Some Thoughts On Price Volatility Of ECC And OXLC

Dec. 24, 2017 10:03 AM ETECC, OXLC27 Comments
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Long Only, CEFs, Deep Value, Long-Term Horizon

Contributor Since 2009

Steven Bavaria is the author of "The Income Factory: An Investor’s Guide to Consistent Lifetime Returns" (McGraw Hill, 2020), and publishes a boutique marketplace service - Inside the Income Factory - here on Seeking Alpha. He introduced the Income Factory philosophy in his Seeking Alpha articles over the past ten years. Bavaria writes about finance, economics and politics, drawing on his fifty years experience in international banking, credit, investment, journalism and public service. His earlier book "Too Greedy for Adam Smith: CEO Pay and the Demise of Capitalism" was inspired by his brief experience running the human resources department at the Bank of Boston, where he first learned about the excesses in the CEO pay arena. The book is available on Amazon and at independent retailers. (Here is the link.)
Bavaria began his career at the Bank of Boston, where he handled international credit workouts that included managing a fleet of ships, chasing a Vatican-owned bank in Switzerland, and leading the turnaround of troubled branches in Australia and Panama, before returning to Boston to run the bank's human resources department.

Later he worked at Standard & Poor's, where he introduced ratings to the leveraged loan market. (Read about it here.) In between Bank of Boston and S&P he was Assoc. Commissioner of the Massachusetts Dept. of Mental Health, worked briefly for Citibank, and was a reporter for IDD Magazine. He also did a short stint at a smaller rating agency where he had to leave in a hurry after writing an article called "From Banker to Bookmaker" that was deemed too candid in describing the conflicted role of major commercial and investment banks. (Read it here.)

Bavaria graduated from Georgetown University and New England School of Law. He lives in Ponte Vedra, Florida.

Summary

  • A reader asked me about volatility of stocks like OXLC and ECC that own CLOs and I shared some thoughts in the comment string.
  • I thought I'd put it in a blog to make it more accessible to the relatively small but focused group of us that follows these funds.
  • In a nutshell: Love/hate relationship for some investors who love the high dividends, but are scared owning a more complex investment they don't fully understand.
  • CLOs actually no riskier than more conventional high yielding investments, but "the market" demands higher yield because it sees them as "exotic" and complex.

Re the seeming volatility of CLO fund pricing, there may be various issues at work. Because of the nature and complexity of CLOs, which were bought for years by large institutions that only looked at the cash flow and made no attempt to "mark to market" the equity the way a public vehicle (closed end funds and other funds) is required to do, funds like OXLC and ECC will always be a challenge for many retail investors to understand and be comfortable with. They love the high distributions, but don't always fully understand where they come from (are they income? GAAP income or "taxable" income? what does that mean? are they "wasting assets" like oil and gas trusts? well, not really........ but it's complicated, etc. etc.).

Hence it is no surprise there is a sort of jumpiness among retail holders, especially if they have to get a big quarterly dividend and then wait patiently for another one three months later. Lots of potential nail-biting in between. Oxford Lane Capital (NASDAQ:OXLC) has cut down the nail-biting period the way Eagle Point Credit (NYSE:ECC) did earlier by deciding to go to monthly dividends. Some of its recent price volatility may be due to some people mis-interpreting the announcement at first and thinking it was a dividend cut rather than merely spreading it over three months instead of a single quarterly payment. In fact they added a half cent to it to make it divide more evenly.

I think ECC's price volatility reflects the fact that "the market" no matter how much it likes ECC and its management (and they deserve to be liked - they are really good), may feel 12% is a little too low a yield for a CLO investment. So every time the market price rises enough to push the yield closer to 12%, the price drops and pushes it back closer to 13%-13.5%, the lower end of the "natural yield expectation" for a CLO investment. Not that CLOs are any riskier than many more conventional high yield credit-oriented investments (HY bonds, BDCs, etc.), but their greater "complexity risk" makes them seem more risky or exotic to many in the market.

So some investors have this "love-hate" relationship with the CLO-owning funds in that they love the distributions and would like to believe that management is solid and knows what it is doing, but deep-down don't really understand them enough to be truly comfortable. Hence the itchy trigger finger and tendency to bail out at the smallest whiff of danger or any other anxiety. They find the funds a little scary and aren't sure they really want to own them, except on those dividend days.

In some ways I am reminded of the story Woody Allen told at the end of Annie Hall about the guy who had a brother who believed that he was a chicken. When asked about why the family didn't have him institutionalized, his answer was: "We need the eggs."

Nice eggs. Now delivered monthly rather than quarterly.

Disclosure: I am/we are long OXLC, ECC.

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