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 short week, we saw an increase in volume and only one color - red. The benchmark Invesco Senior Loan ETF (BKLN) went ex-dividend on November 19 and opened at $22.81 (after distribution of $0.085) and finished the week at $22.64 losing 0.17 points. 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 $17.88 trading with increased volume on Monday and Tuesday and closed the week at $17.82 losing 0.06 points. 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 23 was 2.69119 %.
Source: Yahoo Finance
This week several funds declared monthly distributions:
- First Trust Senior Floating Rate 2022 Target Term Fund (FIV) announced that it maintains its monthly distribution for December as $0.0417.
- First Trust Senior Floating Rate Income Fund II (FCT) announced that it maintains its monthly distribution for December as $0.0600.
- Blackstone/GSO Senior Floating Rate Term Fund (BSL) announced that it increases its monthly distribution with $0.0100 for December, January, February to $0.1070 (also announced a transition to dynamic monthly distributions);
- Blackstone/GSO Long-Short Credit Income Fund (BGX) announced that it increases its monthly distribution with $0.0140 for December, January, February to $0.1170 (also announced a transition to dynamic monthly distributions);
- Blackstone/GSO Strategic Credit Fund (BGB) announced that it increases its monthly distribution with $0.0050 for December, January, February to $0.1100 (also announced a transition to dynamic monthly distributions);
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 Blackstone / GSO Senior Floating Rate Term Fund (BSL) with Z-Score 0.30, 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 -3.1 Z-Score and -13.38% discount.
Its portfolio is as follows:
The average 1-year Z-Score for the sector this week is -2.20 with (AIF) included (last week the average 1-year Z-Score was -1.73).
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, only Blackstone GSO Senior Floating Rate Term Fund (BSL) trades at a premium 0.79%. As we already mentioned, the fund is not suitable for short trades based on statistics (0.30 Z-Score).
5. Biggest Discount
Here we have the usual picture for the sector - too many candidates to choose from. This week there was sell off in the senior loans funds. The 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.
One of the funds that take a severe hit during this short week is Aberdeen Income Credit Strategies Fund (ACP). Below you can see how it traded during this week.
This fund widened its Z-Score from -0.4 to -2.3 and its discount from -5.22% to -10.41%. Here you can see how the price traded to its NAV.
The chart translated in numbers.
This fund is not clear senior loan fund and is expected to be riskier. This is how the credit quality and the maturity of the holdings of the Aberdeen Income Credit Strategies Fund (ACP) looks like.
If you try to bottom pick it is better to wait for its NAV to stabilize and to have confirmation from the benchmark. The fund also has approved share repurchase program and the previous months no shares have been repurchased.
I will not supply earnings coverage ratio because the information is old and probably there are changes in this environment.
One of the last week picks Blackstone/GSO Long-Short Credit Income Fund (BGX) announced a dividend increase but this did not improve very much the fund performance. Below you can see how the fund traded during this short week.
This fund exploits a long-short strategy and according to the last available data, there is no short position. If the fund succeeded to enter some shorts during last month it would be great for its performance. Below you can see how the fund traded to its NAV.
The chart translated in numbers.
Now the fund looks even more attractive compared to last week discounts. Unfortunately, now the leveraged loan sector is one of the most riskier places in the market and it is good to have proper hedge if you play it long. Theoretically, you can widen the universe where you look for hedge and you can check how the high yield and the volatility instruments perform.
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 7.28% (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 32.96%. 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.