Update from the Trustees

Hi everyone,

As of NAV on October 19, Kraft High Yield is down 9.9% and Kraft Corporate Bonds are down 12.6% from their peak on August 26. We estimate that the NAV as of October 20 will fall by approximately 1.8% and 1.7%, primarily due to residential real estate in Berlin. This is the issue driving the funds’ performance right now, so this update focuses on what has happened, what various scenarios might mean for the bonds we hold, and how we assess the situation.

1. What has happened?

The Left Party, the Greens, and the SPD in Berlin have recommended moving forward with formal coalition negotiations. One of the points is to transfer housing from large landlords to public ownership. The issue is not new (it has been on the table since the 2021 referendum), but now there are concrete—albeit watered-down—terms:

• This applies only to companies with more than 10,000 apartments in Berlin, and each is allowed to keep the first 10,000. A total of about 150,000 apartments.
• Total compensation is capped at 16 billion euros, provided that it is financially feasible for the state.
• Homes built after 2021 and housing cooperatives are exempt. Traditional expropriation is excluded.

2. Factors that may affect whether and how the proposal is implemented

• Timeline: A bill will be introduced no earlier than 2028. The Left Party will not vote on entering negotiations until October 31, and the SPD’s top candidate has previously rejected expropriation.
• The federal government is opposed: In July, the governing coalition decided to enact a federal law that would make this impossible at the state level. Chancellor Merz has reiterated this, stating that property rights “are not something to experiment with.”
• Legal Proceedings: Vonovia believes the proposal is unconstitutional. In our view, a compensation cap significantly below market value could become a key legal issue, and any legal proceedings could be protracted.
• Funding: Berlin already has about 70 billion euros in debt. 16 billion in compensation is a lot for a state that needs to tighten its belt.

Grand City, Aroundtown, and CPI are not included : Grand City is below the threshold, and Aroundtown’s and CPI’s Berlin properties consist of offices, hotels, and commercial spaces. The companies named are Vonovia (about 128,000 apartments), Heimstaden (about 10,000 of 20,000 in Berlin), Adler (about 7,300), and Covivio (about 7,000).

4. Stress scenario: What could the Berlin proposal mean for the bonds we own?

Heimstaden Bostad. Approximately 10,000 apartments are affected, representing 7.5–8% of the property value. With compensation capped (around 100,000 euros per apartment), the loss relative to book value would be around 1.0–1.7 billion euros, or 4–6% of the property value. The loan-to-value ratio (currently 47.9%) would increase by no more than 1–2 percentage points, and the funds would not be disbursed until after 2028 in any case.

Heimstaden AB, in which we hold bonds. Heimstaden AB’s ownership stake in Bostad is valued at approximately 49.5 billion SEK, compared with approximately 16 billion SEK in bond debt. The assets thus cover the debt approximately three times over (32% loan-to-value ratio). If we assume that the proposal becomes law:

• With the Berlin proposal and full compensation: coverage of approximately 2.75 times (36% loan-to-value ratio).
• In an extreme case with absolutely no compensation—which is highly unlikely—the coverage would be about 2.5 times (40% loan-to-value ratio).

Even in the worst-case scenario, our claim is exceptionally well covered by assets. Berlin will not change what we receive in return for these bonds. Nevertheless, the EUR-denominated bond fell from 89 to around 75 in a single day, against a claim of around 120 per 100 of face value (face value plus deferred coupons). In our assessment, the magnitude of the price decline is disproportionate to the isolated economic impact of the Berlin proposal, as we calculate it.

Adler is a small position, accounting for about 0.3–0.4% of NAV. Even a total loss would cost less than 0.4 percentage points.

5. Why Prices Have Fallen So Much

• The decline was concentrated in a few bonds with low trading volume. We have checked with brokers and banks in Norway and the United Kingdom, and there were no sellers anywhere near the quoted prices. The trades we are seeing are small in size.
• Vonovia, which is by far the most affected with around 128,000 apartments, fell only 2.6% on the stock market, and its bonds showed little movement. If the market were pricing in a real loss in value, the largest owner of the affected properties would have seen the biggest decline, not least of all.
• Our view is that price movements in Heimstaden bonds may be significantly influenced by positioning and low liquidity in the bonds, and do not necessarily reflect a corresponding decline in fundamental value. If market turmoil subsides, this could also have a positive impact on pricing. However, it is uncertain how and when this might happen.

6. Contributions since the top

• Real estate is the largest contributor, at about −4 percentage points as of October 19 and about −5.5 based on Heimstaden’s stock prices as of October 20.
• The main component in the Communications sector is Virgin Media (−2.7 / −3.4). The telecommunications component in the Kraft Corporate Bonds is TalkTalk (−2.5), which is the only realized loss.
• Interest income has been a positive contributor throughout, at +1.2 in Kraft High Yield and +1.4 in Kraft Corporate Bonds.

7. Our Perspective

The timing is very unfortunate. There is a lot of negative news right now, and the market reactions are sharp. These developments have not led to any significant change in our fundamental assessment of the companies we own. With the exception of TalkTalk, the price movements are in companies that pay interest. At the same time, the scenario analysis above indicates that, viewed in isolation, the described Berlin scenario does not cause the calculated value coverage behind the Heimstaden AB bonds to fall below the debt.

The funds currently have an effective interest rate of approximately 12.5% (Kraft High Yield) and 14% (Kraft Corporate Bonds) in NOK. We believe current pricing offers an attractive balance between expected return and risk. The recent market turmoil has not led to any significant change in our fundamental assessment of the credit risk in the portfolio. At the same time, investors must be prepared for continued fluctuations in market value.