This is an excerpt from a blog published earlier today discussing one purchase. Sold: 100 IGI at $21.02 and 50 PNTA AT $25.52/Bought Roth IRA 200 BHK at $13.305
With inflation trending down, I am become more sanguine at the moment about leveraged bond CEFs that concentrate on U.S. securities. My foreign bond funds have been negatively impacted by the strength of the USD.
I still have a hair trigger on leveraged bond CEFs that borrow short term to buy longer dated bonds.
11/7/14 Closing Prices on Select Bond ETFs
Added 200 BHK at $13.31-ROTH IRA (see Disclaimer):
Snapshot of Trade:
Security Description: BlackRock Core Bond Trust (NYSE:BHK) is a leveraged bond CEF that is weighted in investment grade bonds, but has a significant exposure to junk rated securities. As noted by the sponsor, the fund will generally have at least 75% of its assets in investment grade bonds.
Data on Date of Trade 11/7/14
Closing Net Asset Value Per Share: $14.87
Market Price: $13.36
Discount at $13.305= -10.52%
1 Year: - 9.51%
3 Year: - 5.67%
5 Year: -6.07%
CEFConnect Page for BHK
Last SEC Filed Shareholder Report (fiscal year ending 8/31/14; holdings start at page 13; net unrealized appreciation $37+M-see page 64; capital loss carryforward $5.935+M-see page 91)
Sponsor's Website: Core Bond Trust | BHK (532 holdings as of 10/31/14; 28.32% leverage as of 11/4/14; 100% weighted in USD denominated bonds)
The sponsor states that the effective duration was 9.51 years as of 11/4/2104.
Credit quality is weighted in investment grade bonds with a significant allocation to "A" or better rated bonds.
When I purchased BHK today, the fund had a 4 star rating by Morningstar.
Prior Trades: I recently bought 200 shares in a taxable account. Item # 1 Bought 200 BHK at $13.4 (8/23/14 Post) I hope to sell that 200 share for a profit since I am transitioning the position to the ROTH IRA.
There was a special distribution paid by this fund of $.17 per share in October that was related to its merger with another Blackrock CEF:
I had one earlier trade: Item # 2 Sold All of the Bond CEF BHK at $14.058 (2/21/12 Post)(snapshot of profit in that post)
Total Dividends: $224.67
Total Return: $293.25 or 10.63%
Given the nature of this investment, I am content with harvesting the dividends and exiting the position at a profit. An annual total return of 8% would be viewed as good. Eventually, I am going to get caught holding one or more leveraged bond CEFs when there is a non-temporary, quick and significant share price decline.
Dividends: The current monthly dividend is $.0755 per share. BHK Dividend Date & History
The next ex dividend date is 11/12/14
Rationale: I am moving my BHK position from a taxable account to the Roth IRA. I am in no hurry to sell the shares bought in a taxable account, since the proceeds will simply return to a money market fund yielding .01%. The BHK dividends take on the tax characteristics of interest payments made by the bonds owned by the fund and consequently will be taxed at the highest marginal tax rate when owned in a taxable account.
The primary reason for owning a leveraged bond fund now is to generate income. The dividend yield is about 6.81% at a total cost of $13.31 per share.
In the Roth IRA, the BHK's non-qualified dividends become tax free both when paid and when withdrawn.
Even though interests rates have fallen this year, the discount has widened some compared to 12/31/13. The net asset value per share, unadjusted for dividends, has risen to $14.87 per share as of 11/7/14, up 5.46% from $14.1 as of 12/31/13. The discount has widened slightly to -10.52% at my $13.305 purchase price from -8.65% as of 12/31/13.
I view it as an anomaly for a closed end bond fund to increase its net asset value per share by almost 5.5%, unadjusted for monthly dividend payments, and to increase its discount at the same time. The more typical reaction to such a positive net asset value return, particularly in a low interest rate environment, would be to bid up the market price and to narrow the discount. The unusual phenomenon this year described above may be related to the trauma experienced by individual investors in 2013, when the market price declined at a faster rate than net asset value per share when rates were rising causing many natural buyers to leave the playing field altogether.
This kind of fund does provide historically some ballast when stocks tank. The total return for 2008 was -.34% based on price. The ten year annualized total return is decent for a bond fund at 7.46% based on price and 7.16% based on net asset value, both calculated through 11/7/14. Those numbers can be found under the "performance" tab at CEFConnect.
Another advantage of this fund is the weighting in investment grade bonds and the diversity of holdings.
With inflation trending down, interest rate risk is mitigated to some decree though it remains a material risk.
Another positive is the possibility that the discount to net asset value will return close to its 3 and 5 year average near 6% which would create a 4%+ gain in the shares with the net asset value remaining the same and more with an increase in the net asset value per share unadjusted for dividend payments.
Risks: When interest rates rose in 2013, leveraged bond CEFs saw their net asset values decline some as interest rates rose from an abnormally low level to a less abnormally low level.
While that decline was significant for many of them, the decline in the market price was at a faster rate.
When the market price declines at a faster percentage rate than the fall in net asset value per share, the discount to net asset value expands creating an even larger loss in value. A fairly typical result during periods of rising rates is for the market price to decline at nearly twice the rate of the net asset value per share decline. This phenomenon increases the yield, but that kind of decline can also easily wipe out the benefit of the dividend for a year or more.
At CEFConnect, an investor can explore this recent history for a particular CEF by clicking the "Pricing Information" tab and to change the one month history tab back to 5/1/13 when the 10 year treasury closed at a 1.66% yield. I will generally compare that data with 12/31/13 which was near the peak in that last interest rate spike.
BHK Historical Data:
Market Price: $15.06
Net Asset Value Per Share: $15.67
Market Price: $12.88
Net Asset Value Per Share: $14.1
I can see right away that part of the market price loss was caused by an expansion of the discount from -3.89% to -8.65, more than a doubling.
Unadjusted for the dividends, the net asset value per share declined 10%, which should be a reminder to all investors that bond investing carries risks. The market price decline was greater at 14.48%. That additional loss is what I call a normal CEF risk. It can work both ways which gives investors both more risks than an ETF or a mutual fund investing in the same securities, and potentially greater benefits, depending on what happens to the discount after purchase. It is not a one way street.
At the time of my August 2014 purchase, the discount stood at -10.79% and -10.52% at my purchase today. Ideally, I would want to see that discount shrink now as the net asset value per share drifts up. The less than desirable alternative is for the discount to expand at a greater rate than a decline in net asset value per share.
Interest rate risks is a significant risk at present. With a duration close to 9 years, a slightly more than 1% increase in rates could result in another 10% loss in net asset value per share.
It would not take much of a rise in rates to wipe out a year's worth of dividends.
This fund's leverage increases the risks. A rise in short term rates will cause the borrowing costs to rise. If intermediate and longer term rates are also rising, then the value of securities bought with that borrowed money would be going down in value. Anyone investing in leveraged bond funds needs to understand that risk which would likely be compounded by an increase in the discount in that scenario of rising short to long term rates.
At the moment, short term rates are near zero and bonds have been doing well so far in 2014. That is an ideal scenario for leveraged bond funds who can generate a higher dividend for their investors due to the spread compared to an unleveraged fund investing in the same securities. Conditions will change, possibly or even probably for the worse. So these funds are not viewed as long term holdings but simply as trading vehicles that produce some income for funds otherwise earnings .01% in a brokerage money market fund.
Future Buys/Sells: I am not likely to buy more. I will certainly consider selling the lot purchased in the Roth IRA when and if I hit an total return of 8%, hopefully within a year. After collecting 12 months of dividends, it would only be necessary to capture a small profit on the shares to achieve that objective.
I will consider selling the 200 shares currently held in a taxable account when I can do so profitably.
Closing Price Today: BHK: $13.36 -0.02 (-0.15%)
Disclosure: The author is long BHK.
Additional disclosure: Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.