Author's note: This article was released to CEF/ETF Income Laboratory members on September 27, 2021. Please check latest data before investing.
KKR Income Opportunities Fund (NYSE:KIO) looks quite intriguing here in this month's "High-High-Low" report. Although it doesn't have the best combined metrics, it is the 9th-highest yielding fund and the 10th-ranked "DxY" fund among those with >6.5% yield, >85% coverage and under <+5% premium.
A brief description to KIO, a dynamic bond/loan CEF, can be found from the fund's website:
KKR Income Opportunities Fund (“KIO” or “the Fund”) seeks allocate across credit instruments to capitalize on changes in relative value among corporate credit investments and manage against macroeconomic risks. The Fund is designed to offer investors:
- Potential for attractive levels of current income through monthly distributions
- A targeted portfolio investing primarily in bank loans and high yield securities
- KKR Credit's consistent approach and strong credit investment process that seeks to adapt credit strategies to market conditions
As of October 8, 2021, KIO closed at a -1.78% discount and has a 1-year z-score of +1.2. What attracted me though was its exceptional coverage of 113% on a yield of 7.60%, as well as strong historical performance.
Why then do I feel comfortable potentially owning KIO? The answer is in its performance. It could be the "KKR" factor, but KIO actually did better during the March 2020 crash than other peers like Ares Dynamic Capital Allocation Fund (ARDC) or Aberdeen Income Credit Strategies Fund (ACP), which are other "dynamic" bond/loan fixed income funds.
Over the past 1-year interval, KIO leads at +25.66% followed by ARDC at +21.32% and ACP at +18.88%. Interestingly, ACP was actually ahead of ARDC for the better half of this chart, but then it conducted a highly dilutive rights offering that significantly impacted the NAV.
Over the longer term, KIO has significantly outperformed ARDC, which also in turn significantly beat ACP.
According to CEFData, KIO ranks 2 out of 32 funds in the high-yield bond category over 1 year, 9 out of 29 over 3 years, and 6 out of 27 over 5 years.
KIO had to reduce its distribution by -16% from $0.125 to $0.105 in 2020, like many other fixed income funds, having held it steady for over 7 years since inception.
At this lower distribution rate, its coverage has improved to 113% as we can see from the latest financial highlights of the fund's semi-annual report. This is calculated from the net investment income for the last 6 months being $0.71, which divided by 6 months' worth of distributions (6 x $0.105 = $0.63) gives 113%.
Now, KIO isn't a pure high-yield bond fund; in fact, it has more allocated to the leveraged loan category. Given that bonds have generally outperformed loans during the last decade of declining interest rates, the outperformance of KIO is especially impressive.
However, do note that KIO has an extremely junky portfolio, with 61.7% (gulp!) of the portfolio rated CCC or below. Another 32.4% of the portfolio is in the single B category and only a measly 5.9% rated BB or higher.
To make the above weights easier to visualize, I've sorted the data in terms of credit rating rather than weight to create the following chart:
(Source: Stanford Chemist, KKR)
According to S&P Global Ratings, the one-year global default rate on CCC or below debt is 28.30% (average) and 25.78% (median).
(Source: S&P Global Ratings)
2020 was an especially difficult year for low-rated debt, with CCC or below defaults spiking to 47.48%.
(Source: S&P Global Ratings)
Because of KIO's junky portfolio, it will likely underperform other fixed income funds if economic conditions sour, unless the managers are able to judiciously select the right investments.
Although KIO isn't a great bargain right now at a -1.78% discount, this recent mini-dip might be chance to initiate a position for those who are interested in this fund. Keep in mind though the fund's highly junky portfolio, as well as the maxim "past performance is not a guarantee of future results!"
I do believe that the fund's 7.60% yield is relatively secure and the fund's strong performance through the market crash has raised my opinion of this fund.
Nick (a contributing author to CEF/ETF Income Laboratory) has previously covered KIO in more detail here: KIO: High-Yield, High-Risk "Dynamic" Credit Fund.
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Disclosure: I/we have a beneficial long position in the shares of ARDC either through stock ownership, options, or other derivatives. 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.