ACP: Finally Moving From Sell To Hold For This CEF

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Binary Tree Analytics
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Summary

  • ACP is a fixed income CEF focused on global high yield.
  • ACP is focused on the bottom of the credit spectrum with a high concentration in B & CCC debt (41.8%).
  • The fund is down more than -11% since our Sell rating.
  • This article covers CEFs from our suite of products - we focus on macro portfolio allocation, CEFs and yield-producing options strategies, targeting overall returns of 9%+.

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Thesis

We wrote several articles on Aberdeen Income Credit Strategies Fund (NYSE:ACP) where we recommended and maintained our Sell rating on the fund. After another -11% performance since our last article, we are finally moving to Hold for this fund, with the bulk of the negative performance now behind us.

Aberdeen Income Credit Strategies Fund is a closed-end fund (CEF) investing mostly in dollar high yield ("HY") debt from the UK, Europe, and North America. The fund has a very high concentration in the riskiest type of junk debt (single B and CCC rated) which makes it highly volatile as observed in its five year standard deviation of 18.43.

The fund has a low duration of approximately 3.2 years, but has not escaped the violent move higher in the yield curve, even for short duration tenor points. Three-year yields are up almost 200 bps since the beginning of the year. Correlated with wider credit spreads across the board, wider yields and spreads have caused a -15% price return for the fund so far in 2022. We feel that given, the wide levels of the front end of the curve, there is not much left in terms of negative performance from rates. With credit spreads having widened already, the fund is already pricing a normalizing market default environment. We therefore move from Sell to Hold on ACP.

Analytics

Leverage Ratio: 44%

  • fairly high for the HY CEF space.

Expense Ratio: 3.06%

  • on the high side, ACP seems to justify this because of the high portfolio turnover.

Funding

  • has both Repos/TRS as well as Preferred Equity (OTCPK:ACPPP), which was priced extremely low back in May 2021 (positive for the fund).

Manager: Standard Life Aberdeen

  • premier international asset manager with a solid track record.

Premium / Z-stat: 2.37% premium, -0.3 1-year Z-statistic

  • the fund is trading at a premium
  • the premium is low when comparing the historical premium for this fund (Z-stat).

Performance

The fund is down more than -15% on a price basis in 2022:

ytd

YTD Performance (Seeking Alpha)

Given the fund leverage and credit slice concentration, ACP has held up fairly well so far this year.

From a total return perspective the fund is still up slightly on a 3-year timeframe:

return

3-Year Total Return (Seeking Alpha)

Given the significant recent negative performance, the trailing ten year annual return has now decreased to 3.7%:

return

10-Year Trailing Total Return (Seeking Alpha)

Holdings

ACP is really focused on the bottom of the credit spectrum, with a high concentration in B & CCC debt (41.8%):

rating

Credit Ratings (Fund Fact Sheet)

What does this mean? It means the fund buys the most risky investments in the high yield space which, although providing a higher yield, are the ones to lose value the fastest and the most likely to default in an economic downturn.

As a quantitative way of looking at probabilities of default from ratings, please find below an S&P study on defaults based on ratings:

Global corporate average cumulative default rates

Default Probability Matrix (S&P)

What is particular about this fund is that the focus is not exclusively on North American credits, but the portfolio is composed of UK and European credits as well, with a roughly 1/3rd split to each jurisdiction:

country

Country (Fund Fact Sheet)

The fund is entirely USD-based nonetheless:

currency

Currency Exposure (Fund Fact Sheet)

From an individual name perspective, the fund is fairly concentrated, with the top ten holdings accounting for over 24% of the fund's exposure:

names

Top Ten Holdings (Fund Fact Sheet)

Premium/Discount

The only remaining concern for this fund is the fact that it is still trading at a premium to net asset value:

premium

Premium / Discount (Morningstar)

We can see that, prior to 2021, the fund historically traded at discounts to net asset value of -5% up to -13%. We would have expected to see this year a reversion to a discount to NAV, but it has not occurred yet. We feel this is the only shoe left to drop in terms of risk for this fund.

Conclusion

ACP is a fixed income CEF focused on global high yield. The fund tends to invest in the riskiest credit slices, namely single-B and CCC rated debt. This portfolio composition gives the fund a high historic standard deviation and the propensity to experience significant downside volatility as credit spreads widen.

Although it has a low duration of 3.2 years, the fund has not been spared by the increase in risk free rates this year. The wider yield curve corelated with wider credit spreads have contributed to the fund's negative performance so far in 2022.

Outside the persistent premium to NAV for the fund we feel the bulk of the negative move driven by yield and credit spread factors is behind us. We are therefore moving from Sell to Hold for the fund from the lens of a short-seller who would do well to close such position on ACP.

This article was written by

Binary Tree Analytics profile picture
2.43K Followers
With a financial services cash and derivatives trading background, Binary Tree Analytics aims to provide transparency and analytics in respect to capital markets instruments and trades._____________________________http://www.BinaryTreeAnalytics.com

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.

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