In this article, I will provide a weekly review of CEFs that invest in senior loans. Considering the risk and return, senior loans are positioned between investment grade corporate bonds and high-yield bonds. Usually, they have a floating rate feature and are expected to be less rate-sensitive. In the current market environment of the flattening yield curve, there are many funds that trade at a discount to NAV. The use of leverage in closed-end funds and the fact that they are mostly targeted and used by retail investors make them much more volatile, which offers various opportunities for investors and traders like us.
During this week we saw only bearish bars. The benchmark Invesco Senior Loan ETF (BKLN) started the week at $23.03 and finished the week at $22.90 losing 0.13 points. While 0.13 point decrease is not a big deviation the things look uglier in the Senior Loans CEFs universe. Source: Barchart.com - BKLN daily chart (6 months)
Along with BKLN, investors may look to the passive index-based Highland/iBoxx Senior Loan ETF (SNLN). SNLN tracks the Markit iBoxx USD Liquid Leveraged Loan Index, which consists of the largest, most liquid leveraged loans. This week, the ETF started the week at $18.07 went ex-dividend and distributed $0.0725 then closed the week at $17.91. Source: Barchart.com SNLN daily chart (6 months)
These senior loan ETFs offer an opportunity for diversification because they do not have a strong correlation with investment-grade bonds or US Treasuries. One of the reasons for this is that they use the LIBOR rate as a component for the floating rate calculation. The three-month rate for November 16 was 2.64450 %.
Source: Yahoo Finance
This week several funds declared monthly distributions:
- Apollo Senior Floating Rate Fund (AFT) announced that it maintains its monthly distribution for December as $0.1000.
- Apollo Tactical Income Fund (AIF) announced that it maintains its monthly distribution for December as $0.1070.
- Western Asset Corporate Loan Fund (TLI) announced that it maintains its monthly distribution for December, January, February as $0.0530.
1. Highest Z-Score
We use the Z-Score to find statistically undervalued or overpriced funds in the sector. If the value of Z-Score is negative, it signals a "buy" opportunity. Conversely, if you are looking for a "sell" candidate, you should be interested in a positive Z-Score value. We use a one-year basis to see how many times the current discount deviates from its mean for that period.
At this point, we can see at the top of the table Aberdeen Income Credit Strategies Fund (ACP) and Blackstone / GSO Senior Floating Rate Term Fund (BSL) with Z-Score 1.00 and 0.10, which means that based on statistics we can not consider short trades.
2. Lowest Z-Score
Here the things look a little bit different. As we see from the table above, there are plenty of undervalued closed-end funds. In other words, here we can choose several "buy" candidates, which we can add to our portfolios. Of course, we should not forget that this is only from a statistical perspective and we are scratching the surface here. So, before entering a trade, deeper research should be done.
There is one more fund in this group which I am unable to add to the cefconnect.com screener, so I will mention its Z-Score and discount. Apollo Tactical Income Fund (AIF) has -2.8 Z-Score and -13.16% discount.
Its portfolio is as follows:
The average 1-year Z-Score for the sector this week is -1.73 with (AIF) included (last week the average 1-year Z-Score was -1.84).
3. 5-year Annualized Return on NAV
The aim of the below ranking is to show us the senior loan funds with the higher yields based on the net asset value. Combination of the return with the other metrics that we have is a foundation of our research for potential "long" candidates.
4. Highest Premium
Now, the Highland Floating Rate Opportunities Fund (HFRO) trades at a premium of 1.67%. The fund does not use leverage and does not have a statistically significant Z-Score number (-1.10), so we cannot consider it as a short trade candidate. The other fund that trades at a premium is Blackstone GSO Senior Floating Rate Term Fund (BSL) with 0.79%. But as we already mentioned, the fund is not suitable for short trades based on statistics (0.10 Z-Score).
5. Biggest Discount
Here we have the usual picture for the sector - too many candidates to choose from. This market environment is more suited for short trades, but there are no candidates based on the statistic. So you can wait for selling overreaction and try long trades. This week there are two funds that we usually do not see in this part of the table.
The first one is THL Credit Senior Loan Fund (TSLF). The fund invests at least 80% of its managed assets in fully collateralized, first lien corporate loans and notes, which generally hold a senior position in the capital structure of a borrower and are secured by the assets of the borrower. TSLF also invest up to 20% of its managed assets in second lien loans and high yield bonds. TSLF utilizes leverage to achieve its investment objective. Below are some of the portfolio characteristics.
This is a picture of how the fund trades to its NAV.
The chart translated in numbers.
The fund is 4.78% away from its 52-week average so there is enough profit potential in case the NAV stay stable or rise. I will not supply earnings coverage ratio because the information is old and probably there are changes in this environment.
The other fund that I would like to bring to readers attention is Blackstone/GSO Long-Short Credit Income Fund (BGX). This is the fund investment strategy:
The fund will take long positions in investments which we believe offer the potential for attractive returns under various economic and interest rate environments. BGX may also take short positions in investments which we believe will under‐perform due to a greater sensitivity to earnings growth of the issuer, default risk or the general level and direction of interest rates. BGX must hold no less than 70% of its Managed Assets in first‐ and second‐lien secured floating rate loans ('Secured Loans'), but may also invest in unsecured loans and high yield bonds.
Below is some data for the asset allocation of the fund and the portfolio characteristics.
Here you can see how the fund traded to its NAV: Source: CEFConnect.com
The chart translated in numbers.
The fund is 4.76% away from its 52-week average so there is enough profit potential in case the NAV stay stable or rise. I will not supply earnings coverage ratio because the information is old and probably there are changes in this environment.
6. Highest Distribution Rate
The table shows the funds with the highest distribution rate on price. Additionally, I have included here the distribution rate based on the net asset value. Most of the market participants find the second metric to be more important.
The average distribution rate on price for all Senior Loan CEFs is 7.05% (AIF included in the calculation).
7. Highest Effective Leverage
From a leverage perspective, we have one closed-end fund whose effective leverage is equal to zero - Highland Floating Rate Opportunities Fund (HFRO). The average percent of effective leverage in the sector is about 32.99%. Below, I have shown the funds which have above the average effective leverage. Do not underestimate the effect of the leverage, and be sure it is included in your analysis.
While some of the senior loan CEFs still look attractive for long trades, do not forget that rising rates will affect the ability of companies to pay their debt. Also, most of these CEFs use leverage and the rising rates will increase their already high expenses. If you try mean-reversion trades, my advice is to start small and be patient. Also, it's good to have short-sale candidates (working as hedging reaction) in case problems in the sector become severe.
Note: This article was originally published on Nov. 18, 2018, and some figures and charts might not be entirely up to date.
At Trade With Beta, we also pay close attention to closed-end funds and are always keeping an eye on them for directional and arbitrage opportunities created by market price deviations. As you can guess, timing is crucial in these kinds of trades; therefore, you are welcome to join us for early access and the discussions accompanying these kinds of trades.
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.