Over the last few weeks, a flight to quality by panicky European investors has caused US Treasury bonds (along with German and Japanese bonds) to perform like high powered momentum stocks moving to all time price highs. Yields on higher duration US Treasuries have plunged to levels never seen before.
One side effect has been relative weakness in some of the floating rate senior loan CEFs which have somewhat higher credit risk. It may be a good time to take some profits on US Treasury positions and increase allocations to these funds, since they can help protect a portfolio from future inflation. Senior loan funds invest in floating-rate loans which have payouts that increase with short term interest rates.
The LMP Corporate Loan Fund (TLI) tries to maximize current income consistent with prudent efforts to preserve capital. The fund primarily invests in floating or variable rate collateralized senior loans to corporations, partnerships or other business entities in various industries and geographical regions.
TLI is a leveraged closed-end fund. But compared to most other fixed income asset classes, using leverage to purchase senior loan investments involves less risk from rising short-term interest rates. The income from senior loans generally adjusts to rising rates, as do the rates which determine the borrowing costs.
In 2012, TLI had $35 million in auction rate preferred stock outstanding which allowed it to borrow money at a rock bottom interest rate averaging around 0.30%. It also had other loans with an average interest cost of 1.23%.
TLI is currently selling at a discount to NAV of -6.09% compared to the most recent 3 month average discount of -4.53%. The 3 month Z-Statistic is -1.14. This means the current discount to net asset value is more than one standard deviation below the mean over the last three months.
Over a longer time period of two years, TLI has traded at an average discount of -4.69% and the Z-statistic is -0.52, or about half a standard deviation below the mean.
In May, the fund raised its monthly distribution from $0.0640 per month to $0.0695. The average monthly earnings per share was $0.0718 in March, so the fund is slightly over-earning its payout. There is $0.2867 in UNII per share (undistributed investment income), so the fund may be able to raise the distribution even more in the future.
The fund is managed by Citi Alternative Investments LLC which emphasizes long term investing combined with consistent portfolio monitoring. Their core strategy is to identify strong credits in stable industries via thorough analysis and research.
Asset Allocation (as of 03/31/2012)
|Collateralized Senior Loan||87.7%|
Credit Quality (Moody's)
|NR / WR||1.5%|
Top Industries (as of 3/31/2012)
|Retailers (ex food/drug)||9.2%|
|Oil & Gas||9.2%|
NAV Performance (as of 5/30/2012)
LMP Corporate Loan Fund
- Ticker: TLI
- Total Net Assets= 189 MM Total Common Assets= 124 MM
- Annual Distribution Rate= 7.12%
- Dividend Frequency= Monthly
- Current Monthly Distribution= $0.0695 per share ($0.834 per year)
- Baseline Expense ratio= 1.62% (before interest expense)
- Discount to NAV= -6.09% 52 Week Avg. Discount= -5.20%
- Portfolio Turnover rate= 98%
- Effective Leverage= 34.83%
- Average 3 Mos. Daily Trading Volume= 37,000 shares (about $0.426 MM)
The Federal Reserve is expected to keep short-term interest rates at zero until the end of 2013. This may partially explain the discount to NAV for TLI and several other floating rate closed-end funds. The zero interest rate policy may keep floating rate cash flows fairly low for the next few years, but the fund will also benefit from low borrowing costs during that time period.
Compared to some other riskier funds, TLI invests only a small amount in the lowest quality loans rated C or below. But there would be increased default risk if the economy entered a "double dip" recession. Of course, even in the worst case scenario, companies must pay back short-term loans ahead of all other debt. As a result, a fund like TLI has a much higher recovery rate than a traditional bond investor when a default or bankruptcy occurs.
TLI is attractive now as a very low duration, fairly high income play, with some credit risk as a tradeoff. Perhaps the best scenario would be a slowly growing economy where companies can easily make their debt payments.
It is a good holding for a tax deferred retirement account. I believe the discount to NAV may narrow over the next few months which would add to the total return. TLI is not very liquid and usually trades about 40,000 shares a day, so care must be used for larger purchases.