trade summary

Trade Summary | May 2019

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Core and Mini Core Trade Summary:

  • Swap Blackstone/GSO L/S Credit (BGX) with Blackstone/GSO Strategic Opps (BGB) at 8% target weight in both the Core and Mini Core Portfolios.

Top Quality Funds

  • Blackstone/GSO Strategic Credit (BGB)

  • Nuveen Floating Rate Income (JFR)

  • JH Investors (JHI)

Top Convergence Trade Opportunities

  • Cohen & Steers Global Income Builder (INB)

  • Nuveen Floating Rate Opportunity (JRO)

  • ClearBridge Energy MLP Opps (EMO)

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Obviously, the portfolio is tilted towards high yield bonds and leveraged loans. That is the goal for the time being. Just yesterday, AllianceBernstein had a great piece talking about how high yield can help de-risk a portfolio. I know that sounds counter-intuitive but remember it has to do with from where the capital invested in high yield is derived. If it comes from munis or cash, then you just increased your risk fairly substantially. If it comes from your equities, then you did just de-risk a significant amount.

First, high yield bonds provide investors with a consistent income stream that few other assets can match. This income - distributed semiannually as coupon payments - is constant. It gets paid in bull markets and bear markets alike. It's the main reason high yield investors have historically looked at starting yield as a remarkably reliable indicator of future returns over the next five years - no matter how volatile the environment. After accounting for maturities, tenders and callable bonds, the high yield market typically returns anywhere from 18% to 22% of its value every year in cash.

Along with these payments, high yield bonds also have a known terminal value that investors can count on. As long as the issuer doesn't go bankrupt, investors get their money back when the bond matures. All this helps to offset stocks' higher level of volatility - and provide better downside protection in bear markets.

While spreads are down to 373 bps, down significantly from the levels at the start of the year, the risk-return trade off compared to stocks still makes high yield a decent place to allocate capital. The question is, how much?

We think we will be heavy into both bonds and even greater into loans for the next six months. While markets have recovered from the late 2018 lows, we don't think it is time to "go to cash" or significantly shift the target asset allocation. Reducing some risk is certainly a valid move but we would still avoid making drastic changes.

The Core is likely to be a coupon clipping portfolio for the next several months as valuations are high. Though we can expect some bouts of volatility allowing us better times to buy some funds.

In the last month, we haven't bought too much outside of the muni space. The most attractive opportunities today are:

  • Blackstone/GSO Strategic Opps (BGB)

  • JH Investors (JHI)

  • Putnam Premier Income (PPT)

  • Nuveen Floating Rate (JFR)

  • EV Senior Floating Rate (EFR)

Trades Summary

Core Portfolio:

  • Swap Blackstone/GSO L/S Credit (BGX) with Blackstone/GSO Strategic Opps (BGB) at 8% target weight.

Other More Tactical Trades To Consider:

Consider selling or swapping:

  • Guggenheim Taxable Muni Bond (GBAB): The valuation for GBAB is high, though the risk from calls is not likely to start significantly effecting the fund until early next year. This fund is about collecting safer taxable muni income so making a tactical trade is not recommended. Another option is BBN which has performed a bit better on NAV, although it's not much cheaper in terms of valuation.

  • Apollo Senior Floating Rate (AFT): Consider swapping from AFT to AIF which has a superior yield and cheaper valuation. AIF made a surprising very small distribution cut for April going from $0.107 from $0.104. AIF has 9.2 cents of UNII plus has coverage of 106%, which is why the cut was a bit of a surprise. Very small difference in holdings but they are both mostly loans with a small allocation to high yield.

JH Investors (JHI): For newer members that are waiting for better entry points into some of the Core funds, this is an optional substitute that you may want to hold until those opportunities open up. This is a decent BTZ/BIT looking fund with a multisector bent. The yield is a bit lower but it does have less junk compared to some other funds. It's about 25% investment grade/ 75% high-yield. NAV is rising nicely and there's a decent chance that on June 1, the QUARTERLY distribution is increased really bumping the price.

Mini Core:

  • Swap Blackstone/GSO L/S Credit (BGXwith Blackstone/GSO Strategic Opps (BGB) at 8% target weight.

Rationale:

The Blackstone/GSO sister funds are very similar floating rate funds from a solid sponsor. The main difference is that BGB is about 3X larger than BGX which means BGX typically trades more 'violently' than BGB. It is likely that BGX reverts back to the same discount levels of BGB, which seems more appropriate than where it trades today. Of course, there's a smaller but still decent chance BGB moves up in valuation towards that of BGX.

BGX:

BGB:

Top "Quality" Funds

These are funds with coverage ratios in excess of 98%, UNII that we deem to be strong or improving, and a z-score below -1.

(1) Blackstone/GSO Strategic Credit (BGB): The fund is a term trust that is slated to liquidate in 2027. While that 8 years is a long way away from today that we do not think a convergence trade will materialize based on it, the fund is undervalued. The current yield is 9.25% and the NII yield is actually 9.95%.

(2) Nuveen Floating Rate Income (JFR): This is one of many floating rate funds we could have selected. This may be more than a one month play but we think the opportunity here is high. The fund is trading at a -12.4% discount to NAV and pays a 7.52% current distribution yield. Coverage is right at 100% and UNII is at zero. The one-year z-score is -1.00 which is one of the few funds that have a z-score that low.

(3) JH Investors (JHI): Keeping this one on the list as we do not see anything more compelling. The next distribution will be announced about June 1. I would really like to see them institute a monthly distribution system which would likely close the valuation nicely. The fund is a lot like BTZ with a straddling of lower quality investment grade and high quality non-investment grade corporate debt. The portfolio managers have the flexibility of investing across the full spectrum of bonds going where they think there is the most value. Performance last year was not great but the fund is rebounding nicely thanks to falling spreads and solid positioning. We think the discount could close by at least two points but even if it doesn't, there is a solid NAV trend. Some of the drawbacks include a quarterly and variable payout and a relatively low yield.

Top Convergence Trade Opportunities

These are funds that have solid total return opportunities that could be realized shorter-term. The current list to select from is one of the smallest of the last couple of years which should tell you about the valuations of the CEF universe today.

(1) Cohen & Steers Global Income Builder (INB): This fund has been performing well though the price hasn't been rising as fast as the NAV. This is creating a widening gap between the two with a nearly -11% discount compared to a -8.5% average. The one-year z-scores are around -1.00 which is cheap but not crazy cheap illustrating the valuations in today's market.

(2) Nuveen Floating Rate Opportunity (JRO): Like JFR above, this fund is trading wide though doesn't quite have enough coverage to reach the "quality" list. The discount is -12.3% and the yield 7.7%. The recent price action is negative but the NAV has been trending higher nicely on the back of a strong risk market (high yield and equities). If floaters start seeing positive flows again, look for JRO to trade better than a -10% discount.

(3) ClearBridge Energy MLP Opps (EMO): One of the rare times you'll see an MLP operator on either of these lists. The 9.60% yielding MLP fund has most of the top "quality" MLP names in its top ten holdings list. The fund is now trading at a -12.2% discount which is near the 52-week lows of 13.3%. The one-year z-score is -1.40. The wider discount is due to the distribution cut to the latest quarterly payment. However, the fund is still paying $0.23 per quarter which places it near the middle of the pack for MLP funds in terms of distribution yield. And of course, given the rebound in oil we've experienced recently, it is likely that NAVs will rise and the cut to the distribution could reverse. Still, our bet is that investors bid up the price some.

Reviewing Top 'Quality' Funds from last month

Last month, our top quality picks were:

  1. JH Investors (JHI)

  2. Ares Dynamic Credit Allocation (ARDC)

  3. Blackrock 2022 Global Income (BGIO)

Reviewing Top Convergence Opportunities from last month

These are funds that look very cheap but may not have the fundamentals for us to hold it long-term.

Our picks from last month were:

  1. RiverNorth/DoubleLine Strategic (OPP)

  2. EV Tax-Managed Global (EXG)

  3. Neuberger Berman Real Estate (NRO)