The opportunities in closed-end funds over the last few months caught the eye of many investors. Most of these products are designed to provide a steady stream of income, usually on a monthly or quarterly basis, as opposed to the biannual payments provided by individual bonds. And this feature continues to attract market participants even when the overall market looks unstable.
In spite of CEFs being mostly of interest to income investors, we have found our path to approach them as active traders and we are constantly monitoring them. As a testament to this, you will be kept up to date with Weekly Reviews such as the one below.
Definitely one of the best weeks for the sector for the past two months. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) increased its price by $0.89 to finish the week at $83.60 per share. The high-yield closed-end funds are still pretty close to their lowest levels for the year and they will have a long way to go before trading in the price range which was observed until the month of September. Of course, the performance of the stock market will have a key role in that task as the sectors are correlated and can be highly affected by the credit risk mood of the market participants.
Source: Barchart, iBoxx $ High Yield Corp Bond iShares
Statistical Comparison And Spread Review Of The Sector
High-yield bonds are typically evaluated on the difference between their yield and the yield on the US Treasury bond. High-yield spreads are used by investors and market analysts to evaluate the overall credit markets. Higher spreads indicate a higher default risk in junk bonds and can be a reflection of the overall corporate economy and/or a broader weakening of macroeconomic conditions.
On a weekly basis, we have a slight increase of 0.01 bps, but still the current levels remain one of the lowest for the past decade.
Source: YCharts, US High Yield Master II Option-Adjusted Spread
Below, you can find a statistical comparison between the iShares iBoxx $ High Yield Corporate Bond ETF and the iShares 20+ Year Treasury Bond ETF (TLT). As discussed, we observe a low correlation between the two sectors. It is only 0.04 points for the last 200-day period:
Source: Author’s software
On the other hand, we have a statistical comparison between the iShares iBoxx $ High Yield Corporate Bond ETF and SPDR S&P 500 ETF (SPY). Definitely, a strong relationship between them.
Source: Author’s software
Source: Yahoo News, High Yield Closed-End Funds News
Several funds from the sector announced their regular dividends:
- AllianceBernstein Global High Income Fund (AWF) $0.0699 per share of investment income.
- Prudential Short Duration High Yield Fund (ISD) $0.0850 per share.
- Prudential Global Short Duration High Yield Fund, Inc (GHY) $0.0825 per share.
- Invesco High Income Trust II (VLT) $0.0964 per share.
- Neuberger Berman High Yield Strategies Fund (NHS) $0.0658 per share.
- MFS Intermediate High Income Fund (CIF) $0.0202 per share.
Review Of High-Yield CEFs
Weekly % Changes In The Sector
1. Lowest Z-Score:
The first criterion that I am going to use is a statistical one. The Z-score indicator shows us how many times the discount/premium deviates from its mean for a specific period. By the value of the Z-score, we can figure out whether the fund is overpriced or undervalued. If we take into an account the sharp incline of the prices in the sector, I do expect to see some reflection on the Z-score of the funds.
Indeed, most of the participants of the ranking increased the value of their statistical metric. Only, Credit Suisse Asset Management Income Fund (CIK) continues to lead the table with pretty low Z-score of -4.20 points and could be categorized as an outlier of the observed sample. The price of the fund decreased by 1.38% on a weekly basis, while its net asset value went up by 0.30%. So, expect pretty soon to see a buying impulse in the price of the fund because I do not find a fundamental reason to be “Short” here.
2. Highest Z-Score:
On the other hand, I have plotted the funds which pretend to be statistically overpriced. When the value of the Z-score is between 0 and 1.00 point, we do not find a statistical reason to short the closed-end funds. Furthermore, we would like to have candidates traded at a premium to review them as potential “Short” trades.
The average Z-score of the high yield CEFs is -1.54 points. A week ago, the average Z-score was -1.78 points. The chart below only proves that we observe a very frequent change in the mood of the market over the past month.
3. Biggest Discount:
The next criterion, which I consider important, is the spread between the net asset value and the price. The prices in the sector are close to their lowest levels for the year, and most of the funds are trading at a discount. The period reveals many opportunities for additions to our portfolios, and along with the passing of the credit panic, I expect to see many of the funds to increase their prices and to narrow the spread with the net asset value.
A fund which caught my eye with its performance is Neuberger Berman High Yield Strategies Fund. A long time it was the most discounted fund in the sector. Currently, NHS is taking the fourth position after a 1.73% increase in its price on a weekly basis.
Source: Barchart, Neuberger Berman High Yield Strategies Fund
The average discount/premium of the high yield CEFs is –11.31%. Last week, the average spread between prices and net asset values was -11.53%.
4. Highest Premium:
Currently, we do not have funds traded at a premium, which satisfy our requirements. The Barings Participation Investors (MPV) looks like the only possible choice, but be aware of its relatively low average daily volume, which bears a risk. As we discussed, I do expect some recovery in the prices of the funds in the next several months, and I am currently focused on finding potential “Buys” rather than potential “Sell” candidates.
Here is the full picture of the funds from the sector. Below, we have depicted their discount/premium and their Z-score:
5. Highest 5-year Annualized Return On NAV:
The average return for the past five years is 4.81% for the sector. The above chart also helps us to compare the current yields to the historical ones. Most of the funds provide us with much higher current yields and the reason behind that fact could be easily explained by the sharp declines in their prices over the past year.
The Wells Fargo Advantage Income Opportunities Fund (EAD) is one of the funds which outperformed their peers in the past by yield on net asset value. Currently, it is trading at Z-score of -1.90 points and pretty high relative discount. Therefore, I think it can be reviewed as potential “Long” candidate.
6. Highest Distribution Rate:
Currently, the funds offer pretty attractive yields. Three funds from the sector have yield more than 10.00%. The average yield on price for the sector is 8.60%, and the average yield on net asset value is 7.61%. The difference between the two values can be easily explained by the spread between the price and the net asset values of the funds.
As we see, EAD has one of the highest yields in the sector. One more reason to analyze it as a potential addition to your portfolio.
7. Lowest Effective Leverage:
We have two funds which are not leveraged and three which use a leverage below 10%. The average leverage for the sector is 26.50%. Below, you can see the relationship between the effective leverage of the funds and their yield on net asset value.
Statistical Comparison And Potential Trades
As we saw, there is one fund which could be categorized as an outlier based on its one year Z-score value. I am talking about the Credit Suisse Asset Management Income Fund. Yes, the fund provides us with a statistical edge to review it, but also has one of the highest returns on price in the sector. For a second consequent week, its net asset value refuses to fall while its price decreases its value. Keep in mind that you can buy this fund on relatively cheap price of only $2.86 per share. Following the logic, even $0.03 decrease in the price will be a change of 1.04% in percentage value.
The closed-end fund is traded at a discount of 13.86%. The below chart shows that the fund is currently undervalued based on its discount if we compare to its peers.
Its leverage is 29.93%. The effective leverage used by CIK is just slightly higher than the average value for the sector, and I do not think is something to worry about.
Below is the short review of the fund’s investment approach:
- Seeks current income consistent with the preservation of capital by investing primarily in fixed-income securities.
- Under normal circumstances, the Fund will invest at least 75% of its total assets in fixed-income securities, such as bonds, debentures, and preferred stock.
- Most of the portfolio invested in U.S. high yield corporate debt, with some exposure to sovereign or corporate debt of developing nations.
We do have a yield on the price of 9.44% and a yield on the net asset value of 8.13%. The current distribution is $0.0225, and it was increased in July.
Let us take a look at the portfolio quality. The main distribution is between “BB” and “B” ratings. Only 1.5% of the assets are labeled as investment grade, which should not surprise us at all for a fund from this sector. The more important fact here is that only 2.00% of the investments are not rated.
Moving to the asset allocation of the portfolio we see that 64.4% are invested in corporate bonds 15.2% in senior loans.
Source: Fund Sponsor Website
Below you can find the statistical comparison between the iShares iBoxx $ High Yield Corporate Bond ETF and Credit Suisse Asset Management Income Fund. The price correlation of 0.64 points for the last 400 days is relatively strong, and as you see, the prices are traded at four standard deviations. In case you need a hedging reaction, you can use the benchmark directly.
CIK data by YCharts
Source: Author’s software
The high-yield sector does not provide us with significant arbitrage opportunities at present. Most of the CEFs are traded at discounts, and it is difficult to find reasonable “Short” candidates. If we see a break of the support or the resistance of the current trading range, we expect significant changes in the funds’ statistical characteristics.
Based on the data that I have reviewed, CIK can be a potential addition to your portfolio.
Note: This article was originally published on Dec. 02, 2018, and as such some figures and charts might not be entirely up to date.
Trade With Beta
At Trade With Beta we also pay close attention to closed-end funds and are always keeping an eye on them for directional and arbitrage opportunities created by market price deviations. As you can guess, timing is crucial in these kinds of trades; therefore, you are welcome to join us for early access and the discussions accompanying these kinds of trades.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CIK over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.