High yield investments had a rough time last year. Deceleration in the Chinese economy raised concerns about global growth. Energy sector defaults soared as some highly leveraged oil exploration companies that were doing so well in the fracking boom became unable to meet their obligations. The Third Avenue Focused Credit Fund announced that it was closing and liquidating, and journalists fueled speculative hysteria that Third Avenue was merely the canary in the coal mine and The End was nigh. Meanwhile the Fed Hawks raised rates for the first time since the Great Recession and boldly promised to continue raising them every few months. Mr. Market swooned and fell into one of his blue moods.
Despite the gloom and doom, Wall Street survived Ides of March and things are definitely looking better. Oil prices have bottomed and provided assurance that there is a floor somewhere above $20 a barrel. The Third Avenue failure has proven to be an isolated problem brought on by a risky portfolio strategy. The domestic economy has produced weak but persistent signs of growth. The Fed hawks quailed and wiser minds decided that further rate hikes will be carefully considered.
The New America High Yield Fund (NYSE: HYB) is a closed-end income fund that invests in fixed income securities rated BB or lower by Standard & Poor's Corporation ("S&P"), which are also known as junk bonds. The portfolio is composed of fixed income securities with 5% rated BBB or above, 23% rated BB, 35% rated B, 12% rated B/CCC, 11% rated CCC and below, plus 0.75% unrated securities. The fund pays monthly and year-end special dividends to shareholders, and yields 10.09% based on the recent market price of $8.06. The investment advisor is T Rowe Price. During 2015 the fund was defensively positioned to underweight the energy sector to limit the risk that oil prices would fall; exposure to the European high yield market provided gains that helped offset losses as the domestic high yield market declined.
Closed-end funds are trusts that hold a portfolio of managed investments and often utilize leverage. The share price of a closed end fund trades at a market price not tied to the net asset value of the underlying portfolio. Over the past 10 years, shares of HYB traded at an average discount of 5.2% to net asset value, although during 2012 the fund often traded at a small premium. In August 2015 the discount increased to a peak of 17.2%. HYB currently trades at a discount of 12% (March 30, 2016).
During a very interesting Barron's Roundtable Discussion, bond guru Jeff Gundlach stated that the large discount in closed-end funds is an opportunity with 10% upside compared to a 2% downside risk. He believed it would take a 2008-style financial meltdown, which he felt to be unlikely, to push discounts higher. He attributed the large discount to investor fear of the Fed tightening cycle and speculated that if the Fed backpedaled from its plan to raise rates four times in 2016, it would reduce the discount.
Today investors can buy HYB shares at a 12% discount to net asset value and lock in an investment that pays a 10% return in monthly dividends with a probable 12% long-term capital gain.
Mr. Market is offering income investors a nice opportunity.
Disclosure: I am/we are long HYB.
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.