash cover ratio, we will review the situation again later in 2023, in the context of our ambition to pay out a sustainable and attractive level of income to our Shareholders.

Portfolio performance

Most of our portfolio has performed well over the course of the year, with many sectors previously adversely affected by COVID-19 improving materially. Specifically, the Fund's exposures to the transportation sector (excluding aviation), student accommodation and midstream assets all improved in credit quality, while other sectors such as telecommunications and healthcare infrastructure remained robust.

Of the three non-performing investments identified a year ago, one has now been exited, albeit at a loss. That leaves only Bulb Energy and a loan backed by the property at 4000 Connecticut Avenue, Washington DC (formerly called Whittle Schools). Progress has been made on these two investments, which represent only 3.3% of NAV. The Investment Adviser discusses these specific transactions in more detail in the NAV and Fund Performance section of its report.

While most of the bonds and loans in our portfolio are performing in line with expectations, some 10% of our portfolio, including the two aforementioned loans, are receiving enhanced scrutiny by our Investment Adviser. The Board has closely reviewed these positions and is comfortable that their current marks, which are generated by our valuation agent PricewaterhouseCoopers, and reviewed by our independent Auditor Grant Thornton, fairly reflect the current value of these positions.

During the financial year, the Investment Adviser has had a highly selective approach to new investments. In general, we have prioritised investments in lower-risk parts of the infrastructure market, which typically have only a moderate or low correlation to the economic cycle, such as businesses with a high degree of contractual income. While net leverage has increased due to the substantial effect the foreign exchange market's volatility has had on the Fund's hedging book, we have refrained from drawing too much on the Company's revolving credit facility ("RCF") and are now rebuilding liquidity reserves - in part, because having low net leverage is clearly prudent in turbulent markets.

A retrospective review of the Company since its IPO

The Company has now been in operation for slightly more than eight years since its IPO on 3 March 2015. As my tenure as Chair is nearing its end, this seems like a natural time to reflect on the Company's performance.

Firstly, it is clear that the Company's strategy, as set out in its very first Prospectus before the IPO, was both attractive to investors and successfully implemented. Through 11 well‑supported capital raises, the Company grew approximately 12‑fold and became a constituent member of the FTSE 250. This scale has produced some important benefits for investors, including:

·    lower costs, since the fixed costs of the Fund are spread over a larger capital base and the Investment Adviser's fee has reduced in percentage terms through a fee‑tapering mechanism;

·    reduced risk due to an increase in diversification;

·    increased access to investment opportunities thanks to our ability to fund larger, more important, infrastructure projects; and

·    greater "pricing power" in the loan terms that we offer to the companies we finance.

Secondly, the Fund has operated through some turbulent times, which have helped to demonstrate the robustness of infrastructure debt as an investment class. Periods of high volatility in the liquid credit markets; COVID-19 lockdowns followed by a recession or a near-recession; the Ukraine war; ultra-low interest rates followed by a normalisation of rates at an almost unprecedented speed; and periods of both abnormally low and abnormally high energy prices have all challenged us. That is a lot in only eight years!

During all this, we have of course had some loans default. That is a natural part of running a loan portfolio - it would be naïve to imagine that the Fund could keep lending money in perpetuity without experiencing some bad debts. However, as the chart below shows, our proportion of defaulted loans is much lower than both the broader credit markets, and indeed comparable infrastructure lending.

Note that within this calculation we are including not just the actual defaults we have experienced but also cases when we have sold loans at a loss to avoid a further deterioration in credit quality and the likelihood of a default in the future.

Moreover, when we have had a default, we have on average recovered more than other lenders. This means that our "loss rate" (i.e. annualised credit losses, expressed as a percentage of the loan book) is very low indeed, at approximately 0.56% per annum. This number includes not just realised losses but projections of future losses, which have not yet come to pass, on non‑performing loans.

Thirdly, the Company has been able to earn its target yield on its investments, net of costs, and this has enabled us to pay a growing and cash‑covered dividend. In its eight years, the Company has met every dividend payment and target.

Fourthly, as discussed below, the Company has adopted a market‑leading ESG policy. This has involved implementing ESG scoring, exiting some non-compliant investments, targeting new investment sectors, engagement with borrowers and a high (and growing) level of sustainability reporting.

Our goal on ESG is to be a market leader, not a follower. We believe that by acting today we are positioning the Company for success in the future, and this is what our investors want.

Liquidity

One important, but easily overlooked, aspect of listed funds is the importance of having sufficient liquidity. This is especially true for companies such as ours that invest in illiquid private assets. Liquidity can be needed to meet potential margin calls on FX hedging, finance share buy‑backs and manage borrowing and funding investment commitments.

We derive liquidity through cash sitting on the balance sheet, the undrawn portion of the RCF, the natural high level of cash generation arising from our investment portfolio and a reasonable number of liquid investments, typically rated infrastructure bonds.

I am pleased to say that the Company has remained liquid at all times since its inception. This is because we are cautious by nature and conservatively assess our liquidity requirement. In response to the deteriorating market conditions over the opening months of the financial year, in September 2022, the Board and the Investment Adviser agreed that it would be beneficial to increase liquidity via targeted asset sales. Over the last nine months since then, the Investment Adviser has cumulatively raised £460 million through sales and loan redemptions. This has provided funds to support our share price through our buy-back programme and has allowed our Investment to make selective purchases at attractive prices of more liquid infrastructure bonds and broadly syndicated leveraged loans.

Environmental, social and governance ("ESG")

This year has seen continued progress on the development of the Company's approach to ESG. We have focused on applying the comprehensive ESG policy which we published in June 2021, and refreshed earlier this year, across all of our portfolio and deal pipeline. Our policy sets out in detail our approach to asset selection and portfolio construction, as well as broader themes such as how we can engage with our borrowers on ESG-related matters.

We continue to report under Article 8 of the EU Sustainable Finance Disclosure Regulation ("SFDR") directive.

In February 2023 we were delighted that our Investment Adviser won the 2022 global award for Best ESG Infrastructure Investment Strategy by Capital Finance International ("CFI"), in recognition of its progress against its ESG commitments and framework.

Overall, the portfolio has shown progression during the year from an average score of 61.88 to 62.29. A significant number of the lowest‑scoring loans have been sold or allowed to roll off at their maturity, and most of our new investments generally score higher than the ones they replace. Generally, we expect this trend to continue, and believe that our scoring framework will allow us to continue to allocate more capital towards sectors and borrowers who demonstrate appropriate environmental, social or governance characteristics. However, because we are willing to lend to borrowers who are seeking finance transition programmes to improve their ESG metrics, sometimes from a relatively low base, it is not a given that our portfolio's average ESG score will improve at every future reporting date.

For the third year running we have mandated KPMG LLP to provide independent limited assurance of our portfolio's overall ESG score, which we believe is indicative of our intention to raise standards of rigour in the qualification of ESG credentials across portfolios of loans.

As noted in my review last year, the Board wrote to all the Company's key service providers to request information about the management of their carbon footprints and the steps they are taking to reduce these over time. We were greatly encouraged to discover that the majority of our larger key service providers have already set up impressive programmes to monitor and reduce their carbon intensity.

We also put in place a programme to offset our emissions from our own activities, such as the difficult-to-avoid ones relating to flights to and from Guernsey. This programme is financed by a voluntary levy on Directors' fees and by contributions from some of our key suppliers, most materially from our Investment Adviser.

The credits we acquired during 2022 are expected to be sufficient to offset estimated corporate-level emissions for 2022 and, pending verification of the Peatland Code certified units due for conversion in 2025, for 2023 and 2024 as well.

Overall, I continue to believe that the policies that our Investment Adviser is operating and developing firmly establish us at the forefront of ESG thinking in the context of an infrastructure debt‑focused fund.

Board succession plans

In previous Chair's statements, I have discussed Board succession planning, and I would now like to introduce Fiona Le Poidevin, who joined the Board in January 2023, having previously been the Chief Executive Officer of The International Stock Exchange Group and, before that, the Chief Executive of Guernsey Finance, the promotional body for Guernsey's finance industry internationally. Fiona is a Chartered Director, a Fellow of the Institute of Directors and a Chartered Accountant and brings a wealth of experience in listed funds. Going forward, Fiona will chair the Company's Audit Committee.

I would like to thank Sarika Patel, who has diligently served as a Director of the Company for two years and is now stepping down for personal reasons at this year's AGM. She has brought many years of experience to the Board and has contributed significantly to the Company's success and we wish her the best for the future. The process to recruit a replacement for Sarika is already underway.

Of the original four Directors on the Board at the time of the Company's IPO in March 2015, only two now remain, Sandra Platts and I. In accordance with best practice, it is anticipated that we will both retire from the Board over the course of the next 12 months.

Outlook

As noted above, we are taking advantage of credit markets that are currently favourable to debt providers. As loans mature, we are able to redeploy capital at higher returns for less risk, and improve our cash yield and average credit rating on our portfolio. Tight lending conditions, across not just the banking sector but also the liquid credit markets (specifically the high yield and leveraged loan markets) mean that the Investment Adviser can be extremely selective in the opportunities it chooses to pursue.

In general, not only do the assets that we add to the portfolio carry attractive yields, but they also:

·    improve the average credit quality of the loan book, for example by targeting senior over subordinated debt, and defensive over cyclical sectors;

·    improve the balance of the portfolio by investing in parts of the infrastructure market where the Fund currently has no or little exposure; and

·    improve the portfolio's ESG profile.

In addition, higher yields available in the market have allowed the Investment Adviser to add investments (typically rated infrastructure bonds) to our liquid asset bucket.

We believe that this approach will position us well to deliver attractive and sustainable returns for Shareholders.

We will also continue to monitor our Share price closely and, where appropriate, to engage in limited Share buy-backs. The rate at which we buy back Shares will flex depending on various factors, including the level of our Share price discount to NAV. We believe that buying in Shares at greater discounts will generate Shareholder value over the long term, even if it means that the size of our portfolio has to fall somewhat over the interim.

I would like to end by noting that the Company has demonstrated its resilience throughout the challenges of the last eight years. Our well diversified portfolio, growing interest income and disciplined approach to capital deployment give us confidence for our future.

Robert Jennings

Chair

28 June 2023

INVESTMENT ADVISER'S REPORT

The Investment Adviser's objectives for the year

Over the course of the financial year, Sequoia Investment Management Company Limited ("Sequoia" or the "Investment Adviser") has had the following objectives for the Fund:

Goal	Commentary	[Achieved]
Gross portfolio return1 of 8-9%	The Fund is fully invested with a portfolio that yields1 in excess of 11%, compared to 8% as at 31 March 2022, the increase being primarily driven by increases in long-term interest rates during the year	Yes
Manage the portfolio responsibly through an inflationary and rising interest rate environment	The Fund has continued to position its portfolio beneficially considering the rise in interest rates and has increased the floating rate proportion of its portfolio from 50.1% at 31 March 2022 to 58.4% at 31 March 2023	Yes
Follow a sustainable investment strategy	The Fund has improved the overall ESG score of its portfolio from 61.88 to 62.29 by allocating capital to higher-rated opportunities and selling off legacy investments	Yes
Timely and transparent investor reporting	Factsheet, commentary and the full portfolio have been provided monthly for full transparency, with increased investor engagement over the year	Yes
Continue to improve the ESG profile of the Fund and the portfolio	The Fund's pioneering ESG approach was recognised by investors when the Investment Adviser won the 2022 global award for Best ESG Infrastructure Investment Strategy by Capital Finance International	Yes
Dividend target of 6.875p per Ordinary Share per annum, increased by 10% from 6.25p per annum starting in Q3	The Company paid two quarterly dividends of 1.5625p and two of 1.71875p per Ordinary Share in respect of the year, in accordance with the increased dividend target, amounting to a total of 6.5625p	Yes

Economic infrastructure is a diverse and highly cash‑generative asset class

Economic infrastructure debt is a type of investment that is widely recognised for its stability and reliability. This asset class is characterised by several key features that make it attractive to investors. Firstly, there are high barriers to entry, which means that it is difficult for new players to enter the market, creating a certain level of protection for existing investors. Secondly, the cash flows generated by economic infrastructure debt are typically stable and predictable, providing a steady income stream to investors. This is due to the essential nature of the services provided, which ensures a consistent level of demand. Finally, the physical assets that support economic infrastructure debt provide tangible collateral that can be used to secure the investment. These features have made economic infrastructure debt an increasingly popular asset class among investors seeking a stable source of income and a reliable long-term investment.

Economic infrastructure debt sectors such as transportation, utilities, power, telecommunications and renewables are often supported by long-term concessions or licences to operate infrastructure assets. Projects in these sectors typically earn their revenues from demand, usage or volume, such as a data centre's revenue depending on the number of clients using its services. This contrasts with social infrastructure, such as parks and hospitals, which are often compensated for the physical asset simply being available for use.

To mitigate demand risk, economic infrastructure projects are typically less highly geared than social infrastructure and have higher equity buffers, more conservative credit ratios, stronger loan covenants, and higher levels of asset backing for lenders. This has remained true during the financial year, and SEQI's investment opportunities continue to be based and analysed on these characteristics.

Despite market volatility during the period, the Fund took pre‑emptive actions to position its portfolio defensively for potential downturns, such as targeting mainly floating rate assets, focusing on senior debt, and favouring non-cyclical industries. These measures helped mitigate risks from the lingering effects of the COVID-19 pandemic, the current inflationary market and opposing rate hikes, and other global uncertainties, such as Russia's war with Ukraine.

Overall, economic infrastructure debt remains an attractive asset class with stable cash flows and high barriers to entry. As sustainability continues to be a key investment topic, SEQI notes that investing in new economic infrastructure is often necessary for the implementation of the latest technologies and manufacturing processes into existing industries. This creates an abundance of ESG‑incorporating investment opportunities, benefiting not only SEQI's portfolio but also the modernisation of otherwise high barrier-to-entry sectors.

The market environment during the year

Despite the fundamental stability of infrastructure debt as an asset class, the broader financial markets experienced significant turbulence over the year, which has inevitably impacted the valuations of the Fund's investments. For instance, the FTSE All-Share Index, representing the overall London equity market, increased by 2.5%, while the FTSE 250, tracking mid-cap companies, declined by 8.1% during the period. 10-year Gilts (UK government bonds) decreased by 11.0%, leveraged loans declined by 4.2%, and high yield bonds fell by 4.7%. These figures include dividends or interest income, providing a total return for the period.

The deterioration in financial markets resulted from several factors, such as high inflation, global supply chain disruptions and rising interest rates. The COVID-19 pandemic continued to impact economies worldwide, and investors displayed a high level of risk aversion, requiring higher interest rates and credit spreads as compensation for elevated risk. Some markets, such as high yield bonds, experienced significant volatility, with year-on-year new issuance declining.

The Fund's portfolio of private debt is impacted by interest rates and credit spreads in liquid markets. While weakness in high yield bond markets negatively affects in the valuation of the Fund's investments, the Fund also benefited from weak markets, as infrastructure businesses had fewer options for raising capital, and the pricing power enjoyed by the Fund increased. This translated to higher lending margins, better credit terms, or both, which benefited the Fund's overall performance. Despite the challenges, the Fund's investments in infrastructure debt continue to provide investors with an attractive risk-return profile.

Portfolio overview

Our strategy for the period has been to continue building and managing a diversified portfolio of private debt investments backed by infrastructure assets in low-risk jurisdictions. We aim to maintain our target returns with a focus on avoiding excessive credit risk. Throughout this period, we continued to employ cautious investment strategies that were put into place in 2019. These strategies involve maintaining a large portion of the portfolio in defensive sectors, prioritising senior debt over mezzanine debt, and maintaining or gradually improving the portfolio's credit quality.

The economic outlook for the period ahead remains uncertain, with concerns over inflation and the impact of rising interest rates on global growth. Despite these challenges, our diversified approach to private debt investing has helped us to achieve solid returns and manage risk effectively. As a result, we have been able to take advantage of new opportunities to lend to high-quality infrastructure projects. Following this strategy, we believe that we can continue to generate attractive returns for our investors while mitigating risk in a challenging market.

·    We have 57.6% of the portfolio in defensive sectors. These include telecommunications, accommodation, utilities and renewables, which are viewed as defensive because they provide essential services, often operate within a regulated framework and have high barriers to entry.

·    Our telecommunications sector, which stands at 28.8% of the portfolio, continues to perform as previous PIK assets become cash-paying and the appetite for infrastructure such as data centres grows.

·    We have 57.2% of the portfolio in senior and 42.8% in mezzanine as opposed to more of a 50-50 blend to position the portfolio better for a slow-growth environment.

·    We have maintained the credit quality of the portfolio over the last 12 months while still achieving our target yield. We have continued our policy, instituted shortly after SEQI's launch in March 2015, not to invest in CCC profile names.

·    We have maintained a low modified duration¹ of 1.5 with 58.4% of the portfolio in floating rate deals and investing in short-term fixed rate assets, which currently have a low weighted-average life of 3.5 years.

The Fund's investment portfolio is diversified by borrower, jurisdiction, sector and sub-sector, with strict investment limits in place to ensure that this remains the case. The chart below shows portfolio sectors and sub-sectors on 31 March 2023:

The Fund has a clear focus on investing in stable and low-risk regions, which is in line with its investment criteria. As a result, it limits its investment activities to countries that meet certain standards, such as being classified as investment-grade. The Fund's investment philosophy is centred around identifying opportunities that offer attractive risk-adjusted returns while avoiding potential pitfalls, such as regulatory and legal risks. While the Fund is exploring potential investments in Spain, it has decided not to pursue investment opportunities in Portugal or Italy, as these markets are perceived to be more challenging due to a combination of economic, regulatory and legal risks. The Fund may revisit this opinion in the future.

The Fund's investment strategy is primarily focused on private debt, which is the largest asset class in its portfolio. This approach is driven by the fact that private debt typically offers an illiquidity premium, which means it yields higher returns than liquid bonds with similar characteristics. Since the Fund's main investment strategy is a "buy and hold" approach, it makes sense to capture this illiquidity premium. This is supported by Sequoia's research, which indicates that infrastructure private debt instruments typically yield about 1% more than public, rated bonds.

Despite its focus on private debt, the Fund also considers bonds as an attractive investment option in certain situations. For example, some bonds may be structured as "private placements", offering attractive yields that are comparable to loans. Additionally, some sectors, such as US transportation, primarily borrow through the bond markets, which means having an allocation to bonds can improve the diversification of the portfolio. Lastly, having some liquid assets in the portfolio enables the Fund to take advantage of future opportunities while avoiding the costs associated with holding cash.

NAV and Fund performance

The Fund takes a cautious approach to its investment activities, particularly when it comes to greenfield construction risk. While the Fund is willing to allocate up to 20% of its NAV to lending for such projects, its actual exposure to assets in construction¹ as at 31 March 2023 was 14.2% of its portfolio. The Fund selects projects carefully and only invests in those where it believes it is well-compensated for the moderate level of construction risk taken. Furthermore, the Fund has strict criteria when judging the underlying strength of the borrower's business or project to ensure that the potential risk is mitigated.

Over the financial year, the Company's NAV per share¹ decreased from 100.5p per share to 93.26p per share ex-dividend, driven by the following effects:

Factor	NAV effect
Interest income on the Fund's investments	10.61p
Gains on foreign exchange movements, net of the effect of hedging	0.19p
Negative market movements	(9.86)p
IFRS adjustment from mid-price at acquisition to bid price	(0.24)p
Operating costs	(1.71)p
Gains from buying back shares at a discount to NAV	0.18p
Gross decrease in NAV	(0.83)p
Less: Dividends paid during the year	(6.41)p
Net decrease in NAV after payments of dividends	(7.24)p

The total return on the NAV¹ was equal to -0.9% over the period. Whilst this is a disappointing outcome, it ought to be analysed in the context of the wider market. The portfolio has outperformed leveraged loans by 3.3%, high-yield bonds by 3.8%, the FTSE 250 by 7.2% and 10-year Gilts by 10.1%.

As it has been a volatile year for asset valuations, it would be sensible to compare the performance between the first and second half of the financial year. It is important to note that given the continuous increase in interest rates and credit spreads, the Investment Adviser is not expecting a complete reversal of negative movements in asset valuations but is more focused on a slowing trend and a stabilising portfolio.

To capture these characteristics, the portfolio has been split into two categories, namely cashflow-based valuations and recovery-based valuations.

Cashflow-based valuations

Cashflow-based asset valuations constitute investments whose cashflows are reasonably predictable and can therefore be analysed using a discounted cashflow model. Valuation decreases for assets that are marked via this methodology are predominantly driven by systematic inputs such as the previously mentioned increase in long-term rates and credit spreads. As these do not represent underlying underperformances of the assets, the Investment Adviser expects the majority of unrealised losses to be recovered as the investments reach maturity.

Of the 9.86p per share total loss due to market movements over the financial year, a valuation loss of 6.42p can be attributed to cash-flow based valuations. Further decomposing the negative movement, almost the entirety of this negative movement, 6.41p, was recognised in the first half of the year, while a minimal further loss of 0.01p has been recorded for the second half. The explanation for this substantial improvement is a stabilising of long-term interest rate forecasts towards the end of the year, which allowed credit spread tightening and the natural pull-to-par of the portfolio's asset to counter the loss of valuation due to risk-free rate adjustments. While a 6.42p loss in valuations for the full year remains, the Investment Advisor expects further price appreciation of these assets as they pull-to-par and eventually get repaid at their maturity.

Recovery-based valuations

Whilst cashflow models may still be used to value assets in this category, the Investment Adviser tracks their development more closely and uses additional valuation methodologies to assess idiosyncratic risks and eventual recoverability of these assets. This category therefore contains investments with an above-average degree of uncertainty on future price appreciation.

The remaining 3.44p loss in valuation of the total 9.86p decline due to market movements falls into this category. In the first half of the financial year, a loss of 2.18p was due to these investments, of which 1.47p was attributable to Bulb, Salt Lake Potash and Whittle Schools. An additional decline of 1.26p was recognised in the second half of the year, with a 0.35p loss due to the remaining non-performing loans. While this indicates that progress has been made on this category of assets, systemic factors such as long-term interest rates and credit spreads evidently play a lesser role in the valuation recovery than for cashflow‑based valuations. Therefore, the potential reversal of negative market movements for these investments may be slower and less predictable.

Given that the portfolio has outperformed the FTSE 250, leveraged loans and high-yield bonds, and supports evidence of future NAV appreciation, the Investment Adviser wishes to reiterate why such outperformance can be achieved:

·    resilience of infrastructure debt by leveraging the inherent defensive attributes of infrastructure assets and the strong asset backing typically associated with our loans;

·    mitigation of interest rate sensitivity through a significant proportion of floating rate debt in the portfolio (58%), resulting in a low level of sensitivity to changes in interest rates; and

·    enhanced portfolio diversification by investing across various sectors, sub-sectors and jurisdictions, thereby minimising the impact of country-specific political and economic risks.

Share performance

As at 31 March 2023, the Company had 1,734,819,553 Ordinary Shares in issue. The closing share price on that day was 80.4p per share, implying a market capitalisation for the Company of approximately £1.4 billion, compared to £1.8 billion a year previously.

After taking account of dividends paid during the year of 6.40625p, the share price total return over the period was -16.1%. This decline in the share price is driven by two factors:

·    the decline in NAV as discussed above; and

·    a decrease in the rating of the shares from a 2.3% premium¹ to a 13.8% discount¹.

The rating decrease of the Fund is due to negative market sentiment towards debt funds, which has also affected the majority of alternative income vehicles listed on the LSE. The concerns over inflation and increasing interest rates have contributed to this sentiment, which is further compounded by long-term economic prospects. Both the Investment Adviser and the Company's Directors consider the current share price discount as disproportionate. They believe that it does not reflect the investment portfolio's potential for generating attractive risk-adjusted returns during uncertain periods or its long-term prospects. With this conviction the Fund has been repurchasing Ordinary Shares, as it considers the shares to be undervalued, and such repurchases are accretive to our NAV.

Dividend cover

The Company has paid 6.40625p in dividends during the last 12 months in accordance with its target. It is worth noting any declared quarterly dividend is paid out to investors in the following quarter. Therefore, this financial year consisted of three annualised 6.25p per Ordinary Share dividends and one increased annualised 6.875p per Ordinary Share dividend. The fourth quarter dividend payment will be accounted for in the first quarter of the financial year 2023/24.

The level of dividend cash cover¹ has been increasing and has reached 1.21x for the financial year 2022/23, which is a significant improvement from 1.06x for the prior year. The increase is due to a combination of rising short-term rates, as reflected in the uplift in the yield-to-maturity¹ from 8.4% to 11.9%, and interest being received in cash that was previously capitalised, known as "PIK interest". The Investment Adviser expects further PIK interest to materialise as loans repay.

Fund performance

		31 March 2023	30 September 2022	31 March 2022
Net asset value	per Ordinary Share	93.26p	93.64p	100.50p
	£ million	1,617.9	1,634.9	1,777.0
Cash held (including in the Subsidiary)	£ million	68.7	38.2	94.1
Balance of RCF	£ million	181.8	193.0	121.4
Invested portfolio1	percentage of NAV	106.5%	116.0%	95.0%
Total portfolio1	including investments in settlement	109.6%	121.3%	101.5%

Portfolio characteristics¹

		31 March	30 September	31 March
		2023	2022	2022
Number of investments		68	72	76
Valuation of investments		1,723.5	1,924.5	1,804.5
ESG score		62.29	61.59	61.88
Single largest investment	£ million	61.0	64.3	64.7
	percentage of NAV	3.8%	3.9%	3.6%
Average investment size	£ million	25.3	25.0	23.7
Sectors	by number of invested assets	8	8	8
Sub-sectors		26	28	29
Jurisdictions		12	11	12
Private debt	percentage of invested assets	98.1%	96.3%	94.7%
Senior debt		57.2%	59.2%	53.6%
Floating rate		58.4%	56.9%	50.1%
Construction risk1		14.2%	12.3%	13.1%
Weighted-average maturity	years	4.1	4.6	5.2
Weighted-average life	years	3.5	3.9	4.1
Yield-to-maturity1		11.9%	11.2%	8.4%
Modified duration1		1.5	1.6	2.1

1.  Relates to the portfolio of investments held in the Subsidiary.

Credit performance

At an overall portfolio level, the credit performance over the year remained positive, except for the aviation sector which was still affected by the COVID-19 pandemic. However, higher energy prices, even when combined with volatility, had a positive impact on the power generation, renewable energy and midstream sectors.

The current inflationary environment could also prove beneficial to infrastructure assets, as businesses can increase their revenues by linking the cost of the product or service provided to inflation while maintaining a constant level of leverage. However, this is a double-edged sword that could hit borrowers by increasing their internal costs as well, leading to an unexpected increase in expenses. In particular, investments exposed to construction risk are particularly affected, as projected budgets might be overrun. Continued monitoring of such exposed assets to ensure debt serviceability is maintained is an essential part of analysing the portfolio's credit performance.

In the Company's 2022 Annual Report, we highlighted three investments that were facing significant credit issues, namely a private school in Washington DC, a UK energy supply business, and a potash project in Australia. We have since exited most of the potash project, with only a small residual facility remaining, and the profit share on the project has been valued at nil. The non-performing loans incurred a net cost of 1.82p per Ordinary Share during the period, the majority of which can be attributed to the potash facility. The status of the two remaining non‑performing loans is as follows:

1. US private school

A loan secured on a large building in a prime area in Washington D.C., originally occupied by a private school under a long-term lease agreement. Mostly as a consequence of the COVID-19 pandemic, enrolments at the school declined to the point where it could not cover its operating costs, which ultimately led to its insolvency. The loan was amended and extended in May 2022 to allow the borrower to deliver on its business plan after the COVID-19 pandemic but the school failed to recover and was then formally evicted from the property on 19 October 2022. The owner of the property continues to market it to other potential tenants, predominantly in the education sector, with an encouraging early response from a number of educational and governmental entities. However, the commercial real-estate market continues to suffer globally as a result of reduced demand, remote work, economic uncertainty, and shifts in consumer behaviour. All these factors have contributed to a valuation decline during the year. As at 31 March 2023, the value of this loan is 2.2% of the portfolio.

2. UK energy supply company

The Investment Adviser has made substantial progress on recovering value from the Fund's loan to Bulb Energy, a UK energy supply company. During the year, the Company became the majority shareholder, through a partial debt‑for‑equity swap, of Zoa, a newly formed business set up to market Bulb's best-in-class software to energy supply companies in the UK and elsewhere. The Fund still maintains a claim on the assets of Bulb and its parent Simple Energy and has recovered c.£14 million in cash since Bulb went into administration. The combined value of the Fund's shares in Zoa and its loan to Bulb is 1.1% of the portfolio.

Net leverage

The net debt of the Fund has increased from £27.3 million to £113.1 million as a result of an increase in drawings on the Company's revolving credit facility from £121.4 million to £181.8 million and a decrease in cash holdings from £94.1 million to £68.7 million. This increase in net leverage is mainly due to the volatility and devaluation of Sterling currency experienced over the financial year. As Sterling lost value, the Fund's non-Sterling assets gained value in Sterling terms. However, the Fund remains currency-hedged, and hence the value of its hedging book falls by roughly the same amount. Eventually, as the Fund's currency hedges approach their maturity dates, the Fund needs to settle them by paying cash, a factor which caused the increase in net leverage during the year.

The Company has repaid a portion of the revolving credit facility with the capital repayments it has received, resulting in additional capacity to manage future volatility in exchange rates, while simultaneously reducing cash drag on non‑invested capital.

Portfolio valuation

Currently, the average loan in the portfolio is marked at a price of about 88 pence in the pound; this mostly reflects the higher interest rates and credit margins used to value the loan, compared to those available in the market at the time the loan was made.

Over time, as these loans approach their repayment dates, their valuations will accrete back up to 100 pence in the pound - this is the so-called "pull-to-par" effect.

These NAV estimates are calculated on the basis that interest rates and bond yields remain constant and does not take into account NAV-accretive mechanisms other than the pull-to-par; the only variable is the passage of time. Non-performing loans are excluded from the calculation.

In monetary terms, the pull to par is expected to be material:

	Pull to par	Pull to par
Period	(£m)	(pence per share)
1 April 2023 to 31 March 2024	38.4	2.2
1 April 2024 to 31 March 2025	28.0	1.6
1 April 2025 to 31 March 2026	16.3	0.9
1 April 2026 onwards	37.6	2.2

Origination activities

The investment strategy of the Fund involves investing in both primary and secondary debt markets. This approach offers several advantages: investing in the primary market enables the Fund to earn upfront lending fees and customise its investments to align with its requirements, while purchasing assets in the secondary market facilitates the swift deployment of capital into seasoned assets with demonstrable performance.

Primary market origination

The Fund continues with its focus on the primary loan markets, which remain an important opportunity. The Investment Adviser has been able to source bilateral loans and participate in "club" deals, where a small group of lenders join together. Additionally, the Fund has participated in more widely syndicated infrastructure loans.

Primary market loans are appealing since they often come with favourable economics. As the lender, the Fund benefits from upfront lending fees and improved term negotiability. With the growth of the Fund, its primary market investment activity has increased and has now surpassed secondary market investments. As at 31 March 2023, 87.5% of the portfolio consists of primary investments.

Secondary market origination

Although the Company has been focusing on primary market investments, it continues to acquire some of its investments from banks or other lenders in the secondary markets. This has allowed not only for faster deployment of capital, as primary market transactions in infrastructure debt can often take a considerable amount of time to execute, but also provides the Fund with more liquid assets, providing optionality when times require more cash at hand.

Furthermore, secondary market loans have a performance history that allows for credit analysis based on actual results rather than financial forecasts. Research indicates that infrastructure loans tend to improve in credit quality over time, so in many cases, secondary loans have improved in credit quality from the time of their initial origination.

Strengthening the team at Sequoia Investment Management Company

Within the past year, the Investment Adviser has expanded its team by hiring two new team members.

Matt Dimond, who has joined as Head of Client Capital, will be working with investors, evaluating strategies, and has expertise in real asset investments. Matt previously held senior roles at InfraRed Capital Partners and Swiss Life.

Leah Dean joined as a new Associate and will focus on ESG matters. Leah has previously worked as a Language and Behaviour Analyst at AKO Capital before starting her role at the Investment Adviser. The Fund is committed to sustainable investing and is dedicated to complying with regulatory requirements while engaging with borrowers on ESG topics. With Leah's addition to the team, the Fund will be better equipped to stay up to date with the constantly evolving ESG landscape, assess the current portfolio for possible enhancements, and offer assistance to investors with any enquiries they may have.

Strong pipeline of opportunities

While the Investment Adviser has been largely focusing on monitoring existing positions, it is also seeing a wide range of attractive potential investments which are being considered. With weak high yield bond and leveraged loan markets coinciding with the current risk aversion dominating bank lending, borrowers are more willing to accept the additional pricing power enjoyed by alternative debt providers. As such, improved terms can be negotiated than those typically available in times of abundant bank lending, which feeds through to favourable conditions for investors such as higher interest rates, fees, covenants and collateral provision.

Our strategy is to take advantage of these attractive lending conditions while adhering to our previously mentioned late cycle strategies, which in the current market provides us with higher yields for the same quality of assets compared to last year or similar yields with improved asset quality. As the Investment Manager is satisfied with the current yield composition of the portfolio, the focus has been primarily on improved asset quality. Preference is therefore given to assets with the following characteristics:

·    senior debt, as opposed to mezzanine or holdco lending, which provides additional security over collaterals;

·    defensive sectors, or borrowers with a high degree of contractual or predictable income, as opposed to businesses exposed to the economic cycle;

·    assets that will maintain or improve portfolio diversification;

·    operational projects, as opposed to construction projects, as these have improved visibility over cash flows; and

·    BB or better implied credit quality.

With this selective approach to new investments and limited funds, we are turning down over 90% of the lending opportunities we come across. Nonetheless, our portfolio provides security for the volatile markets ahead as we continue to prioritise quality, diversity and cash generation.

Sequoia Investment Management Company Limited

Investment Adviser

28 June 2023

STATEMENT OF COMPREHENSIVE INCOME

For the year ended 31 March 2023         

		Year ended	Year ended
		31 March 2023	31 March 2022
		£	£
Revenue
Net gains/(losses) on non-derivative financial assets at fair value through profit or loss		26,891,111	(27,520,112)
Net losses on derivative financial assets at fair value
through profit or loss		(96,628,102)	(39,932,471)
Investment income		80,814,469	151,920,575
Net foreign exchange losses		(1,513,107)	(1,023,582)
Total revenue		9,564,371	83,444,410
Expenses
Investment Adviser fees		11,989,220	11,836,201
Investment Manager fees		369,422	349,634
Directors' fees and expenses		366,699	305,202
Administration fees		440,937	453,630
Auditor's fees		201,990	188,598
Legal and professional fees1		2,973,313	1,327,377
Valuation fees		741,000	821,400
Custodian fees		255,108	255,221
Listing, regulatory and statutory fees		143,257	168,318
Other expenses		497,307	497,617
Total operating expenses		17,978,253	16,203,198
Loan finance costs		9,534,772	4,522,522
Total expenses		27,513,025	20,725,720
Profit and total comprehensive (loss)/income for the year		(17,948,654)	62,718,690
Basic and diluted (loss)/earnings per Ordinary Share		(1.02)p	3.55p

1.  Legal and professional fees includes an amount of £2,218,093 (2022: £666,019) in respect of fees relating to the Fund's investment in Bulb Energy.

All items in the above statement are from continuing operations.

STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

For the year ended 31 March 2023

		Share capital	Retained losses	Total
Year ended 31 March 2023		£	£	£
At 1 April 2022		1,837,390,531	(60,347,699)	1,777,042,832
Ordinary Shares buy-backs during the year		(28,768,020)	-	(28,768,020)
Total comprehensive loss for the year		-	(17,948,654)	(17,948,654)
Dividends paid during the year		-	(112,472,856)	(112,472,856)
At 31 March 2023		1,808,622,511	(190,769,209)	1,617,853,302

		Share capital	Retained (losses)/earnings	Total
Year ended 31 March 2022		£	£	£
At 1 April 2021		1,831,856,145	(12,725,764)	1,819,130,381
Issue of Ordinary Shares during the year, net of issue costs		5,534,386	-	5,534,386
Total comprehensive income for the year		-	62,718,690	62,718,690
Dividends paid during the year		-	(110,340,625)	(110,340,625)
At 31 March 2022		1,837,390,531	(60,347,699)	1,777,042,832

STATEMENT OF FINANCIAL POSITION

At 31 March 2023

		31 March 2023	31 March 2022
		£	£
Non-current assets
Non-derivative financial assets at fair value through profit or loss		1,704,493,932	1,770,022,999
Current assets
Cash and cash equivalents		7,363,120	8,759,040
Trade and other receivables		100,122,134	143,092,101
Derivative financial assets at fair value through profit or loss		23,254,199	17,536,684
Total current assets		130,739,453	169,387,825
Total assets		1,835,233,385	1,939,410,824
Current liabilities
Trade and other payables		4,530,899	3,855,430
Derivative financial liabilities at fair value through profit or loss		31,060,322	37,143,642
Total current liabilities		35,591,221	40,999,072
Non-current liabilities
Loan payable		181,788,862	121,368,920
Total liabilities		217,380,083	162,367,992
Net assets		1,617,853,302	1,777,042,832
Equity
Share capital		1,808,622,511	1,837,390,531
Retained losses		(190,769,209)	(60,347,699)
Total equity		1,617,853,302	1,777,042,832
Number of Ordinary Shares		1,734,819,553	1,768,238,998
Net asset value per Ordinary Share		93.26p	100.50p

The Financial Statements were approved and authorised for issue by the Board of Directors on

28 June 2023 and signed on its behalf by:

Sarika Patel

Director

STATEMENT OF CASH FLOWS

For the year ended 31 March 2023

		31 March 2023	31 March 2022
		£	£
Cash flows from operating activities
(Loss)/profit for the year		(17,948,654)	62,718,690
Adjusted for:
Net (gains)/losses on non-derivative financial assets at fair value through profit or loss		(26,891,111)	27,520,112
Net losses on derivative financial assets at fair value through profit or loss		96,628,102	39,932,471
VFN capitalised interest		-	(7,309,761)
Investment Adviser fees settled through issue of Ordinary Shares		-	878,100
Net foreign exchange losses		1,513,107	1,023,582
Loan finance costs		9,534,772	4,522,522
Decrease/(increase) in trade and other receivables (excluding prepaid finance costs)		42,063,321	(33,004,700)
Increase in trade and other payables (excluding accrued finance costs and Ordinary Share buy-backs)		67,578	45,287
		104,967,115	96,326,303
Cash received on settled forward contracts		16,174,078	43,775,627
Cash paid on settled forward contracts		(124,603,014)	(16,124,456)
Purchases of investments		(302,102,305)	(399,588,003)
Sales of investments		394,522,483	339,810,204
Net cash inflow from operating activities		88,958,357	64,199,675
Cash flows from financing activities
Proceeds from loan drawdowns		138,712,919	36,023,268
Loan repayments		(80,000,000)	-
Payment of loan finance costs		(9,058,791)	(5,772,304)
Ordinary Share buy-backs1		(27,770,733)	-
Dividends paid (excluding scrip dividends) 1		(112,472,856)	(105,684,339)
Net cash outflow from financing activities		(90,589,461)	(75,433,375)
Net decrease in cash and cash equivalents		(1,631,104)	(11,233,700)
Cash and cash equivalents at beginning of year		8,759,040	20,018,189
Effect of foreign exchange rate changes on cash and cash equivalents during the year		235,184	(25,449)
Cash and cash equivalents at end of year		7,363,120	8,759,040

1.  Excludes non-cash transactions.

 

END