Trade Summary | February 2019

Trade Summary

Core Summary:

  • PCI to 14% from 18%

  • PDI to 9% from 10%

  • ARDC to 7% from 6%

  • AIF to 7% from 5%

Mini Core Summary:

  • PCI reduced to 13% from 16%

  • PDI reduced to 9% from 10%

  • DBL reduced to 5% from 7%

  • AIF increased to 8% from 7%

  • ARDC increased to 9% from 7%

Rationale:

We are taking advantage of the closing discounts to re-align some positions in the most beaten down areas based on our premise that there would be a snap back in January as tax loss selling abated. And again, given the FOMC meeting last Wednesday, we think CEF discounts are likely to tighten beyond the 52-week average levels. That should be supportive of pricing trends for at least the next few months.

We reduced our exposure to PCI and PDI in the month by taking off the addition made to PCI during the market swoon. PCI was reduced to 14%, from 18% while PDI was reduced by 1% to 9%. The value that these funds once traded is no longer there and the funds are back to their rich valuations that we saw towards the end of the summer.

So why not reduce to zero? Because there is nothing like these funds in terms of long-term holds. In addition, the funds continue to provide that long-term income stream much needed by most of us. We will re-add once the funds see another unwarranted sell-off.

We also still believe ARDC is one of the best values in the market. We increased the allocation again to take advantage of the discount convergence opportunity in addition to a juicy yield.

Apollo was one of our top funds (below) for the month. We continue to like the NAV movement and think the discount could close a few points in the next few months, especially if high yield spreads come in further and floating rate prices rise back towards par.

On DBL for the Mini Core, the fund has recovered three-quarters of the pricing lost after they cut the distributions. At a 1.6% discount, the fund no longer is a screaming buy (and is much closer to a sell). The 52-week average premium is +2% so we think there's may a point or two more to go but that's it.

In general, we try to keep overall trading to a minimum but do like to tweak the allocations based on valuations and underlying sector exposure. The Flexible Portfolio is likely to see more trading opportunities (buying and selling) and will be more of a focus for some of our members.

Top "Quality" Funds

(1) Western Asset High Yield Def Opp (HYI): This fund self-liquidates in September 2025 given the limited term structure. It invests primarily in high yield bonds but does have some emerging market debt, bank loans, and investment grade corporates. The portfolio is 17.5% CCC and some of the top holdings are communications firms like Altice SA which bears some watching. The effective duration is 4.1 years. There is no leverage in the fund. The yield is 7.71% but coverage is ~107% and UNII trending up from the current -8.2 cents. At that coverage ratio, the true yield is 8.25%. With the fund self-liquidating in 6.5 years, you are getting nearly 2% of kicker to your yield for a total return just north of 10%. Despite the credit quality, we think this is compelling even compared to equities. Additionally, I do not think we will have to wait until 2025 to see that discount close. It is likely that within the next two years, the discount will tighten significantly as we have noted that the sweet spot for these term trusts are around 2-4 years out.

(2) Apollo Tactical Income (AIF): This 8.95% yielding fund is currently earning 104% of the distribution, has positive UNII of 9 cents, and has both of those trending higher for a trifecta of what to look for. Again, the fund deals in lower quality debt of mostly health care and financial services companies. The discount is near 13% compared to a one-year average of 11.3% and longer-term average near 10%. The fund is levered by 33% and does have relatively high expenses, which can account for some of the discount.

(3) PIMCO Corporate & Income Strategy (PCN): This PIMCO CEF is yielding 8.72% and trades at a ~9% premium to NAV. While we typically do not recommend a fund that trades at a premium to NAV, PIMCO is often different in this regard. The fund has coverage of 106.7% and UNII of 13 cents through the end of December. Most importantly, the fund is trading well below the one-year average premium offering up some total return opportunity. We think the premium could rise as much as 5-7 points. Non-agency MBS makes up nearly 20% of the fund and ABS makes up another 18%.

Top Convergence Trade Opportunities

These are funds that have solid total return opportunities that could be realized shorter-term.

(1) Blackrock Floating Rate Strategy (FRA): This may be a new name to some but the fund has been around awhile. A relatively lower-risk floating rate fund, the shares yield just 6.20%. That is on the lower end of the category but the fund is earning nearly 110% of the distribution. NII yield is actually over 6.8% making it a little more competitive. In addition, the discount convergence opportunity is over 5 point creating a compelling total return opportunity. It is possible that they increase the distribution on the fund given the fundamentals in which case that 5 points of discount opportunity could be captured quickly.

(2) Highland Floating Rate Opp (HRFO): This was in our top funds list last month and it has moved up nicely (from $12.96 to $13.92, plus a distribution). However, we do think there is some juice left in the move with the discount at 3.5%. Our target is a 1% premium, leaving 4.5 points of juice left to squeeze. The yield on the fund 6.65% through a managed distribution policy. Last month, the z-score reached an abismal -4.10 that is typically indicative of a large distribution cut. But there was none in the case of HFRO. The fund returned over 10% in a month.

(3) Blackrock Floating Rate Income (BGT): Similar to FRA above, this lower yielding fund is greatly outearning the distribution. In addition, UNII is nicely positive and the discount very wide compared to average levels. This is another total return opportunity as we think we could see 3-4 points of discount tightening perhaps driven by a higher distribution. This fund already raised back in July from $0.618 from $0.0583 (an increase 6%). The one-year discount is just -1.30.

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