The closed-end funds from the high-yield sector significantly increased their prices over the past four months. Currently, most of them are traded at positive Z-scores, which is an indication that they have lost most of their statistical edge. Still, they are traded at high discounts, but we are cautious when we select our positions due to the lack of statistical edge. I still see several interesting buying opportunities in the sector, which I am going to discuss with you in this article.
At the end of the article, we will review in more details Apollo Tactical Income Fund, Inc. (AIF) as interesting buying opportunity based on the attractive yield and one of the lowest Z-score in the sector. Currently, the offered yield is 8.18% and you will appreciate the positive earning/coverage ratio and UNII/Share balance. The portfolio of the fund is different from the rest of the high-yield funds due to its big portion of "Loans" in its portfolio.
The price of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) moved away from its highest level from the year but mainly because it distributed its monthly dividend. On the 1st of May, the benchmark distributed the amount of $0.3664 which is slightly lower compared to the previous amount which we saw in April. On a weekly basis, the main index fell by $0.40 and finished the week at $86.57 per share.
After the loud climbing in the first weeks of the year, now the high-yield closed-end funds seem switched to quiet mode. The environment in the sector indicates for returned appetite from the investors for riskier assets and seeking higher yields.
Source: Barchart, iBoxx $ High Yield Corp Bond iShares
Statistical Comparison And Spread Review Of The Sector
High-yield bonds are typically evaluated on the difference between their yield and the yield on the US Treasury bond. High-yield spreads are used by investors and market analysts to evaluate the overall credit markets. Higher spreads indicate a higher default risk in junk bonds and can be a reflection of the overall corporate economy and/or a broader weakening of macroeconomic conditions. On a weekly basis, we notice a slight decrease of 0.04 bps.
Source: YCharts, US High Yield Master II Option-Adjusted Spread and US High Yield Master II Effective Yield
Below, you can find a statistical comparison between HYG and the iShares 20+ Year Treasury Bond ETF (TLT). As discussed, we observe a low correlation between the two sectors - it is only 0.62 points for the last 200-day period:
Source: Author's software
On the other hand, we have a statistical comparison between HYG and the SPDR S&P 500 Trust ETF (SPY). There is definitely a stronger relationship between them for the last 80 days. As you see, it is 0.99 points.
Source: Author's software
Source: Yahoo News, High Yield Closed-End Funds News
Over the past week, several of the funds announced their dividends:
- New America High Income Fund (HYB) $0.0550 per share.
- Ivy High Income Opportunities Fund (IVH) $0.1000 per common share.
- Invesco High Income Trust II (VLT) $0.0964 per share.
- MFS Intermediate High Income Fund (CIF) $0.0204 per share.
- Apollo Tactical Income Fund, Inc. (AIF) $0.1020 per common share.
- Pioneer Diversified High Income Trust (HNW) $0.0950 per share.
- Pioneer High Income Trust (PHT) $0.0675 per share.
Review Of High-Yield CEFs
Weekly % Changes In The Sector
1. Lowest Z-Score:
The pure statistic is always an important part of my analysis. Therefore, the first criterion that I am going to use is a statistical one. The Z-score indicator shows us how many times the discount/premium deviates from its mean for a specific period. By the value of the Z-score, we can figure out whether the fund is overpriced or undervalued. Theoretically, when the Z-score is negative, the fund may be reviewed as potential "Long" candidate. As you see, most of the high-yield CEFs are traded at positive Z-scores. For me, this is a signal to be cautious when I select my long positions and to decide whether I can gain from a capital gain.
However, the statistical approach is only one piece of the puzzle and for the investors who seek a higher return for their portfolio, I still see several interesting opportunities in this sector. Ivy High Income Opportunities Fund (IVH) is one of the funds which caught my eye. This fund has one of the lowest Z-scores in the sector and offers a pretty attractive yield of 8.68% which can help you to boost your return. Of course, if you are more conservative investor, then IVH should be only a small percentage of your total portfolio. The dividend of the closed-end fund is very stable and the latest earning report proves that the earnings from the portfolio of IVH are high enough to cover the current dividend. In other words, we do not see a risk of dividend cut based on the earning/coverage ratio.
2. Highest Z-Score:
On the other hand, I have plotted the funds which should be statistically overpriced. The strong performance of the sector led to a situation where most of the closed-end funds are traded positive Z-scores.
Last week, we saw Pioneer High Income Trust (PHT) on the second position with Z-score of 2.50 points. Over the past week, the price of the fund remained in a red territory with 1.39% decrease and PHT is going at the bottom of the table.
Once again, Neuberger Berman High Yield Strategies Fund (NHS) is the CEF with the highest Z-score. The positive impulse for the price came after the announcement of the dividend increase from $0.0658 to $0.0905 per share. Somehow, I can understand the high Z-score of NHS and BGH because these funds have one of the highest yields in the sector and the market participants are willing to pay for this luxury.
For me, Invesco High Income Trust II (VLT) remains the fund which can be reviewed as a potential "Short" candidate or potential hedging reaction of our long positions. A current yield of 7.87% which is below the average for the sector and Z-score of 2.10 points are among the factors which make me think this fund is slightly overpriced compared to its peers.
The average Z-score of the high-yield CEFs is 1.15 points. On a weekly basis, we find an increase of 0.30 bps of the average value. At the end of December, we had -3.43 points average Z-score, and now, it is above 1.00 point.
3. Biggest Discount:
Only two of the funds reported a decrease in their prices on a weekly basis. Expectedly, we see a narrowing of the discounts in the sector and only eight of the high-yield closed-end funds have a discount of more than 10.00%. Six months ago, most of the participants from this table were traded at a discount of around 15.00% but the stabilization of the stock market and the credit panic led to a significant increase in the prices of the high-yield funds.
Based on the Z-score, we do not have many options but based on the spread between the price and the net asset value you can still decide to include some of these funds to your portfolio.
The average discount/premium of the high-yield CEFs is -6.56%. Last week, the average spread between prices and net asset values was -7.01%. This is the lowest average discount for the past 40 weeks.
4. Highest Premium:
Definitely, lack of candidates which can be reviewed as potential "Short" trades based on their premiums. Although the funds have positive Z-score, it is difficult to label the sector as "overpriced" because most of the CEFs are still traded at discounts.
Babson Capital Participation Investors (MPV) and Barings Corporate Investors (MCI) lower their premium after the announced increase of their net asset values. If you follow the sector, then you are probably aware that these two funds do not announce their net asset values on a daily basis.
Here is the full picture of the funds from the sector. Below, we have depicted their discount/premium and their Z-score:
5. Highest 5-year Annualized Return On NAV:
The average return for the past five years is 5.06% for the sector. As you can see, the current yields of most of the funds are much higher than the historical ones.
Unfortunately, none of them provide us with an attractive statistical edge to review it. Then, the Z-score value is between -1.00 point and +1.00 point that means 68% of the time the fund was traded at this discount or premium. However, if I have to select one fund which deserves to be reviewed as a potential "Buy" candidate for your portfolio, I will choose Wells Fargo Advantage Income Opportunities Fund (EAD). It combines good past results with the opportunity to buy it now at an attractive valuation.
6. Highest Distribution Rate:
Four funds from the sector have yield more than 9.00%. Keep in mind that NHS offers a current yield of 9.10% and should be in the third position. The information is still not updated in CEFconnect. The average yield on the price for the sector is 8.08%, and the average yield on net asset value is 7.55%. The difference between the two values can be easily explained by the spread between the price and the net asset values of the funds.
7. Lowest Effective Leverage:
We have two funds which are not leveraged and three which use leverage below 10%. The average leverage for the sector is 26.87%. Below, you can see the relationship between the effective leverage of the funds and their yield on net asset value.
Statistical Comparison And Potential Trades
The potential "Long" candidate which I am going to review today is Apollo Tactical Income Fund, Inc. (AIF). We have already seen that this fund has one of the highest discounts in the sector. In addition to the satisfying spread between the price and net asset value, we should highlight its relatively low Z-score. I will delve into more details, but before that will provide you a brief summary of the investment policy of the fund:
Apollo Tactical Income Fund Inc. (the "Fund") is a diversified, closed-end management investment company. The Fund's primary investment objective is to seek current income with a secondary objective of preservation of capital by investing in a portfolio of senior loans, corporate bonds and other credit instruments of varying maturities. The Fund seeks to generate current income and preservation of capital primarily by allocating assets among different types of credit instruments based on absolute and relative value considerations. Under normal market conditions, the Fund invests at least 80% of its managed assets (which includes leverage) in credit instruments and investments with similar economic characteristics.
Current Yield & Earning/Share Ratio
We do have a yield on the price of 8.18% and yield on the net asset value of 7.25%. Both of them are close to the average value for the high-yield sector. The current distribution is $0.1020 and it is paid on a monthly basis.
Another important fact is the positive earning/coverage ratio of the fund which signals that the management team can fully cover the dividend with the earnings from the investments. In other words, based on this ratio the fund is able to keep the current dividend unchanged.
The positive UNII/Share balance is another fact which should be taken into consideration when we are talking about the protection of the dividend. In combination with the earning/coverage ratio, it is an important factor for the distributions.
Portfolio Quality & Composition
Most of the investments owned by this CEF are with rating "B." A brief overview of the investments shows that "Services Business" and "High Tech Industries" sectors have the biggest weights.
Source: Fund Sponsor Website
The fund seeks current income with preservation of capital through investment in different types of credit instruments including senior, structured loans and high yield corporate bonds. Inevitably, you will notice the big portion of "Loans" in its portfolio. That is why it will be an appropriate task to compare it not only to high-yield CEFs but to senior loan CEFs, as well.
Source: Fund Sponsor Website
Duration & Leverage
When we are talking about fixed-income, it is almost impossible to miss the duration as a factor. The weighted average modified duration of the portfolio of AIF is 4.39 years.
The total assets managed by the fund are $366.5 million and $126.5 million of them are coming from the leverage. In other words, the effective leverage of the fund is 34.51%.
Comparison To The Benchmarks
Below is the comparison with the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and how their prices and net asset values change over the past years. As we discussed, the fund is a little bit different from the rest of the funds in the sector. Therefore I will compare it to the Invesco Senior Loan ETF (BKLN), as well.
The high-yield sector does not provide us with significant arbitrage opportunities at present. Most of the CEFs are trading at discounts, and it is difficult to find reasonable "Short" candidates. On the other hand, there are still interesting funds which provide us with an attractive valuation to review them as potential "Buy" candidates.
Based on the data that I have reviewed, AIF can be a potential addition to your portfolio.
Note: This article was originally published on May 05, 2019, and, as such, some figures and charts might not be entirely up to date.
Trade With Beta
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, but may initiate a long position in AIF over 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.