The Pacholder High Yield Fund (NYSEMKT:PHF) is a diversified portfolio of high-yield debt securities of US companies. The closed-end fund wrapper gives the investor some unique advantages including the permanency of the capital base along with the ability to leverage. This fund does use leverage to the tune of 32%, right in that sweet spot around 30%. Total common assets are approximately $98.5 million and total net assets are $141.5 million.
This fund has been around a long time and is now sponsored by JPMorgan (NYSE:JPM). We think this lends itself to being a target by activists who typically look for orphan funds from larger sponsors who generate a meaningless amount of revenue from the product. The fund is a marginal performer generating returns mostly in line with the benchmark (CSFB Domestic High Yield Index) on a NAV-basis.
The shares are trading at a 7.3% discount to NAV which is below the one-year average of 12.7% but close to the 3-year average of 8.1%. So while the discount may appear tight by one-year standards, it is not when looking at more long-term time frames. The total yield is close to the median average of the peer group at 8.5% with an "adjusted forecasted total return" (our proprietary adjusted yield) at 10.1%, slightly above the median average of the group.
Risk Of The Fund
Over the last three years, the price of the fund has risen by 5.3% annualized, but the NAV has increased by 10.8% annually showing the weakness in "price" from 2013-2015. Our contention and first criteria in these activist-driven special situation investing ideas is to be comfortable with the underlying while it plays out. PHF is an average high-yield fund with fairly low risk for a high-yield fund.
The credit quality of the fund is in the B and BB area, with very little (13%) triple C-rated debt. Many of the higher-yielding (and thus more attractive to the unsophisticated CEF investor) closed-end funds are loaded with CCC-rated debt exposing the investor to equity-like returns. The fund also has little exposure to the energy markets, which is the largest segment of high-yield debt. 21% of the fund is in the consumer discretionary sector and 12% in healthcare. Lastly, their maturity breakdown is fairly short with 35.4% of the maturities within four years and 91.6% within nine years.
Overall, we think the underlying assets are safe to hold if one needs exposure to high-yield debt. (In this primer, we are not assessing the attractiveness of high-yield as an asset class, just this particular idea within the area.)
On June 8th, Bulldog Investors LLC disclosed in a new 13D filing with the SEC that it held 1.52 million shares or 11.67% of the outstanding. They accumulated the shares over the course of the April-June period including a massive 687,500 shares on June 6th alone (clearly visible on the chart below).
And how they purchased the shares by day-
c) During the past 60 days the following shares of PHF were purchased:
(Source: SEC Filing)
The SEC filing's key facet is within item 4 which states: "The filing persons believe the shares are undervalued and may communicate with management about measures to enhance shareholder value." Clearly, some sort of action will be taken by Bulldog over the next few months - and likely shorter given the quick accumulation of shares of the last several weeks.
We think they will seek a full liquidation or open-ending (liquidation more likely although JP Morgan could roll it into an existing JP Morgan High-Yield fund) of the fund given the CEF's "orphan status." This should eliminate most of the fund's discount as investors are likely to go along with Bulldog and approve the liquidation or open-ending.
We think the shares offer lower-risk, high-yield exposure for investors seeking such an allocation with an 8.5% yield and monthly payout ($0.05 per share). However, the real play here is the 7.1% that is left on the table and added capital gain potential should the highly likely outcome of a liquidation (or open-ending) occur.
Our base case assumes a 4-6 week timeline before they accumulate their target number of shares (typically between 15% and 20%) to initiate the discussions with the board of the fund. If the board is compliant with their efforts, then the timeline will be significantly shorter. The board of directors of the fund is re-elected annually, which gives Bulldog greater flexibility to electing compliant directors that would support their objective.
One of the more drawn-out and well-known activist plays over the last five years concluded just a few months ago when AllianceBernstein Income Fund (NYSE:ACG) was open-ended. The open-ending which occurred in February followed a year-and-a-half of wrangling by activists and the board. In August of 2015, AllianceBernstein relented and announced the open-ending, which was executed six months later. That is a rare case in that it took two years for it to conclude. ACG was one of the largest CEFs at the time with $1.8 billion in assets and had been around for three decades.
But the activist pressure finally won over investors who had a vested economic interest to close the 10% discount to NAV. That open-ending resulted in a $170 million gain (done at 99.5% of NAV) to investors but it did take two years for them to realize it - from the start of activist involvement (press release) to the actual open ending.
We do not foresee that type of outcome here given the small size of the fund and the fact that it's JPMorgan's only closed-end fund. The likelihood that they will put up much of a fight to save this inconsequential source of revenue to the firm is negligible. Our one-year timeline projection could be long but errs on the side of conservative.
We think the discounts will close over time as more 13Ds are released and Bulldog's true intentions are announced. Still, an investor looking for high-yield, especially high-yield of the safer variety with minimal triple-C rated securities, should take a hard look at PHF. The tighter duration and higher credit quality along with the 8.5% monthly distribution are very attractive on a standalone basis. The current 7.1% discount is likely to juice that return as the discount narrows. If one is going to have an allocation to high-yield anyway, either through ETFs, or open or closed-end funds, then it makes sense to add one with the high probability for additional upside potential should activists prevail in their efforts. That is pure alpha, which is what we are all seeking.
If investors like these types of ideas, we suggest you take a look at our marketplace service that will focus on finding unique yield-generating opportunities, mainly within closed-end funds and BDCs.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PHF 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.