3 Higher-Yielding Opportunities You Should Exploit

Oct. 27, 2020 7:00 AM ETARDC, BIT, CBH34 Comments26 Likes

Summary

  • ARDC is a higher risk mix of loans and fixed coupon bonds that remains very cheap. It's being valued like an all loan funds but has more bonds in it.
  • BIT is a long-term holding for many in the YH service but we sold out of it last year after the Aviron Capital LLC debacle.
  • Since then the NAV of BIT has been very strong even when not including the recoveries from Aviron.
  • Lastly, we have a target term fund, CBH, which is slated to liquidate in less than four years but trades at greater than an 8% discount.
  • The tailwind yield for CBH is more than 2.3% which we like but even better is the NAV is already near the target.
  • I do much more than just articles at Yield Hunting: Alt Inc Opps: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

(This report was issued to members of Yield Hunting on Oct. 12. All data herein is from that date).

I typically divide my non-Core Portfolio into two pieces:

1) Safer, consistent income 2), higher-risk, higher income positions.

These three funds would be the latter though the second two are marginally in that category.

I'll be issuing lengthier full reports on each of these names on the public side starting in about 10 days. All three look compelling here and we think can be purchased today. My goal with these articles (and there will be more) is to bring you the most on-topic actionable information rather than go into each fund with granularity.

Ares Dynamic Credit Allocation (ARDC), yield 9.17%, discount -14.42%

This is a Core Income Portfolio fund but I also own a little in another account (small allocation) that I'll likely increase relatively soon. I consider that position a peripheral portfolio position. The yield is an attractive 9.17% and the discount now at -13.7%. The buy threshold on the Core Portfolio tab is -14% but that warranted fair value actually is a few points tighter. But we like to set those thresholds a bit wider for a margin of safety.

The fund continues to be a portfolio mix of fixed-coupon bonds and floating rate loans. In the last year the fund has shifted its dynamic strategy further toward fixed rate coupons over floaters. According to the March 2019 fact sheet, 53% of the portfolio was floating and 47% was fixed. In the most recent fact sheet from August shows 57.7% fixed and 42% floating.

(Source: August Fact Sheet)

The portfolio mix also is slightly different with bonds going from 44% to 53.5%, CLO debt to 20% from 26%, CLO equity from 10.2% to 8%, and loans from 24.2% to 19%. The trimming of the CLO equity is a good sign given the stresses in that market. Defaults and delinquencies are up in that space.

The fund was forced to de-lever in March going from $163M of drawn assets on its line of credit (out of $212M) to $123M as of June 30. This is one reason why the fund cut the distribution in April from $0.1075 to $0.0975 (-9.3%). The other is that floating rate assets have taken a beating and are producing less income.

The new distribution is now fully covered as the last three 19a notices show 100% net investment income for the payment. Ares does a good job of not over-distributing like many other one-off, higher income funds.

In some ways, the wide discount is warranted given it's only two points wider than the one-year average. However, I do think the persistent discount of this fund is not. For one it's being valued like a pure loan fund. However, as we noted, the fund has the ability to shift between loans and fixed coupon bonds. Right now, nearly 58% of the portfolio is bonds.

High-yield bond CEFs are trading much tighter than loans. The average high-yield CEF is trading at a -6.5% discount while the average loan CEF is at -11.9%. ARDC is trading wider than both but clearly more so as a loan CEF. A lot of that has to do with CEFConnect placing the fund in the loan category. It's hard to know if they will shift it to high yield now that the fund is majority fixed coupon high yield bonds.

Blackrock Multi-Sector Income (BIT), yield 9.47%, discount -9.6%

This is a perennial holding in the Core Portfolio and optional substitute list. The fund is the mirror to the Blackrock Credit Allocation (BTZ) in terms of credit quality with two-thirds non-investment grade and one-third investment grade (whereas BTZ is two-thirds investment grade and one-third non-investment grade). So it does contain a bit more risk than BTZ but it is a nice complement.

BIT is large and liquid, a good combination in the CEF space. Fees are reasonable and the distribution has not been cut since its inception in 2013. The only time the distribution was altered was back in late 2018 when they increased it from $0.1167 to $0.1237 (+6%).

The long-term NAV performance has been mediocre, especially compared to BTZ but a lot of that has to do with a large position that defaulted, Aviron Capital LLC.

Aviron Pictures is a film production and distribution company founded by William Sadleir with the intention of releasing up to eight wide release films per year. Blackrock was one of the larger investors in Aviron through their private equity/ mezzanine financing arm. They issued a three-year term loan for $55 million at three-month libor plus 5.00%. Blackrock initially invested $12M in Aviron in 2015 and increased its investment to up to $75M by July 2017.

In 2019, Blackrock alleged impropriety and fraud and filed a lawsuit on behalf of BIT shareholders in the Supreme Court of NY where they accused Sadleir of forgery and fraud. In May of 2020, Sadleir was charged with an alleged $25M fraud for illegally transferring money from a Blackrock investment fund to a sham company and using some it to support his lavish lifestyle including purchasing a $14M Beverly Hills Mansion.

BIT was the chief instrument from Blackrock that was affected by the fraud. The SEC noted that in a news release:

“We allege that Sadleir raided millions from BIT and its investors, and rather than using those funds for investment purposes he spent them lavishly on himself,” Adam Aderton, co-chief of the SEC Enforcement Division’s asset management unit, said in a news release.

The filing of the SEC’s civil complaint came on the same day Sadleir was arrested in a separate criminal case alleging he scammed the federal government’s coronavirus-relief Paycheck Protection Program out of $1.7 million in forgivable loans.

The Aviron position was nearly 8% of BIT as of April 30, 2019 at a market value of just over $55M. In the next semi-annual report dated Oct. 31, 2019, the position had been marked down to zero. Marking down a $55M to zero on a $1B fund has a net effect of reducing the NAV by 5.5%.

The fund then underperformed in 2019 with the NAV up only 5.3% whereas high yield benchmarks were up over 14%.

This year we are seeing the opposite. The fund's NAV is outperforming the passive benchmark by approximately 11%.

Chart

Data by YCharts

The driver of that outperformance was a recovery on some of the Aviron position.

During the six months ended April 30, 2020, the Trust received a $25,000,000 payment from an affiliate, which is included in Payment by affiliate in the Consolidated Statement of Operations, in connection with a defaulted term loan investment in Aviron Capital LLC.

As of April 30, 2020, the Trust held floating rate loan interests in Aviron Capital LLC (“2017 Loan”) and Aviron Pictures LLC (“2020 Loan”). Subsequent to period end, but prior to financial statement issuance, the 2017 Loan and the 2020 Loan were sold to an unaffiliated third party for approximately $5.25 million. If these investments would have been sold as of April 30, 2020, the impact of these transactions on the financial statements would have been to increase the Trust’s net asset value per share by $0.14 and to increase total return based on net asset value for the 6 months ended April 30, 2020 by 0.85%.

Since then, BIT has continued its winning ways in terms of NAV performance with the top three-month total NAV return of the multisector group at +11.6%.

With the Aviron headwind gone and settled, the shares look poised to recover. Investors are still punishing it a bit for this debacle with the nearly -10% discount to NAV though it is not far off the three-year average. Still, we think the NAV performance and higher yields could push that discount a bit tighter. Even if it does not, the recent performance of these shares warrants a good look or at least keeping it high on your watch list for a potential opportunistic entry point.

AllianzGI Convert & Income 2024 Target Term (CBH), yield 6.15%, discount -8.5%

The fund is a mix of bonds and convertibles which is why CEFConnect throws it into the "multisector" bucket. About 60% of the portfolio is in fixed-coupon bonds and another 40% in convertible securities. This is a lower yielding fund for this report but it is a target term that's near its NAV objective already plus it is trading at a large discount. Thus, we are adding in the tailwind yield or the additional return generated as the fund approaches liquidation date.

The fund is slated to liquidate Sept. 1, 2024, or just under four years from now. The target NAV payment is $9.82 on that date but with the most recent NAV at $9.81, we don't expect the fund to have to cut the distribution to the bone in order to achieve that target.

What we typically need to do is analyze the holdings to see the proportion of them that mature prior to the fund's liquidation date. Those that do mature prior would then have their capital invested in short-term, high-quality securities. That will reduce the earnings power of the fund. The greater the portion that liquidates prior, the greater the chances of the fund having to cut the distribution.

All that is moot however if the NAV is greater than the objective and/or the fund has built up a lot of undistributed net investment income ("UNII"). The weighted average maturity of the holdings is 4.12 years so clearly some of the holdings are scheduled to mature prior to fund liquidation. In scanning the 137 holdings, the earliest maturing security is as early as 2022 but that position can be re-invested. There are a few 2023 maturities as well but the bulk are 2024 and 2025.

The kicker is the UNII at $0.354 (as of May 31, 2020). With a distribution of 4.6 cents that covers nearly eight months of the distribution. And that UNII value continues to increase. However, earnings coverage did decline in the most recent six-month period which covers the COVID-19 Crash so we could be nearing the end of that UNII increase trend.

Back to the term structure. A fund that liquidates does so at NAV. Thus, if you can buy at a share price below NAV and then the fund liquidates, you capture that spread. We annualize that figure and get our tailwind yield. The current spread is -8.5% which equates to a tailwind yield of 2.3%.

When you add that to the current distribution rate of 6.15%, you get a total yield of 8.5%. That's extremely attractive for this fund. Additionally, not all 8.5% yielders are alike. Since we know that 2.3% of the yield is almost guaranteed, i.e. it's a capital gain that's highly likely to occur rather than reliant on distribution stability, you can think of it as a safer yield compared to other similar strategy funds.

CBH is currently near the high end of its range in high yield bonds and lower end for convertible securities. Convertibles are mostly issued by technology companies and those securities have run big in the last six months. It seems prudent that they would reduce that allocation and shift toward more reasonable priced securities in the high yield corporate debt market.

We think investors, both traders and buy-and-holders, can buy shares at an -8% discount or greater here. The upside potential from the convertibles remains and the income production and distribution stability, for now, appears intact.

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This article was written by

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Yield Hunting: Alternative Income Opportunities is a premium service dedicated to income investors who are searching for yield without the high risk of the equity market. We are one of the top experts in closed-end funds ("CEFs") in the country having spoken at many national conferences on how to incorporate CEFs into client portfolios. We manage four portfolios that investors can follow:



- YH Core Income Portfolio: yield ~8%
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Disclosure: I am/we are long CBH, BIT, ARDC. 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.

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