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Term CEF Ladder #3: Senior Loan Closed-End Funds And CLOs

by: History and Finance

This is the third installation in a series of planned articles exploring the concept of a Term CEF Ladder.

Today's focus: Senior Loan Closed-End Funds with termination dates.

A brief CLO Primer is included.

Updated data for 45 Term CEFs is provided as well as a worksheet with fundamental information for 11 Mortgage/Senior Loan CEFs.

The fundamental worksheet will continue to grow as more funds are investigated.

The first article in this series, which framed our investment objective and introduced the idea of a Term CEF Ladder, can be found here. The second article, specific to Mortgage Bond CEFs, is here.

There are 45 CEFs with scheduled termination dates. Reader "Commish JW" alerted us to the imminent liquidation of KMM and KST, both scheduled to liquidate at the end of 2018, but not flagged by CEFConnect's screener.

Sheet #1: Master Term CEF Worksheet (KMM and KST added):

Term CEF List - 042418

(Source: CEFConnect, Fidelity, Morningstar, Fund Fact Sheets, Author's Own Spreadsheet)

Sheet #2: Fundamental Worksheet: Mortgage and Senior Loan CEFs:

Fundamental CEF Sheet - 042418

(Source: CEFConnect, Fidelity, Morningstar, Fund Fact Sheets, Author's Own Spreadsheet)

Deep Dive #2: Senior Loan Funds with Term Dates

Before we jump into the fund data, I believe a brief discussion of the basics is warranted. On page four of their Floating-Rate Loan Chart Book, Eaton Vance gives a good overview of a hypothetical corporate capital structure. Please note: the terms Senior Secured Loans, Floating-Rate Loans, Leveraged Loans, and Bank Loans all refer to the same product type.

(Source: Floating-Rate Loan Chart Book, 12/31/17, Page 4)

There are nuances to each individual capital structure, including the difference between 1st and 2nd-lien debt, but this slide provides most of the information needed for a basic understanding of the difference between senior secured loans and high-yield bonds.

Senior secured loans are floating-rate instruments. Their coupon rates typically reset every 1-3 months. Typical benchmarks are 1-month and 3-month LIBOR. LIBOR = London InterBank Offered Rate. LIBOR is set by large banks in London and is highly correlated (but not identical) to the fed funds rate. The advantages of this floating-rate structure during periods of rising short-term rates is highlighted by another chart from Eaton Vance. Note the strong relative performance of loans vs. bonds during these periods.

(Source: Floating-Rate Loan Chart Book, 12/31/17, Page 15)

Floating-rate products have a duration of close to zero given that their coupon rates rise almost in lock-step with interest rates. In other words, they have little price sensitivity to either rising or falling interest rates. For this reason, the asset class has had a strong run recently, as investors are looking for natural hedges to rising short rates.

In my opinion, one of the main appeals of termination-date CEFs is that the term date provides managers with an incentive to control duration. With Senior Loan CEFs, duration risk is minimal, therefore, the existence of a term date may be less important when analyzing securities of this type.

Collateralized Loan Obligations (CLOs) are closely related to senior secured loans. CLOs are structured products that purchase blocks of senior loans, while at the same time selling debt tranches to investors. CLO debt comes in various shapes and sizes. "Senior CLO" debt tranches are typically rated AAA, are sold to large banks and insurance companies, and trade with spreads somewhere around LIBOR + 100bps. BBB-rated CLO debt currently trades around LIBOR + 300bps, while BB-rated paper is around LIBOR + 600bps and single-B rated debt is quoted around LIBOR + 900bps. These are very generic quotes sourced from current market participants. I included these levels to highlight current all-in yields. Benchmark 3-month LIBOR is continuing its slow-but-steady climb and is now around 2.36%.

This primer from Guggenheim gives a good overview of CLOs, including data on their very low historical default rates.

With the preliminaries out of the way, let's dive into the fund data (funds are presented in alphabetical order by ticker).

Senior Loan Fund #1: Blackstone/GSO Strategic Credit (BGB)

Investment Objective: According to the BGB website:

"Blackstone/GSO Strategic Credit Fund ("BGB" or herein, the "Fund") is a closed‐end term fund that trades on the New York Stock Exchange under the symbol "BGB." BGB's primary investment objective is to seek high current income, with a secondary objective to seek preservation of capital, consistent with its primary goal of high current income. BGB invests primarily in a diversified portfolios or loans and other fixed income instruments of predominantly US Corporate issuers, including first‐ and second‐lien loans ("Senior Secured Loans") and high yield corporate bonds of varying maturities. BGB must hold no less than 80% of its Managed Assets in credit investments comprised of corporate fixed income instruments and other investments (including derivatives) with similar economic characteristics. The Fund has a limited term and will dissolve on or about September 15, 2027, absent shareholder approval to extend such term."

Term Date: 9/15/2027

Current Pricing (4/24/18 close):

1yr Z-Score: 0.20

Current Premium/Discount: -6.26%

Market Return YTD: 3.05%

NAV Return YTD: 1.99%

Distribution Rate (Mkt): 7.94%

Underlying Assets: Effective Duration is 0.75 yrs. According to the fund's latest fact sheet:

(Source: BGB Fact Sheet, 12/31/17)

Leverage/Expenses: Effective leverage is 35.74%, and according to the fact sheet is in the form of both a credit facility as well as mandatory redeemable preferred shares. According to page 69 of the annual report, BGB pays LIBOR+0.975% on their credit facility and 3.61% fixed on their preferred share leverage. This is a taxable fund, so the preferred shares are likely taxable as well (no tax-free leverage gained here).

Management fees: In their annual report, BGB advertises a management fee of 1.00% of the average daily value of total managed assets, but that does not include an assortment of other expenses. Excluding expenses associated with leverage, according to the annual report's statement of operations, BGB's expense ratio on common shares is about 2.04%.

Manager Commentary: BGB, BGX, and BSL share a common annual report, in which they made the following comments (dated 12/31/17):

"Loans, as represented by the S&P/LSTA Leveraged Loan Index, returned 4.12% in 2017, a relatively muted performance primarily driven by spread compression despite the benefit of rising LIBOR. Strong demand for loans continued to support heavy refinancing and repricing activity, which pressured loan spreads, capped price performance, and subdued returns throughout the year.

Meanwhile, high yield bonds, as represented by the Barclays US High Yield Index, returned 7.50% in 2017, a relatively strong performance amongst fixed income assets that benefited from solid fundamentals, limited macro stresses and a less‐than‐anticipated increase in rates. This performance compares to full‐year returns for investment grade assets, as represented by the Bloomberg Barclays Corporate Index, of 6.42% and full‐year returns for the S&P 500 of 21.83%. While 2017 was predominantly a "coupon‐clipping" year for loan investors, we believe that spread compression should stabilize in 2018. Additionally, new issue supply from increased M&A and leveraged buy‐out activity, along with potential market volatility, could provide periodic attractive buying opportunities.

In 2017, larger loans with tranche sizes greater than $1 billion underperformed smaller loans. The largest loans in the market generally saw the greatest amount of refinancing and repricing activity due to the liquidity in those issues. Lower‐quality loans (rated CCC/split CCC and default) outperformed the higher‐quality segment of the market (rated split BBB/BB) during 2017. The lower‐quality loan segment is mainly composed of second‐lien loans and less liquid or middle market loans, which benefited from an increasing risk appetite and less repricing and refinancing activity. This translated into outperformance in the strong market environment. However, the relative performance of different quality segments for high yield bonds differed from that of loans. The lowest‐quality segment of the high yield bond market performed more weakly than the higher‐quality segments in 2017, as distressed/defaulted assets within the energy and retail sectors meaningfully detracted from performance…"

GSO/Blackstone on default rates from same commentary - most recent defaults were concentrated in the energy and retail sectors (health care is not mentioned here, but certain portions of that sector have been under pressure as well):

"Default activity in the credit markets registered the lowest annual total since 2013, with $34.1 billion in combined default volume across loans and high yield bonds ($17.5 billion in loans and $16.7 billion in high yield bonds, respectively). The par‐weighted U.S. loan default rate for 2017 was 1.84%, a 35 basis point increase above the default rate at the end of 2016 but notably below the 10‐year historical average default rate of 2.96%...

The par‐weighted U.S. high yield bonds default rate for 2017 was 1.27%, excluding distressed exchanges, a decrease of 230 basis points since the end of 2016 and well below the 20‐year historical average of 3.07%...

In 2017, the energy sector accounted for the largest number of defaults, including distressed exchanges, as well as the largest total default volume, while the retail sector accounted for the second‐largest number of defaults and the third‐largest total default volume. Despite a modest uptick in defaults in the fourth quarter of 2017, we expect loan and high yield default rates to remain low throughout 2018 with analyst estimates ranging between 1.2‐2.5% for loans and 2.0‐3.0% for high yield."

BGB/BGX/BSL Outlook for 2018:

"U.S. credit strategists forecast stable returns for loans and high yield bonds with most predicting in the range of 3‐5% and 4‐6%, respectively, for the coming year. Expectations for rising interest rates, coupled with current relative yields, reinforce the attractiveness of floating rate loans relative to other longer‐duration fixed income assets. Given there is currently greater predictability around defaults than the path of inflation and interest rates, we continue to favor high yield over investment grade as the latter will likely continue to be constrained by low spreads/yields and duration risk in 2018."

My Thoughts on BGB: This is a fairly simple fund, with ~83.5% of assets concentrated in senior secured loans, about 17.8% in high-yield bonds, and about 1.7% in equity. The fact sheet does not list exposure to 2nd-lien paper. My concerns revolve around the preponderance of lower-rated debt, especially within the high-yield bond slice of the portfolio. It looks like only about 3% of the fund's assets are rated Ba3 or better. This fact implies that the fund has at least 14-15% exposure to high-yield bonds rated B1 or worse. Overall, about 25% of the portfolio is in assets that are rated Caa1 or worse.

This fund looks appropriate for an investor who believes the economy will remain strong for the next several years. The ~8% distribution rate looks juicy, but asset quality appears lower than some comparable funds of its type.

Senior Loan Fund #2: Blackstone/GSO Floating Term

Investment Objective: According to the BSL website:

"Blackstone / GSO Senior Floating Rate Term Fund ("BSL" or herein, the "Fund") is a closed‐end term fund that trades on the New York Stock Exchange under the symbol "BSL." BSL's primary investment objective is to seek high current income, with a secondary objective to seek preservation of capital, consistent with its primary goal of high current income. Under normal market conditions, the fund invests at least 80% of its total assets in senior, secured floating rate loans ("Senior Loans"). BSL may also invest in second‐lien loans and high yield bonds and employs financial leverage, which may increase risk to the fund. The Fund has a limited term, and absent shareholder approval to extend the life of the Fund, the Fund will dissolve on or about May 31, 2022."

Term Date: 5/31/2022

Current Pricing (4/24/18 close):

1yr Z-Score: 0.40

Current Premium/Discount: 0.51%

Market Return YTD: 0.69%

NAV Return YTD: 2.57%

Distribution Rate (Mkt): 6.48%

Underlying Assets: Effective duration is 0.46 yrs. According to the fund's latest fact sheet:

(Source: BSL Fact Sheet, 12/31/17)

Leverage/Expenses: Effective leverage is 33.01%. According to page 69 of the annual report, BSL pays LIBOR+1.00% on their credit facility. Also in their annual report, BSL advertises a management fee of 0.90% of the average daily value of total managed assets, but that does not include an assortment of other expenses. Excluding expenses associated with leverage, according to the annual report's statement of operations, BSL's expense ratio on common shares is about 2.06%.

Manager Commentary: For market commentary, see above - comments for BGB and BSL are identical.

In their annual report, BSL discusses the recent decision to extend the fund's term date from May 31, 2020, to May 31, 2022:

"Absent shareholder approval to extend the term of BSL, BSL was initially scheduled to dissolve on or about May 31, 2020. On November 17, 2017, BSL's shareholders approved extending the term of BSL by two years by changing BSL's scheduled dissolution date from May 31, 2020 to May 31, 2022. Upon dissolution, BSL will distribute substantially all of its net assets to shareholders, after making appropriate provision for any liabilities.

Pursuant to BSL's Amended and Restated Agreement and Declaration of Trust (the "Declaration of Trust"), prior to the date of dissolution a majority of the Board of Trustees, with the approval of a majority of the shareholders entitled to vote (as defined in the 1940 Act), may extend the life of BSL by a period of two years or such shorter time as may be determined. The dissolution date of BSL may be extended an unlimited number of times. On March 31, 2017 BSL announced an extension of BSL's reinvestment period. The extension will allow BSL to continue to reinvest proceeds generated by maturities, prepayments and sales of investments until one year prior to BSL's scheduled dissolution date, which is currently May 31, 2022."

My Thoughts on BSL: This fund differs from BSL in that it has only about 6.2% exposure to high-yield bonds. Instead, BSL has ~13.9% of the fund in second-lien loans. BSL doesn't have quite as much exposure to Caa-rated paper as BGB but still owns a large percentage of lower-rated assets.

BSL appears to have a slightly more conservative asset mix than BGB, but both funds will likely be economically-sensitive.

It is also interesting that this fund has already voted to extend its termination date on one occasion. Around the time of the announcement (11/17/17), it does look like the fund's market price took a small hit but has since fully recovered.

Senior Loan Fund #3: Eaton Vance Floating-Rate 2022 Target Term (EFL)

Investment Objective: According to the EFL website:

"The Trust's investment objectives are high current income and to return $9.851 per share (the original net asset value) to holders of common shares on or about October 31, 2022 ('Termination Date')."

Term Date: 10/31/2022

Current Pricing (4/24/18 close):

1yr Z-Score: N/A

Current Premium/Discount: -3.17%

Market Return YTD: 3.77%

NAV Return YTD: 1.49%

Distribution Rate (Mkt): 5.33%

Underlying Assets: Effective duration is not listed on the fund's fact sheet or latest semi-annual report, but it is likely very short.

(Source: EFL Fact Sheet, 12/31/17)

(Source: EFL Semi-Annual Report, 12/31/17)

Leverage/Expenses: Effective leverage is 36.8% and consists of 28% borrowings and 8.8% preferred shares. The fund does not explicitly state the credit facility's spread above LIBOR, however, EFL lists the credit facility's 12/31/17 interest rate at 2.38% on page 26 of the semi-annual report. 2.38% is close to where BGB/BSL were borrowing at the same time, and those funds borrow at approximately LIBOR+1.00%.

According to page 21 of the fund's semi-annual report, annualized expenses applicable to common shares, excluding leverage expense, are 1.19%.

Manager Commentary: I could not find any market commentary specific to this fund.

My Thoughts on EFL: This fund's assets appear to be of higher quality than BGB/BSL, a fact that is reflected in its lower distribution yield. As with FIV, this more conservative asset mix appeals to me at this point in the economic cycle.

The fund launched on July 31, 2017. Perhaps we will receive more thorough manager commentary once the fund releases its first annual report.

Senior Loan Fund #4: First Trust Senior FR 2022 Target Term (FIV)

Investment Objective: According to the FIV fund page:

"First Trust Senior Floating Rate 2022 Target Term Fund (the "Fund") is a diversified, closed-end management investment company. The Fund's investment objectives are to seek a high level of current income and to return $9.85 per common share of beneficial interest ("Common Share") of the Fund (the original net asset value ("Original NAV") per Common Share before deducting offering costs of $0.02 per Common Share) to the holders of Common Shares on or about February 1, 2022 (the "Termination Date"). The Fund will attempt to strike a balance between the two objectives, seeking to provide as high a level of current income as is consistent with the Fund's overall credit performance, on the one hand, and its objective of returning the Original NAV on or about the Termination Date on the other. However, as the Fund approaches the Termination Date, its monthly distributions are likely to decline, and there can be no assurance that the Fund will achieve either of its investment objectives or that the Fund's investment strategies will be successful. Under normal market conditions, the Fund will seek to achieve its investment objectives by investing at least 80% of its Managed Assets in senior, secured floating-rate loans ("Senior Loans") of any maturity. Senior Loans are made to U.S. and non-U.S. corporations, partnerships and other business entities which operate in various industries and geographical regions. Senior Loans are typically rated below investment grade. As it nears the Termination Date, the Fund may invest in higher credit quality instruments with maturities extending beyond the Termination Date to seek to improve the liquidity of its portfolio and reduce investment risk. Investing in higher credit quality instruments may reduce the amount available for distribution to Common Shareholders."

Term Date: 2/1/2022

Current Pricing (4/24/18 close):

1yr Z-Score: -0.50

Current Premium/Discount: -3.10%

Market Return YTD: 4.23%

NAV Return YTD: 1.30%

Distribution Rate: 5.29%

Underlying Assets: Effective duration is 0.94 yrs. Details from FIV's most recent fact sheet (on the industry breakdown slide, I omitted industries with an allocation of less than 1%):

(Source: FIV Fact Sheet, 3/31/18)

Leverage/Expenses: Leverage is 22.35%. According to page 25 of the latest semi-annual report, FIV has a $158mm credit facility with a cost of 1-month LIBOR+0.775%.

According to page 20 of the fund's latest semi-annual report, FIV's ratio of total expenses to average net (common) assets was 1.38%.

Manager Commentary: Latest commentary is dated 11/30/17 from the latest semi-annual report, pages 4-5. It is important to note that LIBOR has risen fairly dramatically since these comments. The remarks are fairly boilerplate, but I am including them because they do contain some good info on historic defaults and relative performance within the high yield/leveraged loan sector itself.

FIV's Market Recap:

"The six months ended November 30, 2017 were relatively stable in the senior loan and high-yield bond markets. The S&P/LSTA Leveraged Loan Index generated positive returns in four of the six months and returned 1.72% during the period. Similarly, the ICE BofAML US High Yield Constrained Index also experienced positive returns in four of the six months, and produced a total return of 2.27% during the period. This compares to the 10.89% total return for the S&P 500® Index for the same period.

From a credit quality perspective, lower rated issues experienced the strongest returns during the period within the senior loan market. Lower quality CCC rated issues returned 2.06% in the period, outperforming the 1.89% return for B rated issues and the 1.77% return for BB rated issues. The average price of senior loans in the market softened modestly, entering the period at $98.33 and ending the period at $97.98. Senior loan spreads over 3-month London Interbank Offered Rate ("LIBOR") remained largely unchanged, entering the period at L+413 and ending the period at L+410. During the same period, 3-month LIBOR increased approximately 28 basis points ("bps") to 1.49%, which mitigated the senior loan market's modest spread tightening."

FIV on Default Rates:

"The last 12 months ("LTM") default rate within the senior loan market entered the period at 1.42% and ended the period at 1.95%. The current LTM default rate remains well below the 3.03% long-term average default rate for the asset class (March 1999 - November 2017). The low corporate default rate has largely been driven by a stabilization in commodity prices as defaults in the oil & gas and nonferrous metals/minerals sectors have slowed. We continue to believe the low default rates in both senior loans and high-yield bonds are reflective of the relatively sound financial condition of most companies, the lack of near-term debt maturities, and the strong backdrop of a healthy macroeconomic environment."

FIV Performance Analysis:

"The Fund's NAV and market price returns were 1.17% and -4.97%, respectively, for the six-month period ended November 30, 2017. For reference, the S&P/LSTA Leveraged Loan Index returned 1.72% over that time. The Fund's market price return was negatively impacted by the Fund's premium/discount to NAV widening over the period. At the start of the period, the Fund's market price was at a 1.21% premium to NAV and by the end of the period, the Fund moved to a 4.93% discount to NAV, reflecting a widening of 614 bps. This widening was experienced by most closed-end funds in the market. We believe the dichotomy we observed in the market price when compared to the NAV performance suggests that the widening may have been driven by investors selling prior to year-end for tax purposes or perhaps trading to swap into new term closed-end funds…

…Detracting from returns was the Fund's position in Toys R Us, which filed an unexpected bankruptcy to address its balance sheet at the end of September 2017. The Fund has experienced one bankruptcy since inception, which compares to 16 within the S&P/LSTA Leveraged Loan Index…"

FIV 2018 Outlook:

"We believe that with the potential for additional interest rate hikes on the horizon, LIBOR should continue to migrate higher through 2018. Importantly, the default rate for senior loans remains low at 1.95% and we believe it is likely to remain low given the overall health of the U.S. economy.

We believe that the favorable backdrop for the macroeconomy will persist for the near to intermediate term and that we are in a healthy part of the economic cycle to own senior loans and high-yield bonds. We also believe that the current cycle continues to have a long runway. Specifically, we believe senior loans, given their senior secured position in the capital structure, floating interest rate, attractive income and low default rate are well positioned as we move through 2018. We also believe that high-yield bonds should continue to perform well given their mid-cycle valuations and declining default rate. As we evaluate new investment opportunities, decisions will continue to be rooted in our rigorous bottom-up credit analysis and our focus will remain on identifying the opportunities that we believe offer the best risk and reward balance."

My Thoughts on FIV: This fund runs with a lower leverage level than the other senior loan funds we have looked at, plus its holdings are of higher-quality than BGB/BSL/XFLT on a relative basis (at least according to the ratings agencies).

I am interested in this fund. It looks pretty similar to EFL. FIV will be on our short list for potential purchase at the culmination of this series.

Senior Loan Fund #5: XAI Octagon FR & Alt Income Term Trust (XFLT)

Investment Objective: According to the XFLT fund page, the fund's objective is to seek:

"…attractive total return with an emphasis on income generation across multiple stages of the credit cycle…

The Trust seeks to achieve its investment objective by investing in a dynamically managed portfolio of opportunities primarily within the private credit markets. Under normal market conditions, the Trust will invest at least 80% of its Managed Assets (as defined in the Prospectus) in floating rate credit instruments and other structured credit investments."

Termination Date: 12/31/2029

Current Pricing (4/24/18 close):

1yr Z-Score: N/A

Current Premium/Discount: -5.88%

Market Return YTD: -0.16%

NAV Return YTD: 2.64%

Distribution Rate: 9.07%

Underlying Assets: Details according to the latest XFLT fact sheet:

(Source: XFLT fact sheet, 12/31/17)

The fund's strategy sheet highlight's Octagon's capability as a manager of institutional alternative credit. The fund focuses on "private below investment grade credit markets."

(Source: XFLT Strategy Sheet, 12/31/17)

Leverage/Expenses: Effective leverage was 32.4% as of 12/31/17. According to page 13 of the fund's annual report, the trust has a revolving credit facility at LIBOR+1.20% that is secured by "eligible securities."

Expenses excluding leverage costs are a steep 3.85% according to the fact sheet. After fee waivers, the number drops to 3.16%, but the waiver is set to expire in 2019. This is the highest expense ratio out of all the funds we have looked at thus far.

Manager Commentary: The fund has indicated that a more detailed commentary will be published with the semi-annual report (due mid-2018). From the fact sheet, we have this description of the management team.

XFLT on Portfolio Management:

"Octagon Credit Investors, LLC, is a leading below-investment grade credit investor with $17.9 billion of assets under management (as of 12/31/17). Octagon is the investment sub-adviser to the Trust and has a 23-year track record managing institutional client credit portfolios. The portfolio management team is cohesive, experienced and consists of 26 investment specialists who have worked together for a minimum of 14 years across multiple credit cycles. Over the past two decades, senior team members have been active participants in the CLO market and have built a substantial network enabling efficient industry navigation and an ability to properly evaluate and invest in CLOs. In this time Octagon has also developed a repeatable and scalable credit selection and investment process driven by an investment philosophy centered around relative value. It is this philosophy that informs the team's active management style and is the basis for Octagon's rigorous fundamental credit analysis, a strict awareness of target risk profiles and ongoing portfolio optimization."

My Thoughts on XFLT: Octagon certainly has an experienced management team, but they are charging a very steep price for access. In addition, this fund has exposure to some very risky assets, with over 31% of the fund in CLO equity.

CLO equity is the most junior slice of a CLO's capital structure and is very sensitive to losses in the underlying collateral. The equity is a play on the "excess spread" between a CLO's assets (senior secured loans) and liabilities (debt sold to investors).

As Guggenheim describes in their primer on CLO structure:

"The most senior and highest-rated AAA tranche has the lowest yield but enjoys the highest claim on the cash-flow distributions, and is the most loss-remote. Mezzanine tranches pay higher coupons but are more exposed to loss and have lower ratings. The most junior tranche, equity, is the most risky, is not rated, and does not have a set coupon. Instead, the equity tranche represents a claim on all excess cash flows once the obligations for each debt tranche have been met."

XFLT is not really a "senior loan" fund, as only ~40% of its assets are invested in senior collateral. It's more like an "alternative asset" fund best suited to very aggressive investors.

Summary and Conclusion:

We looked at five funds with varying exposure to senior loans. XFLT has the highest distribution rate and maintains an aggressive portfolio, charging very high fees in the process. BGB and BSL are next in order of distribution yield but each maintains a sizable allocation to assets rated CCC or worse. EFL and FIV offer lower headline yields, but also have higher-quality portfolios.

Interestingly, the comments of these leveraged loan managers echoed the comments of mortgage fund managers - both noted the superior relative performance of lower-quality securities in 2017 due to investors' high appetite for risk. I believe this is a trend that may reverse in 2018.

Indeed, GSO/Blackstone did note (see above for full quote) that unlike the mortgage and secured loan markets, riskier high-yield bond issuers (esp. energy and retail borrowers) actually underperformed higher-quality issuers in 2017. As volatility increases in the equity market, I think credit investors will seek to move up in quality.

I am also interested to see what these leveraged loan managers have to say about refinancing/repricing activity in 1Q 2018. GSO/Blackstone specifically mentioned this dynamic as a drag on sector performance in 2017, especially among larger borrowers. If spreads soften as LIBOR rises, we may see a slower pace of refinancing activity, which could help the sector in general. Bloomberg discussed refinancing/repricing activity in a mid-2017 article here. A website dedicated to leveraged loans discusses the mechanics of a senior loan refi in their primer.

In short: leveraged loans don't have great call protection, and in periods of strong market demand, loan refinancing and repricing activity often acts as a headwind to the sector.

The next installment in our series on Term CEFs will cover high-yield funds. If you have found these articles useful, please consider clicking the "follow" button. Thank you again for reading.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.