The closed-end funds from the high-yield sector significantly increased their prices over the past 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. For me personally, I am in a waiting mode to see a statistical opportunity to review some of the funds.
Over the past week, the main benchmark iShares iBoxx $ High Yield Corporate Bond ETF (HYG) fell slightly by $0.14 per share and finished the last session at $86.25 per share. The market participants continue to be concerned about the economic slowdown and protracted trade dispute between the United States and China. When the economic situation is not stable and volatile we are used to seeing a decrease in the prices of the high-yield bonds and closed-end funds which invest in them due to their lower-quality credit ratings.
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 an increase of 0.21 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). We observe a correlation between the two sectors of 0.82 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 150 days. As you see, it is 0.98 points.
Source: Author's software
Source: Yahoo News, High Yield Closed-End Funds News
Over the past week, three of the funds announced their dividends:
- Apollo Tactical Income Fund (AIF) $0.1000 per 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 Z-score is the statistical tool which I use to follow the discount/premium performance of the funds. Usually, it makes sense to me when it is below -2.00 points and I receive a signal for a potential buying opportunity or when it is above 2.00 points it sends me a message to close my long positions and to consider a short one if the period is favorable. Another situation when Z-score indicator can catch my eye is when a fund has very different Z-score from its peers. Currently, in the sector, we do not find so significant statistical edge to review many potential "Long" candidates as the Z-scores are positive.
Although the benchmark of the high-yield bonds did not fall much, the week can be easily categorized as negative for the prices of the high-yield CEFs. Only Barings Corporate Investors (MCI) increased its price as a result of the announced increase in the net asset value. The rest of the funds finished the week in negative territory.
The price of New America High Income Fund (HYB) fell by 3.49% while its net asset value fell only by 0.30%. This fact pushed down the Z-score of the fund and we find it below the neutral zone. For me, HYB is one of the few interesting buying opportunities which can be reviewed as a potential "Long" candidate. As we see, its Z-score is one of the lowest ones and it is accompanied by an attractive discount of 13.08%. Based on these characteristics, HYB seems undervalued compared to its peers. The solid historical performance and the current yield of 7.70% are other factors which can contribute to your analysis.
2. Highest Z-Score:
In this paragraph, we want to see if some of the funds are traded at very high Z-score. A fund is expected to trade between a Z-score of -2.00 points and 2.00 points for 95.5% of the time. From my perspective, if there is no fundamental reason behind the high Z-score, I will close my "Long" positions in these funds which have statistical parameter above 2.00 points. Currently, I do not see something which raises a red flag for me. None of the high-yield CEFs is traded at extremely high Z-score or premium.
The average Z-score of the high-yield CEFs is 0.96 points. On a weekly basis, we find a decrease of 0.32 bps of the average value. It is pretty interesting to notice the drastic change. At the end of December, we had -3.43 points average Z-score, and now, it is almost 1.00 point.
3. Biggest Discount:
The table above aims to show us the closed-end funds with the highest discounts in the sector. Compared to the previous week, there is almost no change among the top ten candidates. Over the past week, the participant's spreads between prices and net asset values have widened as the prices fell more than their NAVs. If you are seeking new potential "Buys" for your portfolio, you may find it reasonable to start from this table just because most of the representatives offer a discount of more than 10.00%.
First Trust High Income Long/Short Fund (FSD) is one of the leaders of the chart. The discount which you can buy it at is 12.64%, and it is undervalued compared to its peers based on the discount/premium approach. The fund offers a juicy yield of 9.01%, and its new monthly dividend for August is $0.1100 per share. Of course, I cannot miss mentioning the risk which I see here. Although its dividend has been increased, the earnings of the fund are not high enough to cover it, and at some point of time, we may see a dividend cut.
The average discount/premium of the high-yield CEFs is -6.50%. Last week, the average spread between prices and net asset values was -5.81%.
4. Highest Premium:
Barings Participation Investors (MPV) and Barings Corporate Investors (MCI) continue to be the leaders in this sector by premium. The recent announcement of the increased net asset values and the solid past performance are the main reasons why market participants pay such prices for them.
From my perspective, the Credit Suisse High Yield Bond Fund (DHY) and the MFS Intermediate High Income Fund (CIF) may be risky investments at the levels. Both of them are traded almost at net asset value mainly because they offer a high current yield. It seems like the market participants do not take into consideration the fact that their earnings of the portfolios are below the required amount to cover the dividends.
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 5.15% for the sector. As you can see, the current yields of most of the funds are much higher than the historical ones. This fact can be easily explained by the sharp declines in their prices over the last year. The finding of bargains is a difficult task, but trying to incorporate the available fundamental and statistical information is one step ahead.
6. Highest Distribution Rate:
Barings Global Short Duration High Yield Fund (BGH) continues to be the leader of the ranking with its current yield of 10.01%. Actually, I really like this fund and its portfolio characteristics. Its dividend is very stable and protected by positive earnings/coverage ratio and improving UNII/share balance. Also, you will find out that BGH has one of the lowest durations in the area. My concern here is related only to the fact that its price has increased significantly and I will wait for a better time to enter into a new long position.
The average yield on the price for the sector is 8.28%, and the average yield on net asset value is 7.74%. 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 26.43%. Below, you can see the relationship between the effective leverage of the funds and their yield on net asset value.
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 so many potential "Short" candidates. On the other hand, there are still interesting funds which provide us with an attractive valuation based on the discount, and we can review them as potential "Buy" candidates if their Z-scores are not too high. However, we should be careful because the situation on the market seems unstable and the riskier assets such as high-yield bonds CEFs may be affected by the volatility.
Note: This article was originally published on August 11, 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 IVH 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.