Weekly Commentary | April 14, 2019

Week In Review

Equity indices are now within spitting distance of new highs after another modest weekly increase.  The S&P 500 rose 50 bps and is now 1.1% away from all-time highs established in September of last year.  YTD, the S&P 500 is now up 15.98% with the Nasdaq up 20.33%.  Small caps are up 17.52%.

The 10-year treasury rose about 5 bps ending the week at 2.55% on signs of a stabilizing economy.  Oil continues to climb and is now at $64 a barrel amid supply disruption in Libya.  Lastly, the all important VIX indicator fell further to 12.5 from 13 a week ago.  The VIX is signaling an all-clear on the equity markets and for CEF discounts.  

Earnings season has started (typically with the banks) which had better-than-expected reports to power the indices.  Walt Disney was also a strong performer after they unveiled their streaming service.  Still, analysts polled by Reuters are thinking that overall S&P 500 earnings declined slghtly in the first quarter compared to last year- a sharp deceleration from the 20% overall growth in 2018.

Not much other news on the week to report.  US inflation remained soft with the core CPI released Wednesday falling short of expectations.  Fed officials reiterated their doubts about hitting the 2% target.  The next big Fed event comes in early June in Chicago at the Federal Reserve conference.  The ECB also met and had a more dovish tone following the U.S. move last month.  

What's left for equities this year?

The best case scenario would be for earnings estimates to stop falling and perhaps start inching higher by a few dollars towards $185 (where it was a few months ago).   They are at roughly $180 now.  Global growth would need to re-accelerate higher which some market pundits like Guggenheim's Minerd are calling for.  This could push the index multiple up above 16x and perhaps as high as 17x.  At 17x $185 the index would be at 3,145, compared to 2,907 today, for another 8.1% upside.  Again, that is best case scenario.

The more likely scenario would be stagnant EPS around $180-$181 and a 16x -16.5x multiple which puts us at 2,898- 2,986 or 0%-2.7% growth. 

The bear case scenario, which we went through (and then some) in the fourth quarter would be a significant slowdown in global growth with several overhangs (trade, Fed policy error potential, etc).  Clearly that would equate to a negative move in the markets.  

Below is JPMs assessment....

JPM US equity macro outlook – the week ended on an upbeat note w/a slew of pos. headlines Fri morning (strong Chinese exports and money supply, better JPM earnings, a well-received DIS streaming analyst meeting, and a big $50B oil merger) but none of the developments change the bigger picture of EPS and PE constraints creating an SPX ceiling around ~2900. The earnings data points over the last several days were mixed and while the cycle of estimate cuts could abate exiting the CQ1 season, the 2020 consensus is unlikely to recoup all the recent lost ground (i.e. it should stay around $180-181). The PE is a bigger wildcard – if the Fed were to take aggressive action aimed at bolstering inflation (while global growth continues to inflect higher) that could add at least one additional turn to the multiple but for now 16x seems generous (and 16x on a ~$180 EPS number puts the SPX right at where it stands now and as a result the risk/reward just isn’t compelling at the moment).  

Closed-End Fund Analysis

Distribution Increase

Neuberger Berman High Yield Strategies (NHS):  Monthly distribution increased by 37.5% to $0.0905 from $0.0658.

Distribution Decrease

Aberdeen Asia-Pacific Income (FAX):  Monthly distribution decreased by 21.4% to $0.0275 from $0.0350.

Activist Buying/Selling

BSL:  BofA now owns 10.2% of the fund's shares, a 29.5% increase

HNW:  Karpus has been buying this one up like crazy.  Now owns 16.9%, a 131% increase.  

SRV/FMN:  First Trust is buying both of these funds owning 10.6% and 10.4% of each respective fund.  

PCF:  Karpus sold out of this fund.  

Rights Offering

NexPoint Strategic Opp (NHF):  The company announced a non-transferrable rights offering to purchase additional shares of stock in the fund.

  • The Fund is issuing non-transferable rights ("Rights") to its common shareholders of record as of April 29, 2019 (the "Record Date" and such shareholders, "Record Date Shareholders"). Record Date Shareholders will receive one Right for each common share held on the Record Date. The Rights will entitle the Record Date Shareholders to purchase one new share of common stock for every three Rights held (1 for 3). The Rights will be mailed to Record Date Shareholders approximately two business days after the Record Date.                                                        

    1. The subscription price per common share will be determined based upon a formula equal to the lesser of (1) 95% of the reported net asset value on May 22, 2019 (the "Expiration Date"), or (2) 95% of the average of the last reported sales price of the Fund's common shares on the New York Stock Exchange ("NYSE") on the Expiration Date and on each of the four trading days preceding the Expiration Date.

Change of Investment Strategy

High Income Securities (PCF):  Formerly a Putnam fund, this now orphaned fund is changing its investment strategy.  They recently completed a self-tender offer, the board is also taking steps to cease being a registered investment company (NYSEMKT:RIC).  A committee of the Board will be exploring potential acquisitions of controlling stakes in operating companies and other investments that are not securities. Among other factors, the results of that exercise will assist the Board in determining whether the Fund should cease to be a RIC.

  • Substantially all of the Fund’s assets of approximately $52 million are currently invested in money market mutual funds. During this transitional period, the Board has determined that the Fund should continue to be internally managed and, within the parameters of its existing investment policies and restrictions, invest in securities that are likely to generate more income. It is expected that the primary focus of the Transitional Investment Strategy will be to acquire discounted shares of income-oriented closed-end investment companies and business development companies. A Transitional Investment Committee of the Board comprised of Phillip Goldstein, Andrew Dakos, and Rajeev Das will be responsible for implementing the Transitional Investment Strategy.

  • The Fund paid its last regular monthly dividend on August 1, 2018. The Board anticipates that the Fund will re-commence paying a monthly dividend in an amount to be determined in the near future.

Commentary

Some big news on the week in a few positions that need to be covered.  First, as stated above, NexPoint Credit Strategies (NHF) is conducting a fairly large, dilutive, and non-transferrable rights offering.  The additional shares is an amount up to 25% plus an oversubscription allotment that could add another 7-8% to that figure.  In other words, the fund is going to be one-third larger after this rights offering is completed.  

This is one of those offerings where if you do not participate, you will be diluted by roughly one-third.  In addition, since its non-transferable, you cannot sell your rights to another.  

The last two rights offerings in May 2017 and May 2018 had very similar effects.  The discount went from 6-7.5% to the mid-teens.  In 2018, the discount expanded from 7.8% to 16% and from 7% to 13% in 2017.  

2018:

2017:

The price action on Friday was a bit curious as the shares finished down about 1%.  The shares started Friday at a 9.7% discount so it wouldn't surprise us to see the shares trade down to a mid-teens discount again (-12% to -15%).  

Action:  The Flexible Income portfolio has a smallish 2.4% position in NHF that I'll likely blow out tomorrow and see if I can rebuy in a few days/weeks.  The nadir of the price (widest discount) is likely to be in early-to-mid May.  

Neuberger Berman High Yield (NHS) announced its latest effort to stave off the activists from swirling around its funds.  Their defense was the same that Nuveen Credit Strategies (NYSE:JQC) and Putnam Premier Trust (PPT)took; raise the distribution significantly so that some investors pile in not knowing a large portion of the payment is your own money coming back to you.  

The distribution was increased by 38% to $0.0905 from $0.0658 starting with the next payment in May (ex-div is May 14th).  The new yield is 9.32% per share as of the market price on April 10th. 

The announcement has the rationale:  

The distribution rate increase announced today is an effort to enhance the Fund's competitiveness in the secondary market and increase demand for the Fund's common stock in the secondary market, in order to narrow the discount between the market price of the Fund's common stock and its net asset value per share. The Fund's Board has determined that -- like many other closed-end funds -- it is in the best interests of the Fund and its current stockholders to pay a higher distribution rate, even if that distribution represents a combination of net investment income, capital gains and return of capital.

Saba owns a large stake in the fund as well as Morgan Stanley.  It remains to be seen if this will placate them but my guess is, if the price runs a bit more, it will.  

Action:  In summary, I was close to pulling the sell trigger on this one prior to the announcement and am even more interested in doing so now.  This is a 3.2% position in the Flexible Portfolio.  It may not occur tomorrow or even this week but I am going to be watching this one closely.  A discount in the 7s would be a good target.  

Guggenheim Taxable Muni (GBAB) is one we've debated over a bit.  In terms of the concerns surrounding the call wall that is approaching, we have some time.  However, valuations continue to increase and are now at all-time highs.  

Remember, this is a Build America Bond fund which was an outcropping of the stimulus program following the financial crisis.  Given that these bonds have not been issued for awhile, it has been diversifying into other fixed income sectors.  In addition, as they bonds approach their 10-year anniversary (which makes them callable), the fund has had to shift the focus a bit.  

The call wall refers to the large amount of Build America Bond holdings in the portfolio.  These were issued in and around 2010 and most have 10-year call triggers.  Those calls are coming but in the next twelve months, as per the website, only 6.8% are eligible to be called.  Of course, from month 12-24, fully one-third of the portfolio is callable.  

Compared to the other two BAB funds (BBN and NBB), GBAB has a larger call problem.  It's probably safe to say that Nuveen sold some of its callable BAB positions to pay for their recent tender offer.  

The call wall refers to the large amount of Build America Bond holdings in the portfolio.  These were issued in and around 2010 and most have 10-year call triggers.  Those calls are coming but in the next twelve months, as per the website, only 6.8% are eligible to be called.  Of course, from month 12-24, fully one-third of the portfolio is callable.  

Compared to the other two BAB funds (BBN and NBB), GBAB has a larger call problem.  It's probably safe to say that Nuveen sold some of its callable BAB positions to pay for their recent tender offer.  

With approximately 40% of the portfolio likely to turn over in the next two years, the distribution has a high probability to be cut.  Again, not in the next twelve months but perhaps as early as Q1 2020.  

Here is NBB:

BBN:

Guggenheim is a semi-annual issuer so we would have to rely on the monthly distribution announcements for clues as to how the fund is handling the situation.  For example, below is the March announcement.  After the distribution per share figure, they have a footnote "1" that indicates some of the payment is ROC.  All Guggenheim funds EXCEPT GBAB have ROC in the distribution.

We think investors who are concerned about the valuation could sell earlier but long-time buy-and-holders have many more distributions to go before we are concerned the distribution may be cut.  Guggenheim tends to let ROC creep in for awhile before they actually cut.  

The chart below shows the move that the price has made in the last 6 months, going from a ~10% discount to a ~5% premium.  That is a sharp move for a fund that invests in boring taxable muni bonds.  

Action:  For now, we are holding but should the valuation increase much more, we may look for alternative places to allocate that capital.  For those that are total return investors, you may want to think about rotating out and into a more opportunistic trade.  

-----------------

Other news:

I did swap a little of my BGX position into sister fund BGB.  Not a huge potential there but I did improve my yield a little.  A report will be released early next week on floating rate and high yield.  Some early finding indicate some value in NSL and JFR.  Stay tuned..

———————-