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  • Blackrock Credit Allocation Trust IV (BTZ) - Reasonable Yield And Value

    Blackrock Credit Allocation Trust IV ($BTZ) is a closed end fund that has recently undergone a variety of changes, and seems to offer reasonable value at prevailing prices.

    First, a little backstory: during the 2006 timeframe Blackrock launched four different preferred funds to great investor demand, raising close to 2 billion in assets. Unfortunately the timing was poor as investing in financial sector capital securities, prior to the credit crunch, turned out to be disastrous. Dividends were terminated and firms went bankrupt, so capital was permanently impaired. As markets began healing in 2009, Blackrock and the fund's board altered their mandate. The investment policy was shifted to a (primarily US oriented) credit allocation strategy, with guidelines, but not rules, suggesting 50% investment grade bonds, 30% high yield bonds/loans, and 20% capital securities (preferred etc.). In addition to keeping most of its holdings (80%+) in credit oriented assets, the fund focuses (above 50% holdings) on investment grade issuers. For further portfolio detail check the sponsor's site at www.blackrock.wallst.com/public/fund/pro...?symbol=BTZ

    In addition to expanding their hunting grounds of eligible holdings, a new portfolio management team was installed in 2011. The new team does not seem to be either a significant plus or minus, as far as I can observe from the outside. When comparing the mgmt. team's NAV performance to peers (in a couple of different categories) it looks as if they are middle of the road, if skill is demonstrated solely by short term recent returns. In any case, it's difficult to assess this dimension of the fund with the short history we have. I've compared BTZ price & NAV performance versus a passive proxy basket of ETFs (50% LQD, 30% JNK, 20% PFF) and both the beta (1.26) and outperformance (about 30% more over 5 yrs.) makes sense as they are driven by the CEF leverage of ~30%. Whenever hiring active management, it makes sense to compare to passive alternatives.

    During 2012, Blackrock began cleaning up the various Closed End Funds they had outstanding, and moved to consolidate the four similar mandates into one fund. In theory this would improve liquidity, reduce expenses, and perhaps tighten up the persistent discount to NAV the funds had become afflicted with. It is difficult for sponsors to raise assets for closed end vehicles when their existing lineup cannot command prices close to NAV, so this should be a move that works for both end investors and the manager. These funds were PSY, PSW, and BPP which were to be rolled into BTZ, at NAV after any undistributed net investment income (UNII) was paid out. The merger was closed early in December, and in late December, the annual reports were finalized and released.

    For closed end bond funds that are held primarily for their income, it is important that the underlying portfolio held by the fund generate enough income to support the distributions. Many CEFs that trade at a discount to NAV are not so "cheap" once a projected dividend cut is impounded into the valuation. For BTZ, calculating the net investment income (NYSEMKT:NII), going forward, requires some adjustment since no pro-forma projections were provided before/after the merger with her sister funds. So to estimate the fund earnings and distribution coverage we will add up all the prior four funds trailing 12m NII, subtract the 1H of the year, adjust for the merger shares, strip out the UNII, and then calculate the "earned yield" assuming that the last six months cash flow a reasonable basis for a projection.

    PSWPSYBPPBTZNew BTZcomment
    2012 NII (in 1000s)7109311001403148604100844
    1H12 NII36641576771162463851185subtract
    DIV (in 1000s)7652298981404648700100296
    UNIIdistributed
    adj. shrs (in 1000)7679327121586751828108086merger adj
    2H earn0.9189annualized
    current div0.07850.9420x12
    earnings at this px13.756.68%px on 12/27
    distrib at same px6.85%

    The point of all calculations was to determine how well covered the current distribution is. As of right now, the portfolio is under earning the payout. I don't think it's concerning since the potential merger synergies have yet to be captured (lower expenses from one fund rather than four) and most funds can tolerate a small amount of under earning, if they have routine trading activity that leads to profits. Blackrock has a history in this product lineup of adjusting distributions to match earnings, so it's unlikely a large mismatch would be permitted for a length of time. My view based on the pro-forma analysis is that the 6.85% current yield is adequately supported, and the downside is a .2c/mo. cut, which puts the fund at the earned yield of 6.68%. Note that the most recent distributions are classed as partly returns of capital (NYSE:ROC), but that can be explained by the UNII buffers being wiped out by the merger. The unification forced all four funds to distribute accumulated UNII prior to closing.

    Let's take a look at the current discount of -9.50% versus net asset value. BTZ has historically traded at an average discount of -10.12% since release, as advisors who were burned by recommending them once, as well as end investors, stayed away. The changes in the portfolio and management do not appear to have convinced many allocators. In addition, in some screening tools (such as Morningstar's) BTZ is not characterized as what one would expect: as either a multisector bond fund, or an intermediate term bond fund; instead it is considered a conservative allocation fund (a more typical example might be the Wellesley fund). I don't know why that is - it may be a statistical artifact driven by correlations, or a function of the preferred holdings (which looks like equity to many analysis packages), or simply because of the name. The effect of that is that when retail investors go hunting for yield ideas, and run simple screens, BTZ may not show up in all typical searches for leveraged taxable income CEFs. So despite its functional earned yield, and hefty discount to NAV, it's overlooked. To put it in perspective, typical pfd. CEF's trade with only slightly more yield, and much more duration, and tend to be at roughly NAV. And comparable (in terms of distribution yield) junk CEF's are also more typically flat to NAV.

    Sometimes large discounts to NAV are warranted; one typical case is egregious management fees. The portfolio management fee runs 65 bps on the total assets, and when converted to a fee on the net assets (by multiplying by the typical 30% leverage the fund runs) it works out to 85 bps in mgmt. fees, and 107 bps in total. Compared to a cohort of 50-60 comparable taxable funds that I follow, with an average fee of 82 bps, it doesn't seem that the fee is wildly excessive, and causing the discount. In prior years, expenses were held to 100 bps, which seems possible now that all the legal machinations are over. An excellent investment grade corporate open ended fund like PIGIX, run by Mark Kiesel, costs 50 bps which is a reasonable analog. However PIGIX offers a current yield about 200+ bps less, and costs NAV, unlike BTZ, which is discounted.

    Is the discount warranted because of excessive risk? Again, going back to the same peer group of funds, the market price volatility of the typical bond CEF is about 13.5%. BTZ is significantly less volatile, at 9.3% reflecting the more stable investment grade names it holds. The NAV volatility is 3.8%; those ratios are fairly typical in my observation. The effective leverage adjusted duration is 5.5, which is somewhat less than either PIGIX or the low cost LQD alternative (both are in the 7's). I would argue that this is -- if anything -- lower risk than many other offerings. In terms of yield/volatility - a quasi-Sharpe ratio - it seems very attractive at .74, and is among the top ranked on that dimension in my screens, in its cohort.

    BTZ, in its new incarnation, is a large CEF at 1.5 Bn in AUM, and that could draw in new holders as the fund can now soak up larger allocations from professional liquidity constrained CEF investors like the PCEF ETF, RiverNorth, FirstTrust etc. Compared to AWF, a similar sized fund, it has only 100 bps less yield, but trades 1300 bps cheaper on a discount to NAV basis. It seems reasonable to trade a touch of run rate yield, for the chance at capital gains from tightening discounts, as well as the increased margin of safety that buying cheap offers.

    Lastly, there are huge embedded carry forward losses available for the fund to shield gains for a number of years. Even though it's unlikely that the management co. will be able to generate massive capital gains from trading, those are another small plus, especially for holders who might consider placing this in a conventional taxable account. It also creates a mild incentive sometime in the next five years for a fixed income OEF in the Blackrock fund family, perhaps with large unrealized gains, to swallow up the CEF for the tax benefit. Paying NAV in that situation could work out well for both sides. That being said, that particular play is an extreme long shot for value realization.

    In summary, the attractions of BTZ are:

    · Sustainable, earned yield of 6.68 % in world of low yields

    · A discount to NAV of 9.5%, providing a margin of safety, and a chance for capital gains

    · A discount wider than most peers, which appears unwarranted

    · Lower volatility compared to peers, both in terms of price and NAV

    · Investment Grade portfolio, although on the borderline low end of that in aggregate

    · Solid prospective Sharpe ratio

    · Functional management

    · Acceptable fee drag

    · Liquidity and size

    In full disclosure, the author has long exposure in certain accounts.

    Disclosure: I am long BTZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Dec 30 7:03 AM | Link | Comment!
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