Weekly Review: High-Yield CEFs – The Price Of The Benchmark Left In Red Territory

ETFS

Introduction

The closed-end funds from the high-yield sector significantly increased their prices over the past months. Currently, most of them are traded at positive Z-scores, which is an indication that they have lost most of their statistical edge. Still, they are traded at high discounts, but we are cautious when we select our positions due to the lack of statistical edge. For me, personally, I am in a waiting mode to see a statistical opportunity to review some of the funds.

The Benchmark

The Federal Reserve cut interest rates by 0.25 basis points for the third time this year, and on Friday, we saw stronger-than-expected U.S. jobs data. Although the economic data is optimistic and the interest rate cut is a positive fundamental change for the high-yield bonds, the main benchmark of the high-yield sector remained in red territory.

Over the past week, the main benchmark iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG), which we use to track the high-yield bonds, fell by $0.57 per share and finished the Friday session at $86.82 per share. Also, it is important to mention that the main index distributed its monthly dividend of $0.36 per share.



Source: Barchart, iBoxx $ High Yield Corp Bond iShares



Source: Dividend.com

Statistical Comparison And Spread Review Of The Sector

High-yield bonds are typically evaluated on the difference between their yield and the yield on the U.S. Treasury bond. High-yield spreads are used by investors and market analysts to evaluate the overall credit markets. Higher spreads indicate a higher default risk in junk bonds and can be a reflection of the overall corporate economy and/or a broader weakening of macroeconomic conditions. On a weekly basis, we notice an increase of 0.19 bps.

Chart

Data by YCharts

Source: YCharts, US High Yield Master II Option-Adjusted Spread and US High Yield Master II Effective Yield

Below, you can find a statistical comparison between HYG and the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT). We observe a correlation between the two sectors of 0.84 points for the last 200-day period:



Source: Author’s software

On the other hand, we have a statistical comparison between HYG and the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). There is definitely a stronger relationship between them for the last 200 days. As you see, it is 0.96 points.



Source: Author’s software

The News



Source: Yahoo News, High Yield Closed-End Funds News

Many funds from the sector announced their regular dividends:

  • New America High Income Fund (NYSE:HYB) $0.0550 per share.
  • MFS Intermediate High Income Fund (NYSE:CIF) $0.0203 per share.
  • Invesco High Income Trust II (NYSE:VLT) $0.0964 per share.
  • Ivy High Income Opportunities Fund (NYSE:IVH) $0.1000 per share.
  • Neuberger Berman High Yield Strategies Fund (NYSEMKT:NHS) $0.0905 per share of common stock.
  • AllianceBernstein Global High Income Fund (NYSE:AWF) $0.0655 per share of investment income.

Review Of High-Yield CEFs

Weekly % Changes In The Sector



Source: CEFConnect.com

1. Lowest Z-Score:



Source: CEFConnect.com

Over the past week, we did not see some interesting changes in the sector. The closed-end funds which invest high-yield bonds did not have a clear direction of their prices and their net asset values. MFS Intermediate High Income Fund (CIF) was the worst price performer of the week after the 1.09% decline in its price. This small correction was somehow expected because, last week, its price reported a 6.18% increase. From my perspective, CIF is overpriced, and it is too risky to buy it at this price.

The pure statistic is always an important part of my analysis. Therefore, the first criterion that I am going to use is a statistical one. The Z-score indicator shows us how many times the discount/premium deviates from its mean for a specific period. By the value of the Z-score, we can figure out whether the fund is overpriced or undervalued. Theoretically, when the Z-score is negative, the fund may be reviewed as a potential “Long” candidate. As you see, most of the high-yield CEFs are traded at positive Z-scores. For me, this is a signal to be cautious when I select my long positions and to decide whether I can gain from a capital gain.

Apollo Tactical Income Fund, Inc. (NYSE:AIF) is one of the interesting options which I see in the above table. Its attractive discount of 10.53%, which is accompanied by an average Z-score of 0.90 points, is a strong foundation to review the fund as a potential “Buy” candidate. The current yield is 8.15%.

Another important fact is the positive earning/coverage ratio of the fund which signals that the management team can fully cover the dividend with the earnings from the investments. In other words, based on this ratio, the fund is able to keep the current dividend unchanged.



Source: CEFdata.com

The positive UNII/Share balance is another fact which should be taken into consideration when we are talking about the protection of the dividend. In combination with the earning/coverage ratio, it is an important factor for the distributions.

2. Highest Z-Score:



Source: CEFConnect.com

On the other hand, I have plotted the funds which should be statistically overpriced. The strong performance of the sector led to a situation where most of the closed-end funds are traded at positive Z-scores. When the statistical parameter is above 2.00 points, the fund can be categorized as relatively expensive, and we should not buy them. First Trust High Income Long/Short Fund (FSD) is a very good example of a fund that I will avoid at these price levels. Its Z-score of 3.10 points is the highest one in the area, and it is much higher than my border of 2.00 points, which I mentioned. If there is a turbulence in the sector, this closed-end fund may be traded at again at a discount of around 18.00%.



Source: CEFdata.com

The average Z-score of the high-yield CEFs is 1.38 points. On a weekly basis, we find a slight increase of 0.19 bps of the average value.



Source: CEFConnect.com

3. Biggest Discount:



Source: CEFConnect.com

If you are seeking new potential “Buys” for your portfolio, probably, you may find it reasonable to start from this table. Yes, we still cannot talk about a significant statistical edge, but the discounts in the sector remain attractive.

The Ivy High Income Opportunities Fund (IVH) continues to be one of the closed-end funds which have an average value of its Z-score. Still, trading at an attractive discount of 9.46%, this fund may catch your attention. The current yield is 8.89%, and it has one of the most stable dividends in the sector. On top of this, the latest earnings per share were higher than the dividend, which is a positive sign for stability of future payments.



Source: CEFdata.com

Most of the investments owned by this CEF are with rating “B.” The portfolio is constructed by issuers located globally, but 81.6% of the assets are located in the United States. A brief overview of the investments shows that the portfolio is mainly comprised of corporate bonds and senior loans.



Source: Fund Sponsor Website

The average discount/premium of the high-yield CEFs is -4.56%. Last week, the average spread between prices and net asset values was -5.19%.



Source: CEFConnect.com

4. Highest Premium:



Source: CEFConnect.com

Barings Participation Investors (NYSE:MPV) is again traded at a high premium after the strong performance in the last two weeks. On a weekly basis, its price reported an increase of 5.43%. As I main reason for this trust, I see the good past results, which were achieved by the management. However, I do not recommend to buy funds which are traded at a high premium.

From my perspective, MFS Intermediate High Income Fund (CIF) may be a very good “Short” candidate if we see turbulence in the sector. As you see, we can easily categorize this CEF as overpriced if we use discount/premium as a reason.



Source: Morningstar.com

Here is the full picture of the funds from the sector. Below, we have depicted their discount/premium and their Z-score:



Source: CEFConnect.com

5. Highest 5-year Annualized Return On NAV:



Source: CEFConnect.com

Above are the funds that outperformed their peers by return on net asset value for the past five years. The average return on NAV for that period is 5.34% for the sector. As you can see, most of the current yields on price and net asset value are higher than the historical ones.

6. Highest Distribution Rate:



Source: CEFConnect.com

Barings Global Short Duration High Yield Fund (NYSE:BGH) continues to be the leader of the ranking with its current yield of 10.18%. Actually, I really like this fund and its portfolio characteristics. Its dividend is very stable and protected by positive earnings/coverage ratio and improving UNII/share balance. Also, you will find out that BGH has one of the lowest durations in the area. My concern here is related only to the fact that its price has increased significantly, and I will wait for a better time to enter into a new long position.



Source: CEFdata.com

The average yield on the price for the sector is 8.23%, and the average yield on net asset value is 7.84%. The difference between the two values can be easily explained by the spread between the price and the net asset values of the funds.



Source: CEFConnect.com

7. Lowest Effective Leverage:



Source: CEFConnect.com

We have two funds which are not leveraged and three which use leverage below 10%. The average leverage for the sector is 26.55%. Below, you can see the relationship between the effective leverage of the funds and their yield on net asset value.



Source: CEFConnect.com

Conclusion

The high-yield sector does not provide us with significant arbitrage opportunities at present. Most of the CEFs are trading at discounts, and it is difficult to find so many potential “Short” candidates. On the other hand, there are still interesting funds which provide us with an attractive valuation based on the discount, and we can review them as potential “Buy” candidates if their Z-scores are not too high. However, we should be careful when the situation in the market seems unstable and the riskier assets such as high-yield bonds, CEFs may be affected by the volatility.

Note: This article was originally published on November 03, 2019, and some figures and charts may not be entirely up to date.

Trade With Beta

At Trade With Beta, we also pay close attention to closed-end funds and are always keeping an eye on them for directional and arbitrage opportunities created by market price deviations. As you can guess, timing is crucial in these kinds of trades; therefore, you are welcome to join us for early access and the discussions accompanying these kinds of trades.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IVH over 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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