Our research revolves around the topics of identifying attractive income investments that balance risk and reward, portfolio allocation and construction topics, deep dives into individual funds and securities, sector and fund family e.g. PIMCO updates, new IPOs and other key topics for income investors.
The full text of our articles resides on our home at SeekingAlpha. Below are extracts from some of our articles.
Portfolio Allocation / Construction
Alternatives To Cash When Cash Pays Nothing
With the Federal Reserve pushing short-term rates to near zero in their bid to prop up markets and the broader economy, high-quality “cash-like” investments have seen dramatic drops in yields. While 3-month T-Bills were trading around 2.5% yield in mid 2019, they are currently yielding just 0.10% – a drop of 96%. In this article we take a look at a number of options to risk-free short-term investments at investor disposal. These options are not risk-free but they also do not require sizable risk outlays.
Investors who want to maintain a degree of safety without completely forgoing income can take measured risk across a number of dimensions such as corporate and securitized credit risk, short-duration muni risk, equity tail risk or low-volatility NAV risk in term CEFs. Our own approach across the Income Portfolios has been to hold both low-volatility term CEFs as well as CEF preferreds, with yields of 2-4% while offering a greater degree of safety and dry powder, which may turn out particularly useful as we head into year-end.
We highlight a few securities with yields well above short-term risk-free rates that have an attractive risk profile:
- AAF First Priority CLO Bond ETF (AAA)
- Invesco BulletShares 2025 Municipal Bond ETF (BSMP)
- The JPMorgan Ultra-Short Income ETF (JPST)
- Gabelli Dividend & Income Trust, 5.375% Series H (GDV.PH)
- Nuveen Corporate Income November 2021 Target Term Fund (JHB)
A November Volatility Income Gameplan
Many investors are growing increasingly nervous about, not just the outcome of the coming election, but the likelihood that the results are contested, leading to an extended period of uncertainty about the final winner. In this article we take a look at the components of a plan that can allow investors, not only to survive a period of extended volatility, but also to be able to profit from it by allowing them to rebalance from more resilient holdings into more aggressive securities through the drawdown. We also highlight the following funds that are either held in our income portfolios now or are on our radar.
As the former Treasury Secretary Tim Geithner observed “plan beats no plan” and so investors ought to think about positioning their portfolio in a way that allows them not just to survive a period of additional volatility but also to profit from it. A portfolio with a number of securities that are less fragile to macro shocks, that feature more robust investment wrappers, that invest in higher-quality sectors and that are more attractively valued should put investors in a strong position to profit from a potential dislocation and grow both their capital as well as income levels.
- BrandywineGLOBAL Global Opportunities Fund (BWG)
- BlackRock MuniVest Fund (MVF)
- AllianzGI Convertible & Income Fund (NCV)
- Angel Oak Multi-Strategy Income Fund (ANGLX)
- Nuveen High Yield Municipal Bond Fund (NHMAX)
What Goes In Our CEF Checklist
Professional poker players focus much more on following a rigorous process rather than taking their cues from individual outcomes. As the former professional poker player Annie Duke says, “If we get our focus on process then, over the long run, the outcomes are going to come”. In this regard investing and poker are very similar. One way to formalize a rigorous investment process for income investors is to adopt an investment checklist.
In this article we discuss some of the things that go into our own CEF checklist. This, of course, does not mean that they make sense for everyone but we have found these steps to clarify our thinking, increase conviction that avoids the typical behavioral errors and ensures that the overall portfolio remains aligned with our broader goals. Something as simple as having a checklist for managing a CEF portfolio can provide a number of benefits such as avoiding impulsive allocations, controlling portfolio risk and aligning the allocation to the broader portfolio goals. While no checklist is perfect, its ultimate goal is to ensure that the investor does the necessary due diligence to minimize portfolio construction errors that can result in longer-term underperformance.
Some of they key questions we ask are:
- Do CEFs Historically Outperform ETFs In This Sector?
- Are CEFs Appropriate For This Sector?
- Are You Sufficiently Diversified In The Sector?
- What Is The Impact Of Short-Term Rates On The Fund?
- Have We Considered All Other Options In This Sector?
- How Is Distribution Coverage Changing?
Don’t Overlook These Resilient Income Sectors
The recovery period across markets after the drawdown earlier in the year has hit its six-month anniversary. Investors who taken advantage of the bounce-back may be looking to preserve their gains and tilt their portfolio toward more robust assets. In this article we take a look at some niche income sectors that may be overlooked by investors but that have been able to maintain their value through time while offering yields of around 7% or more.
The increased volatility in the income space over the last week illustrates the attraction of having more robust and resilient securities in the portfolio. Though sharp drawdowns are difficult, if not impossible, to eliminate entirely even in the very high-quality assets, it is still possible to build the portfolio around securities that have been able to maintain their value through time. These securities not only support portfolio wealth through time but also give investors additional opportunities to reallocate into attractively priced assets.
We also highlight a number of securities we like in these sectors:
- Armour Residential 7% Series C (ARR.PC)
- Oxford Square Capital Corp. 6.5% 2024 Notes (NASDAQ:OXSQL)
- Eagle Point Credit 6.6875% 2028 Notes (ECCX)
Full-Spectrum Credit Investing
Income investors face a wide variety of investment options, each featuring many different characteristics. This panoply can make it difficult to construct a portfolio with a desired profile. In this article we take a look at the key investment characteristics of credit funds, their interaction and overall impact on portfolio performance as well as how investors can go about constructing portfolios with attractive profiles – their ultimate goal. We use the corporate credit sector as a case study, particularly the high-yield subset which is particularly rich in different types of securities and fund options.
In our own Income Portfolios we try to combine funds with the right set of characteristics which not only drives income and total returns, but also allows for diversification and portfolio resilience over the longer term. It is often tempting to populate an income portfolio with the highest-yielding options, however, doing so can often result in permanent capital and income loss. It can also reduce the potential to take advantage of attractive opportunities during drawdown periods leading to lower total wealth.
Our key takeaway is that it is important to know the role each security plays in the portfolio, whether it is yield, drawdown control, total return, etc. This is because no single investment can perform best along all the relevant roles. The role each security plays in the portfolio is determined largely by its characteristics, such as credit quality, investment wrapper, duration and others. We discuss the link between these characteristics and how they can translate into overall portfolio performance.
We also highlight a number of funds that look attractive to us and that we hold in our portfolios, including:
- Invesco BulletShares 2023 High Yield Corporate Bond ETF (BSJN)
- Vanguard Long-Term Corporate Bond ETF (VCLT)
- Western Asset High Yield Defined Opportunity Fund (HYI)
- Eagle Point Credit Company 6.75% 2027 Notes (ECCY)
Being Long-Term Greedy Pays Off For Income Investors
Financial markets have continued to rally after the March drawdown. With income asset yields falling seemingly every day it is tempting for investors to respond to this trend by reaching for yield and taking on more risk to sustain or boost their income levels. In this article we take a look at the value of maintaining a portion of an income portfolio devoted to more defensive assets. Doing so may feel like a sacrifice of both income and total returns, however, this does not have to be the case. Because volatility is a persistent feature of markets and the fact that income assets, particularly CEF prices and discounts, tend mean-revert, having the ability to rebalance from more to less defensive assets during periods of volatility can lead to outperformance in the longer-term with respect to both income and total returns. This is precisely why we maintain varying allocation levels to defensive assets across all of our model income portfolios.
Maintaining some part of income portfolios in more defensive assets makes sense for a whole host of reasons. First, it mitigates the likelihood of permanent capital and income loss. Secondly, it helps with behavioral implications of sharp drawdowns. And thirdly, perhaps most importantly, it can result in portfolios boasting higher income levels than more aggressive portfolios by allowing investors to rebalance into higher-yielding assets during volatile periods.
In our view, building up a defensive portion of the portfolio is more important now than it has been over the last few months as yields continue to compress and CEF discounts continue to tighten. An all-in bet on a very higher-yielding CEF portfolio is an implicit bet that nothing will go wrong over the next few years. And though markets are impossible to predict, one of the few consistent and predictable features are periodic sharp drawdowns. The only question for income investors is whether they will be able to take advantage of them or not.
Preferreds / Baby Bonds Commentary
Upgrading Yield Without Adding Credit Risk In Preferreds
With strong capital gains much less likely from here on after five months of a strong market recovery investors have to look elsewhere to generate alpha or enhance yields of their portfolios. One strategy that can still add alpha in this market is to rotate into newly issued preferreds of those issuers that investors may already hold in their portfolios. And while newly issued preferred may have different coupons, call dates and reset terms their credit risk is identical to the existing series of the same issuer. This means that investors can often pick up decent yield without taking on additional credit risk. An added bonus is that investors usually get longer call protection to go along with it.
Using this strategy we have recently upgraded our Public Storage preferred holding by rotating from Public Storage 4.625% Series L (PSA.PL) into Public Storage 4.125% Series M (PSA.PM) in our Defensive Income Portfolio and adding nearly 1% of yield-to-call in the process. It is important to stress that there is no perfect yield metric that will accurately forecast the actual return of a given preferred since the timing of the issuer call is highly uncertain. That said, Public Storage is a serial refinancer that doesn’t like to leave money on the table which makes us more comfortable that in this case the yield-to-call metric is the one to use.
A Focus On High Reset-Yield Preferreds
A few weeks ago we warned investors about allocating to preferred stocks with low reset yields caused by the collapse of short-term rates. Since then a number of fixed-to-float stocks have come to the market with very attractive reset yields which provide asymmetric risk/reward in our view.
With interest rates so close to zero and great uncertainty around the path of inflation in the medium term high reset-yield preferreds are offering an attractive opportunity for investors to diversify their inflation risk profile and take advantage of low interest rates. Interest rates moving below zero does remain a risk however the likelihood of sharply negative rates appears low at this stage. The Fed also appears committed to avoiding pushing rates below zero.
Higher reset-yield stocks should appeal to investors who think that interest rates are likely to be higher 5 years from now or investors who think that credit spreads are likely to remain elevated over that time frame. In either case these stocks should outperform.
How To Get CEF Yields Without CEF Problems
As the market enters its sixth month of recovery with valuations moving ever higher CEF investors may be thinking of ways how to bulletproof their portfolio in case the market hits another speed bump. Because CEFs tend to boast some of the highest yields across the investment space, many investors tend to allocate primarily or exclusively to these products. However, this misses out on the advantages that other investment products have over CEFs that do not necessarily require significant yield sacrifice. In this article we discuss some of the advantages of senior securities such as preferred stocks and baby bonds over closed-end funds.
Income investors should seriously consider allocations to senior securities such as preferred stocks and baby bonds in addition to their CEF holdings. Senior securities can boast attractive yields without some of the less attractive aspects of CEFs such as frequent distribution cuts, huge dradowns driven by discount widening, forced deleveraging and high fees. Preferred stocks and baby bonds can serve as a more stable capital base that not only delivers high levels of income but also provides a more stable source of capital than CEFs to take advantage of fast-moving opportunities and generate higher longer-term income levels and total returns.
We also highlight a number of senior securities such as:
- Highland Income Fund 5.375% Series A (HFRO.PA)
- Eagle Point Credit Co 6.75% Notes (ECCY)
- Prospect Capital Corp 6.25% Notes (PBY)
Fund Market Topics
Preparing For Distribution Changes For CEFs With MDPs
Because closed-end funds are prized for their high distribution rates, income investors put a lot of weight on changes in fund distributions in their allocation decisions. A number of funds have, what is called a managed distribution policy or MDP, under which distributions are not directly linked to underlying income or realized capital gains. A smaller subset of funds have a policy that ties its distributions directly or indirectly to the fund’s net asset value and which allows investors to anticipate changes in distributions. This can give them a leg up in a market that is not always very efficient.
In this article, we walk through a number of fund sponsors with such policies. Overall, we find the Wells Fargo Multi-Sector Income Fund (ERC) and the Utilities and High Income Fund (ERH) attractive here. The funds should be able to raise their distributions in Q2 of next year, absent another sharp drawdown or a change in the MDP. The funds are also currently trading at attractive discount valuations, we suspect, due to distribution cuts that were a result of NAV drops earlier in the year.
We would also avoid the RiverNorth/DoubleLine Strategic Oppotunity Fund (OPP) and RiverNorth Opportunities Fund (RIV) tactically into year-end as their distributions are likely to shift significantly lower, assuming their distribution approach remains the same and asset prices remain broadly at current levels or move lower.
Generating Alpha With CEF Tender Offers
With yield compression running apace many investors are turning to alpha generation strategies to keep returns of their portfolios at healthy levels without having to take on additional risk. In a previous article we covered some of these strategies. In this article we discuss CEF tender offers, in particular, we look at a case study using the recently completed transaction for the BrandywineGLOBAL – Global Income Opportunities Fund (BWG).
Our main takeaway is that tender offers can generate alpha for investors in two ways. First, tender offers have in the recent past generated about 1% in PL over the two-week period covering the expiration of the tender offer. And secondly, a tender offer can generate alpha even without having to participate in the offer by providing a measure of discount control for the given fund since the tender offer will tend to anchor the discount at a certain level based on the specific characteristics of the individual offer.
That said, because tender offers can feature very different characteristics, investors have to approach them on an individual basis. Specifically, they should have a plan for dealing with the sell-down of the residual shares, which can be difficult for less liquid and high-beta funds, especially when the share acceptance rate is low.
A Look At Dividend Capture In CEFs
The strong capital gains over the last few months in the CEF market are unlikely to be repeated. This means that to generate alpha income investors will need to rely more on alpha generation strategies. One such popular strategy is dividend capture. There are two reasons why the CEF population may be potentially attractive for dividend capture strategies. First, the CEF market is relatively inefficient in large part owing to its small size which means it does not attract a lot of smart institutional money. And secondly, the CEF population looks like an attractive target because of the tendency to pay larger dividends and do so monthly.
A dividend capture strategy sounds promising for the CEF market which boasts securities with both high distribution rates and high frequency of distribution payments. However, we find that in aggregate the naive strategy of buying and selling funds around the ex-dividend dates does not appear to work. That said, there is some evidence that selling opportunistically prior to the close on the ex-dividend date as well as focusing on certain funds rather than the overall population may lead to excess returns. Finally, we also find evidence that dividend strategies are being pursued in the CEF market, particularly in the higher-yielding funds. Because discounts tend to widen on and after ex-dividend dates across the higher-yielding fund population investors looking to time their entry into these funds should focus on these dates.
The Role Of Swaps In PIMCO CEF Earnings
Taxable PIMCO CEFs remain one of the best-performing and hence best-regarded funds in the world of income investing. There are many drivers behind the stellar track record: elevated leverage, exotic holdings, the use of auction-rate preferreds, at-the-market offerings and others. In this article we take a look at one of the less well understood drivers of this outperformance – interest rate swaps.
Swaps are a significant and volatile contributor to income of PIMCO taxable CEFs. As of the last filing, swaps contributed about 1% of additional yield to PFN. And they are also a volatile contributor because over the last year this contribution ranged from 0.6% to 1.7% in yield terms relative to current net assets. This is due to PIMCO’s penchant of tweaking the swaps portfolio.
Investors who pay attention to monthly changes in coverage and UNII have to take them with a grain of salt since they don’t provide the full picture of what happens inside the funds. Since PIMCO can move current income to future income via a change in swap market value, a drop in current income and UNII is not necessarily an indicator of lower earning capacity going forward.
Reasons To Remain Constructive On CEFs
Many income portfolios have taken a substantial hit in March due to the macro-economic impacts of the COVID crisis. This has caused some investors to sit out the sharp bounce-back in asset prices and hunker down. While we expect near-term volatility to persist due to the extreme uncertainty about the path of the crisis we think there are reasons to dip into the CEF market. Our main takeaway is that if we do see another drawdown in the near-term it is likely to be less painful that what we experienced in March due to a number of mitigating factors that we go through in this article.
While we expect volatility to persist for the remainder of the year the CEF market boasts a number of mitigants that should limit the extent of the next drawdown. Improved underlying asset as well as discount valuations, a distribution cut wave that is largely past, few available income alternatives and the Fed standing ready to help markets should continue to support CEFs.
Individual Fund / Security Commentary
NCV: Attractive Entry Point For This High-Yielding Multi-Sector CEF
Income investors are always on the lookout for higher-yielding investment options. In this article we take a look at one such option – the AllianzGI Convertible & Income Fund (NCV). The fund has a number of attractive features and this is why we have recently added it to our Core and High Income Portfolios.
First, the fund features a robust borrowing profile due to its reliance primarily on preferred stock. Unlike bank-facing leverage instruments, preferred stock do not force a fund to deleverage in order to maintain a certain asset coverage ratio. Though this raises the fund’s overall cost of borrowing relative to funds that rely primarily on repo or credit facilities by about 0.5-0.75%, in our view this is more than compensated by a stronger profile. The fund has been able to maintain the same level of borrowing through and out of the drawdown, unlike many other higher-leveraged CEFs.
Secondly, the fund has a more growth-oriented allocation than a typical income CEF due to its 1/3 allocation to convertible bonds. This is fairly attractive in the current macro environment due to both low interest rates which favors growth over value assets and benefits sub-sectors that can continue to perform well in a pandemic.
Thirdly, the fund is trading at an attractive discount valuation relative to its own history, its sister CEF and the broader sector. In the sections below we take a look at the fund in more detail.
RMM: A Note Of Caution For This CEF Of Muni CEFs
With yields grinding lower and volatility increasing in the CEF market, income investors may be looking to bulletproof their portfolios while retaining a capacity to generate attractive yields – two factors that are typically mutually exclusive. The RiverNorth Managed Duration Municipal Income Fund (RMM) appears to square the circle – boasting the highest current yield in the sector while allocating almost entirely to investment-grade municipal bonds. In this article we take a look at the fund, its unusual structure and investment strategy.
Our main takeaway is that the fund fails in both its income and total return strategies. The combination of low underlying yields, high management and leverage costs result in a sub-1% income yield. And the fund’s duration hedge, fragile leverage structure, high leverage and CEF holdings are likely to dampen its total return potential as they have over the fund’s short lifetime so far. The article also touches on some of the ways we look at municipal CEFs which will hopefully be interesting even for those investors who choose to steer clear of RMM.
EDI: Fewer Headwinds For This High-Yielding EM Fund
The pair of Stone Harbor Emerging Market debt CEFs have been for many years the poster-children of exactly the types of funds to avoid. For years, they were trading at hefty premiums while heavily overdistributing. This year they finally went through what we call the CEF three-step: a deleveraging followed by a distribution cut and premium collapse. With the funds now on more solid ground we opened a small position in the EM Total Income Fund (EDI) earlier this month in our High Income Portfolio.
EDI is an EM debt CEF, focusing primarily on high-yield sovereign EM external debt with pockets of EM corporate and local sovereign debt. The fund closed Monday at a 12.36% current yield and a 3.2% discount. In this article we discuss the headwinds that made the fund uninvestable for years, why the fund looks more attractive now and the risks that the fund continues to face.
OCCIP: A Dozen Tailwinds
Collateralized loan obligation CEFs have taken a beating in this last drawdown, however, the preferred shares of these funds have remained much more resilient. Over the last few weeks we have touched on this sector and described some of the structural mitigants that have supported prices. In this article we turn our attention to the OFS Credit Company 6.875% 2024 Series A Preferred (OCCIP) – the only series issued by the OFS Credit Company (OCCI). The stock closed Tuesday at a 9.28% yield-to-maturity.
Our takeaway is that the preferred has a number of tailwinds and attractive features such as the fund’s payment-in-kind distribution profile, substantial cash hold, good asset coverage and others. Investors do have to be mindful, however, that the current recession has mostly been pushed forward because of strong fiscal and monetary support and the corporate loan sector could see additional volatility ahead.
PHK: A More Defensive PIMCO Option
The PIMCO High Income Fund (PHK) is easy to dismiss – it has a history of cutting distributions, its NAV has lagged other funds out of the drawdown and its recent distribution coverage trend is poor. It is also true that the fund is unlikely to outperform if we see an extension of the current rally due to its modest leverage. However, at this stage of the market recovery it offers a compelling option chiefly for its more defensive stance within the PIMCO taxable suite. This characteristic of the fund is due to its low premium, modest leverage, low expense drag and the recent right-sizing of its distribution. This is why we have added the fund to our High Income Portfolio where our focus is as much on risk control as on yield.
After a steep run-up in the price and premium of PKO – a fund that we continue to like but one that has gotten quite a bit more expensive – we think PHK is worth a look. PHK is not a fund that is going to deliver outsized NAV gains if we see an extention of the current rally. But it is a fund that is positioned somewhat more defensively. This is due to its low premium, modest leverage, low expense drag and the recent right-sizing of its distribution. This is why we have added the fund to our High Income Portfolio where our focus is as much on risk control as on yield.