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), which we use to track the high-yield bonds, fell by $0.02 per share and finished the Friday session at $87.14 per share. It is important to mention that the index distributed its monthly dividend of $0.37 per share.
The high-yield bonds started the week positively after China and the U.S. agreed to trade talks next month. The announcement came after the world’s two largest economies imposed new tariffs on each other’s goods.
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 U.S. 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 decrease of 0.01 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 0.77 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 200 days. As you see, it is 0.96 points.
Source: Author's software
Source: Yahoo News, High Yield Closed-End Funds News
Several funds from the sector announced their dividends:
- Pioneer Diversified High Income Trust (HNW) $0.0950 per share.
- Apollo Tactical Income Fund, Inc. (AIF) $0.1000 per share.
- New America High Income Fund (HYB) $0.05500 per share.
- MFS Intermediate High Income Fund (CIF) $0.0202 per share.
- Invesco High Income Trust II (VLT) $0.0964 per share.
Review Of High-Yield CEFs
Weekly % Changes In The Sector
1. Lowest Z-Score:
The first week of September was positive for the closed-end funds which invest in high-yield bonds. Most of them reported an increase in their net asset values and prices. The only exception was First Trust High Income Long/Short Fund (FSD). The net asset value of this fund finished the week in a red territory even when its price went up by 1.02% on a weekly basis.
The Z-scores in the sector are higher compared to the previous time as the prices of the funds reported bigger increase than the net asset values. 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.
Taking a look at the closed-end funds with the lowest Z-scores, you will notice that Ivy High Income Opportunities Fund (IVH) has one of the lowest statistical parameters. Currently, we find that it is traded at 11.33% discount, which is significantly higher compared to the average 6.47% discount of the sector. We do have a yield on the price of 8.86% and yield on the net asset value of 7.86%. The current distribution is $0.1000, and it is paid on a monthly basis. At all, IVH has one of the most stable dividend distributions in the sector.
Most of the investments owned by this CEF are with rating "B." The portfolio is constructed by issuers located globally, but 81.8% of the assets are located in the United States. A brief overview of the investments shows that the portfolio is mainly comprised of Corporate Bonds and Senior Loans.
Source: Fund Sponsor Website
2. Highest Z-Score:
On the other hand, we are sorting the funds by the highest Z-score. It is an appropriate indicator to highlight the funds, which are statistically overpriced. I am not really interested in most of the participants because most of them are still traded at a discount.
The two funds of Babson Capital Management are leaders of the ranking. Over the past month, they have increased their prices after the announced change in their net asset value.
- For Barings Corporate Investors (MCI), it is $15.29 per share or $0.29 change from the net asset value of March which was $15.00 per share.
- For Barings Participation Investors (MPV), the determined value is $13.87 per share. Compared to the net asset value from March, we see $0.27 increase.
The average Z-score of the high-yield CEFs is 0.82 points. On a weekly basis, we find an increase of 0.28 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 close to 1.00 point.
3. Biggest Discount:
If you are seeking new potential "Buys" for your portfolio, probably, you may find it reasonable to start from this table. The current market environment provides us with many opportunities in the sector. Yes, we still cannot talk about a significant statistical edge, but the discounts in the sector remain attractive.
PGIM Global High Yield Fund (GHY) is on the second position. The spread between its price and the net asset value is 12.77%. It is interesting to mention the dividend increase from March. On top of that, it will be increased one more time in September. The current yield is 8.82%, and I am eager to see the next earnings report and the earning/coverage ratio. The recent increase in the dividend may be a signal that the management team expects to see an improvement in the earnings.
The average discount/premium of the high-yield CEFs is -6.47%. Last week, the average spread between prices and net asset values was -7.12%.
4. Highest Premium:
The two funds sponsored by Babson Capital Management are the ones which are traded at higher premiums. The trust in the management team and solid past performance are the reasons for this situation. If you believe that the past results are very important for the future performance, then MCI seems the more reasonable choice for each of the uses if we compare it to its brother MPV. Both of them offer very similar yield on the net asset value but MCI is traded at a much lower premium and offers higher current yield on its price.
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:
Above are the funds that outperformed their peers by return on net asset value for the past five years. The average return on NAV for that period is 5.10% for the sector. As you can see, most of the current yields on price and net asset value are higher than the historical ones. The situation seems justified because, last year, we saw two sharp declines in the prices of the funds.
6. Highest Distribution Rate:
Four funds offer yield on price above 9.00%. The average yield on the price for the sector is 8.29%, and the average yield on net asset value is 7.74%. We have already seen that most of the funds are trading at a discount, so this difference should not surprise us.
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 26.69%. 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 in 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 September 08, 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.