The Chemist's Quality Closed-End Fund Report - August 2018

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Includes: ACP, AIF, AOD, ARDC, AWF, BGH, BGT, BGX, BQH, BTZ, BWG, DSL, FPF, FT, HNW, HPF, HPI, HPS, HYB, IVH, JGH, JPS, JQC, JRI, MHE, MIY, MNE, MUJ, NAN, NAZ, NBO, NHS, NMI, NSL, NUM, NXJ, PDI, PHT, VVR
by: Stanford Chemist

Summary

Only funds with coverage >100% are considered.

Top lists of discount, yield, D x Y and D x Y x Z are given.

A brief look at Neuberger Berman High Yield Strategies Fund (NHS).

Quantitative screens help to rapidly narrow down attractive candidates from the database of 500-plus closed-end funds for further due diligence and investigation.

Based on the feedback and comments that I see in both my premium and public articles, it seems that a very many number of investors, understandably, place a great emphasis on coverage and return of capital. While I'm not going to rehash the entire ROC argument here (it is suffice to say that the issue is much more complicated than "ROC = bad"), some investors may consider a fund with over 100% coverage to be attractive simply because they know that the distributions are being covered by earnings. Such a fund may be at lower risk of a distribution cut, which can cause devastating impacts to a fund's market price, and may even afford to raise its distribution in the future.

What does the "quality" indicate? Simply put, it means that the distribution coverage is greater than 100%. However, please note these caveats: Firstly, coverage ratios are calculated using earnings data from CEFConnect. No efforts have been made to independently verify the coverage ratios from the individual fund annual/semi-annual reports themselves. Secondly, having a coverage ratio >100% does not guarantee that the fund's distribution is secure. Many funds reduce their distributions periodically in line with market conditions in order to maintain good coverage. Thirdly, a coverage cut-off ratio of 100% is, ultimately, an arbitrary number. A fund with 99.9% coverage will be excluded from the rankings, whereas funds with 100.1% coverage will be considered, even though only a sliver of coverage separates the two.

I hope that these rankings of quality CEFs will provide fertile ground for further exploration.

Key to table headings:

P/D = premium/discount

Z = 1-year z-score

Dis = distance

Lev = leverage

BE = baseline expense

Cov = coverage

Data were taken from the close of August 14, 2018.

1. Top 10 highest Quality discounts

The following data show the 10 CEFs with the highest discounts and coverage >100%. Yields, z-scores and leverage are shown for comparison.

CEF

Category

P/D

Yield

Z

Lev

BE

Cov

(NUM)

Tax-Free Income-Michigan

-15.74%

4.23%

-1.1

38%

1.00%

102%

(FT)

Taxable Income-Multi-Sector

-15.54%

5.69%

-1.7

23%

1.09%

103%

(NBO)

Tax-Free Income-New York

-15.38%

4.08%

-1.2

40%

1.31%

107%

(NXJ)

Tax-Free Income-New Jersey

-15.31%

4.99%

-0.8

39%

0.98%

101%

(BQH)

Tax-Free Income-New York

-15.30%

4.23%

-1.1

40%

1.37%

104%

(NHS)

Taxable Income-High Yield

-15.19%

7.26%

-1.6

32%

1.24%

115%

(MNE)

Tax-Free Income-New York

-15.10%

3.78%

-1.0

38%

1.23%

105%

(MUJ)

Tax-Free Income-New Jersey

-14.99%

4.85%

-1.5

40%

0.90%

107%

(BWG)

Non-US/Other-Global Income

-14.80%

8.17%

-2.6

37%

1.53%

102%

(NAN)

Tax-Free Income-New York

-14.71%

4.60%

-1.2

38%

1.01%

105%

https://static.seekingalpha.com/uploads/2018/8/15/49181399-15343412928501987.png

(Source: CEFConnect, Stanford Chemist)

2. Top 10 lowest z-scores

CEFs with the lowest z-scores are potential buy candidates. The following data show the 10 CEFs with the lowest z-scores. Premium/discount, yields and leverage are shown for comparison. Only funds with coverage >100% are considered.

CEF

Category

Z

P/D

Yield

Lev

BE

Cov

(BWG)

Non-US/Other-Global Income

-2.6

-14.80%

8.17%

37%

1.53%

102%

(VVR)

Taxable Income-Senior Loan

-2.4

-12.65%

5.45%

29%

1.60%

102%

(NSL)

Taxable Income-Senior Loan

-2.4

-11.24%

6.53%

37%

1.44%

101%

(BGT)

Taxable Income-Senior Loan

-2.0

-8.75%

5.64%

29%

1.19%

101%

(MHE)

Tax-Free Income-Massachusetts

-2.0

-5.31%

4.17%

39%

1.12%

102%

(JQC)

Taxable Income-Senior Loan

-1.9

-13.35%

5.61%

36%

1.34%

105%

(MIY)

Tax-Free Income-Michigan

-1.7

-14.65%

4.85%

39%

0.87%

105%

(FT)

Taxable Income-Multi-Sector

-1.7

-15.54%

5.69%

23%

1.09%

103%

(NMI)

Tax-Free Income-National

-1.7

-0.81%

3.96%

3%

0.78%

102%

(NAZ)

Tax-Free Income-Arizona

-1.6

-10.65%

4.19%

39%

1.07%

102%

https://static.seekingalpha.com/uploads/2018/8/15/49181399-15343412929603314.png

(Source: CEFConnect, Stanford Chemist)

3. Top 20 highest quality yields

Some readers are mostly interested in obtaining income from their CEFs, so the following data presents the top 20 highest yielding CEFs. I've also included the premium/discount and z-score data for reference. Before going out and buying all 10 funds from the list, some words of caution: [i] higher yields generally indicate higher risk, and [ii] some of these funds trade at a premium, meaning you will be buying them at a price higher than the intrinsic value of the assets (which is why I've included the premium/discount and z-score data for consideration). Only funds with coverage >100% are considered. To make the charts more manageable I've split the funds into two groups of 10.

CEF

Category

Yield

P/D

Z

Lev

BE

Cov

(ACP)

Taxable Income-Senior Loan

10.21%

-4.86%

0.7

30%

2.25%

112%

(BGH)

Taxable Income-High Yield

9.27%

-7.16%

0.0

26%

1.60%

108%

(DSL)

Taxable Income-Multi-Sector

8.84%

-0.34%

1.8

29%

1.66%

100%

(PHT)

Taxable Income-High Yield

8.43%

-10.71%

-0.9

29%

1.08%

110%

(IVH)

Taxable Income-High Yield

8.36%

-10.48%

-0.7

32%

1.58%

119%

(BWG)

Non-US/Other-Global Income

8.17%

-14.80%

-2.6

37%

1.53%

102%

(PDI)

Taxable Income-Multi-Sector

8.12%

12.90%

2.2

45%

2.13%

117%

(JGH)

Non-US/Other-Global Income

8.11%

-11.05%

-0.4

30%

1.31%

100%

(ARDC)

Taxable Income-Senior Loan

8.11%

-10.39%

-1.5

29%

1.97%

104%

(AIF)

Taxable Income-High Yield

8.11%

-11.72%

-1.5

35%

2.28%

101%

(HPS)

Taxable Income-Preferreds

8.0%

-0.5%

1.1

33%

1.23%

102%

(FPF)

Taxable Income-Preferreds

7.9%

-6.7%

-1.2

30%

1.31%

104%

(HPF)

Taxable Income-Preferreds

7.9%

2.7%

1.1

34%

1.25%

100%

(HNW)

Taxable Income-High Yield

7.8%

-13.5%

-1.1

31%

1.47%

109%

(JRI)

US Equity-Real Estate (Global)

7.8%

-12.0%

-0.9

31%

1.58%

100%

(AOD)

Non-US/Other-Global Equity Dividend

7.8%

-11.4%

-1.5

9%

1.15%

117%

(HYB)

Taxable Income-High Yield

7.8%

-12.7%

-1.1

27%

1.14%

105%

(HPI)

Taxable Income-Preferreds

7.7%

4.3%

2.1

34%

1.24%

101%

(JPS)

Taxable Income-Preferreds

7.6%

-8.5%

-1.6

35%

1.26%

101%

(BGX)

Taxable Income-Senior Loan

7.5%

-3.5%

0.7

36%

1.71%

111%

https://static.seekingalpha.com/uploads/2018/8/15/49181399-1534341293121532.png

https://static.seekingalpha.com/uploads/2018/8/15/49181399-15343412931645913.png

(Source: CEFConnect, Stanford Chemist)

4. Top 10 best combination of quality yield and discount

For possible buy candidates, it is probably a good idea to consider both yield and discount. Buying a CEF with both a high yield and discount not only gives you the opportunity to capitalize from discount contraction, but you also get "free" alpha every time the distribution is paid out. This is because paying out a distribution is effectively the same as liquidating the fund at NAV and returning the capital to unitholders. I considered several ways to rank CEFs by a composite metric of both yield and discount. The simplest would be yield plus discount, however I disregarded this because yields and discounts may have different ranges of absolute values and a sum would be biased toward the larger set of values. I finally settled on the multiplicative product, yield x discount. This is because I consider a CEF with 7% yield and 7% discount to be more desirable than a fund with 2% yield and 12% discount, or 12% yield and 2% discount, even though each pair of quantities sum to 14%. Multiplying yield and discount together biases toward funds with both high yield and discount. Since discount is negative and yield is positive, the more negative the "D x Y" metric, the better. Only funds with >100% coverage are considered.

CEF

Category

P/D

Yield

Z

D x Y

Lev

BE

Cov

(BWG)

Non-US/Other-Global Income

-14.80%

8.17%

-2.6

-1.2

37%

1.53%

102%

(NHS)

Taxable Income-High Yield

-15.19%

7.26%

-1.6

-1.1

32%

1.24%

115%

(HNW)

Taxable Income-High Yield

-13.49%

7.84%

-1.1

-1.1

31%

1.47%

109%

(HYB)

Taxable Income-High Yield

-12.70%

7.75%

-1.1

-1.0

27%

1.14%

105%

(AIF)

Taxable Income-High Yield

-11.72%

8.11%

-1.5

-1.0

35%

2.28%

101%

(JRI)

US Equity-Real Estate (Global)

-11.99%

7.81%

-0.9

-0.9

31%

1.58%

100%

(AWF)

Taxable Income-High Yield

-12.64%

7.23%

-0.9

-0.9

5%

0.99%

109%

(PHT)

Taxable Income-High Yield

-10.71%

8.43%

-0.9

-0.9

29%

1.08%

110%

(JGH)

Non-US/Other-Global Income

-11.05%

8.11%

-0.4

-0.9

30%

1.31%

100%

(AOD)

Non-US/Other-Global Equity Dividend

-11.38%

7.80%

-1.5

-0.9

9%

1.15%

117%

https://static.seekingalpha.com/uploads/2018/8/15/49181399-1534341293127119.png

(Source: CEFConnect, Stanford Chemist)

5. Top 10 best combination of quality yield, discount and z-score

This is my favorite metric because it takes into account all three factors that I always consider when buying or selling CEFs: Yield, discount and z-score. The composite metric simply multiplies the three quantities together. A screen is applied to only include CEFs with a negative one-year z-score. As both discount and z-score are negative while yield is positive, the more positive the "D x Y x Z" metric, the better. Only funds with >100% coverage are considered.

CEF

Category

P/D

Yield

Z

D x Y x Z

Lev

BE

Cov

(BWG)

Non-US/Other-Global Income

-14.80%

8.17%

-2.6

3.1

37%

1.53%

102%

(NHS)

Taxable Income-High Yield

-15.19%

7.26%

-1.6

1.8

32%

1.24%

115%

(NSL)

Taxable Income-Senior Loan

-11.24%

6.53%

-2.4

1.8

37%

1.44%

101%

(VVR)

Taxable Income-Senior Loan

-12.65%

5.45%

-2.4

1.7

29%

1.60%

102%

(FT)

Taxable Income-Multi-Sector

-15.54%

5.69%

-1.7

1.5

23%

1.09%

103%

(AIF)

Taxable Income-High Yield

-11.72%

8.11%

-1.5

1.4

35%

2.28%

101%

(JQC)

Taxable Income-Senior Loan

-13.35%

5.61%

-1.9

1.4

36%

1.34%

105%

(AOD)

Non-US/Other-Global Equity Dividend

-11.38%

7.80%

-1.5

1.3

9%

1.15%

117%

(BTZ)

Taxable Income-Investment Grade

-13.24%

6.57%

-1.5

1.3

22%

0.86%

101%

(ARDC)

Taxable Income-Senior Loan

-10.39%

8.11%

-1.5

1.3

29%

1.97%

104%

https://static.seekingalpha.com/uploads/2018/8/15/49181399-15343412933058355.png

(Source: CEFConnect, Stanford Chemist)

Quick commentary

This month, I'd like to take a brief look at Neuberger Berman High Yield Strategies Fund (NHS), a high-yield fund that ranked second in the D x Y x Z category. It last traded with a discount of -14.99%, a one-year z-score of -1.3 and a monthly yield of 7.29%, which was 115% covered per CEFConnect.

This coverage value seemed very impressive so I wanted to take a look at the latest semi-annual report (April 30, 2018) to confirm that it was the case. In the six months ended April 30, 2018, the fund earned $0.39 per share in net investment income (NII) against $0.43 in distributions, suggesting a coverage ratio of 91%. However, it should be noted that the distributions amount was based on last year's payout rate of $0.0725 per share. In April, the distribution was cut to $0.0658 per share. At the reduced rate, the coverage works out to be 99%.

(Source: Neuberger Berman)

So where does the 115% coverage reported by CEFConnect come from? I'm guessing that the site took the 2017 earnings number, which was $0.87 per share for the whole year. At the reduced distribution rate, the coverage is indeed higher, at 110% (though not 115%). This is yet another warning to always double check CEFConnect numbers before investing!

Is the current yield sustainable? Unfortunately, like most other leveraged CEFs, NHS's earnings numbers have continually fallen during rising interest expenses. As the table above shows, annual earnings for the last five years have consistently declined: $1.15, $1.10, $1.02, $0.92, and $0.87 for 2017. Therefore, while the distribution coverage is currently around ~100%, the fund may have to reduce its payout further if earnings continues to decrease.

NHS's discount has gradually widened over the past year, from around -10% to its current value of -14.99%, the widest since early 2016. The one-, three- and five-year average discounts are -12.52%, -12.54%, and -11.52%, so the current discount is wider than the historical averages.

Performance wise, NHS is an outperformer vs. the category group across three-, five- and 10-year categories, although it underperforms over more recent periods.

(Source: CEFConnect)

Here's a birds eye view of the entire high-yield sector from the database, arranged in order of increasing valuation. As we can see, NHS has the second-lowest widest discount out of the peer group. This suggests that NHS is attractively valued for those considering high-yield bond exposure.

In terms of portfolio allocation, NHS has the highest concentration in BB-rated securities, with nearly half of the weight of the portfolio (49.2%) in this category. I view this positively because BB, being the highest rung of the non-investment grade ladder, is considered by some to be at the "sweet spot" of risk-adjusted returns (think fallen angels). I have seen other funds stack their portfolio with the majority of credits in the B and CCC categories, which increases yield but at the expense of credit safety.

(Source: Neuberger Berman)

The underweight to CCC credits was explicitly stated in the manager's commentary (reproduced below), due to "belief that volatility will persist for lower quality securities." Duration is currently 3.88 years.

The fund also has a minor allocation (~4.5%) to bank loans.

In a nutshell, NHS is an attractively valued high-yield CEF with an overweight in the relatively safer BB credits. Distribution coverage is currently relatively secure at ~100% but further earnings deterioration may force another distribution cut in the future.

Please note: This article was first released to members of CEF/ETF Income Laboratory 1 month ago, so data may be out of date. Please check latest data before making investment decisions.

Disclosure: I am/we are long THE PORTFOLIO SECURITIES.

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.