BIT: Strong Leveraged Bond CEF, 8.0% Distribution Yield, Market-Beating Returns, Risky Holdings

Summary

• BIT is a diversified bond fund, focusing on low-quality, high-yield corporate bonds.
• Risks, returns, and yields are all quite high.
• BIT's strong 8.0% distribution yield seems particularly compelling.
• An overview of the fund follows.
• This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

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The BlackRock Multi-Sector Income Trust (NYSE:BIT) is an actively-managed diversified leveraged bond CEF focusing on high yield corporate bond. BIT's diversified holdings, strong 8.0% distribution yield, and market-beating returns make the fund a buy. On the flipside, the fund's low-quality holdings and leverage significantly increase risk and volatility. As such, the fund is an inappropriate choice for more risk-averse investors and retirees.

BIT Investment Thesis

BIT is an actively-managed diversified leveraged bond CEF.

BIT's investment thesis rests on the fund's:

• Diversified holdings, providing investors with broad-based bond exposure, but tilted towards riskier, higher yielding bonds
• Strong 8.0% distribution yield, which directly boost shareholder returns, and should be of particular importance to income investors
• Market-beating returns, with the fund generally outperforming high yield bond index funds, and by a lot

BIT's overall investment thesis is quite strong, but less appropriate for risk-averse investors and retirees. Let's have a look at each of the points above.

BIT - Diversified Holdings

BIT is a diversified bond CEF, investing in most relevant bonds / bond sub-asset classes. BIT's holdings include high yield corporate bonds, investment grade bonds, mortgage-backed securities, treasuries, and more.

BIT is an actively-managed bond fund with few constraints, so the fund's holdings and performance are somewhat dependent on management decisions, capabilities, and execution. Significant under and overperformance are both somewhat likely.

BIT's asset allocations are as follows.

(Source: BIT Corporate Website)

As can be seen above, BIT's holdings are diversified, and provide exposure to most relevant bond sub-asset classes. BIT's holdings are diversified enough that the fund could provide investors with all the bond exposure they need: BIT has it all. Diversification serves to reduce portfolio risk and volatility, and is a benefit for the fund and its shareholders.

Although the fund's holdings are diversified, there is a strong focus on non-investment grade bonds, with these accounting for 70% of the fund's holdings. Investment grade bonds, mostly mortgage-backed securities, account for the rest.

BIT's current credit quality is as follows.

(Source: BIT Corporate Website)

As can be seen above, BIT focuses on very low-quality, risky bonds. Most of the fund's holdings have credit rating between BB and CC. These are very low, speculative ratings. Risk, volatility, and default risk are quite elevated. Diversification is quite important under these conditions, to ensure that risks are manageable.

BIT's low-quality holdings significantly increase portfolio risk and volatility. BIT's use of leverage, with the fund sporting a 38% leverage ratio, magnifies these risks. Expect significant NAV losses during downturns, as was the case during 1Q2021, the onset of the coronavirus pandemic.

Data by YCharts

Price losses were even higher, as CEF discounts tend to widen during downturns.

Data by YCharts

As a final point, BIT currently sports a negative effective duration. In English, this means the fund would benefit from increased interest rates, and would post small capital gains if rates were to rise. BIT's negative effective duration means the fund has no exposure to interest rates, reduces portfolio risk and volatility, and is part of the fund's investment strategy / active investment decision.

(Source: BIT Corporate Website)

BIT is quite risky for a bond fund, but of comparable risk to equity index funds in general, and to the S&P 500 in particular. Although I don't think that BIT is excessively risky, it is quite risky, and so the fund is not appropriate for more risk-averse investors looking for safe, stable funds. These investors could consider investing in the BlackRock Core Bond (BHK), which is quite similar to BIT, but much safer.

In any case, BIT does provide investors with diversified bond exposure, if perhaps tilted towards higher-risk bonds.

Strong 8.0% Distribution Yield

BIT's focus on low-quality holdings serves to increase portfolio risk and volatility, but also boosts the fund's distribution yield to 8.0%. BIT's distribution yield is quite strong, and much stronger than average for bonds in general, and high yield corporate bonds in particular.

Data by YCharts

BIT's strong 8.0% distribution yield is a significant benefit for the fund and its shareholders, and should be particularly compelling for income investors.

BIT's distribution is quite safe too. The fund has paid uninterrupted monthly distributions since inception in 2013. There have been no distribution cuts, but there has been some growth, and some special distributions too. Importantly, the fund has maintained a stable NAV since inception too. BIT's distribution is strong, stable, and sustainable, with no destructive ROC distributions, or consistent capital losses.

Data by YCharts

BIT's distribution should, in theory, be at risk during downturns and recessions, as the fund's underlying holdings are of very low-quality. BIT's distribution survived the coronavirus pandemic without a cut, and with no NAV losses either, which bodes well for future recessions.

In my opinion, and taking into consideration the above, BIT's distribution is safe, and distribution cuts are unlikely. This is a significant benefit for the fund and its shareholders, and particularly compelling considering the strength of the fund's distribution yield.

Market-Beating Returns

BIT's distribution yield is quite strong, and so are the fund's shareholder returns. BIT has outperformed all relevant bond asset classes, on both a NAV and price basis, since inception, and by quite a bit. Results are as follows.

(Source: Seeking Alpha - Chart by author )

As can be seen above, BIT has outperformed its peers since inception, with returns almost twice as high as those of high yield bonds for the past eight years or so. Strong, market-beating returns are a significant benefit for the fund and its shareholders.

On a more negative note, BIT's returns are somewhat inconsistent, with the fund sometimes underperforming its peers. From what I've seen, underperformance is generally due to negative alpha. As mentioned previously, the fund is actively-managed, and returns are somewhat dependent on management decisions, capabilities, and execution. Sometimes management makes mistaken decisions, causing the fund to underperform.

As an example, the fund's duration reduction strategy has not performed all that well these past three months, as rates have decreased. Further losses are likely if rates continue to decrease. The fund has underperformed for other periods of time, for similar reasons: unsuccessful trades and strategies.

BIT's inconsistent returns are something of a negative for the fund and its shareholders. I would not be surprised if the fund underperforms for shorter periods of time moving forward, but I do think that the fund is likely to outperform long-term.

PIMCO Comparison

Finally, I wanted to do a quick comparison between BIT and the high yield bond PIMCO CEFs. The different PIMCO funds have slight differences in characteristics, but most are quite similar. I'll be using the PIMCO Income Opportunity Fund (PKO) as a stand-in for these funds.

BIT is similar to PIMCO funds, but with lower yields, returns, risk, volatility, leverage, discounts, and losses during downturns. These are small differences, all things considered.

BIT has very slightly underperformed PKO since inception, on both a price and NAV basis.

Data by YCharts

Besides the above, BIT's returns are much less consistent than PKO's.

All things considered, I think that the PIMCO funds are slightly stronger overall choices, but not strong enough to justify a double-digit discount differential.

Data by YCharts

BIT seems like the better choice at current prices and discounts. Still, these are all strong choices.

Conclusion - Buy

BIT's diversified holdings, strong 8.0% distribution yield, and market-beating returns make the fund a buy.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.