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. Me personally, I am in a waiting mode to see a statistical opportunity to review some of the funds. If the stock market situation remains hesitant and we observe increased volatility, we may see some decline in the prices of the high-yield bonds.
An extremely positive week for the high-yield bonds and the closed-end funds which invest in them. The idea that the Federal Reserve will cut interest rates soon was very well accepted by the market participants and helped the riskier assets to finish the week in green territory. Of course, the situation around the trade negotiations and the economic data are crucial for future actions of the central bank.
As a benchmark of the high-yield bonds, we use iShares iBoxx $ High Yield Corporate Bond ETF (HYG) to measure the performance of the sector. On a weekly basis, the main index reported an increase of $1.20 per share and finished at $86.10 per share. Also, it is important to mention that on Monday the benchmark distributed its monthly dividend of $0.39 per share.
Source: Barchart, iBoxx $ High Yield Corp Bond iShares
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 US 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 0.06 bps.
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 (TLT). As discussed, we observe a low correlation between the two sectors – it is 0.70 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 (SPY). There is definitely a stronger relationship between them for the last 80 days. As you see, it is 0.91 points.
Source: Author’s software
Source: Yahoo News, High Yield Closed-End Funds News
Several funds from the sector announced their regular dividends:
- Ivy High Income Opportunities Fund (IVH) $0.1000 per common share.
- Pioneer Diversified High Income Trust (HNW) $0.0950 per share.
- Barings Global Short Duration High Yield Fund (BGH) $0.1482 per share.
- New America High Income Fund (HYB) $0.0550 per share.
Review Of High-Yield CEFs
Weekly % Changes In The Sector
1. Lowest Z-Score:
After four consecutive negative weeks, we see the end of this unfavorable series. Over the past week, 23 of the 24 funds which we do track increased their prices.
As usual, our weekly analysis is starting with a review of the Z-score as an indicator of statistically undervalued or overpriced closed-end funds from this area. If we take into account the significant bounce back of the prices over the past five days it seems reasonable to see only a couple of negative Z-scores in the sector. Last time we had 9 funds with negative Z-score but the optimism among the market participants managed to return most of them to positive territory.
Apollo Tactical Income Fund, Inc. (AIF) is one of the two high-yield CEFs which have statistical parameter below 0.00 points. The fund seeks current income with preservation of capital through investment in different types of credit instruments including senior, structured loans and high-yield corporate bonds.
From my perspective, it can be a very reasonable buying opportunity. Currently, its yield on price is 8.17% and the monthly dividend is $0.1020 per share. I really appreciate the fact that the dividend was stable over the years and the constant level of earnings/coverage ratio which was maintained. As you see in the chart below, the ratio was above the important border of 100% which is a signal that earnings gained by the portfolio of the closed-end fund were enough high to cover the distributed dividend.
2. Highest Z-Score:
Over the past week, we saw an increase in the prices of the funds but not enough to say that it is a time to think about “Short” positions. Why am I saying this? Some of the participants have high Z-scores but they are still traded at discounts. However, from a statistical point of view, a Z-score above 2.00 points is enough strong signal to say that you should be careful with this funds and it is better to close your long positions in them.
The average Z-score of the high-yield CEFs is 0.96 points. On a weekly basis, we find 0.79 bps increase of the average value. It is pretty interesting to notice the drastic change. At the end of December, we had -3.43 points average Z-score and now is almost 1.00 point.
3. Biggest Discount:
We do not find many statistical reasons to review the funds, but the spread between their prices and net asset values remains pretty widened. We do have 11 closed-end funds from the sector with a discount of more than 10.00%. If you are planning to expand your portfolio with “Long” positions, the ranking above is a strong starting point.
Credit Suisse Asset Management Income Fund (CIK) continues to be one of the interesting funds. It has relatively low Z-score and one of the highest current yields. Over the past week, its price rose by 1.66% and its net asset value increased its value by 0.59%. However, its discount is still above 10.00% and I still see an upward potential for the price. its coverage of the dividend is still in a good shape and I do not see anything which should worry us.
The average discount/premium of the high-yield CEFs is -7.19%. Last week, the average spread between prices and net asset values was -8.32%.
4. Highest Premium:
In our previous article, I shared with you the opportunity to review Barings Corporate Investors (MCI) as a potential addition to your portfolio based on its lower premium compared to its historical values. The fund was the best performer of the week with its increase in the price of 3.34%.
For me, 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.
Here is the full picture of the funds from the sector. Below, we have depicted their discount/premium and their Z-score:
5. Highest 5-year Annualized Return On NAV:
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 4.77% for the sector. As you can see, most of the current yields on price and net asset value are higher than the historical ones. The situation seems justified because last year we saw two sharp declines in the prices of the funds.
One of the funds which caught my attention is Credit Suisse High Yield Bond Fund (DHY). It can be reviewed as a potential “Long” candidate because of its relatively low Z-score and as we see, it has one of the best historical returns on its net asset value. On top of that, we are talking about a juicy current yield of 9.16%.
6. Highest Distribution Rate:
Barings Global Short Duration High Yield Fund (BGH) continues to be the leader of the ranking with its current yield of 9.91%. 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 better timing to enter into a new long position.
The average yield on the price for the sector is 8.23%, and the average yield on net asset value is 7.63%. The difference between the two values can be easily explained by the spread between the price and the net asset values of the funds.
7. Lowest Effective Leverage:
We have two funds which are not leveraged and three which use leverage below 10%. The average leverage for the sector is 26.87%. Below, you can see the relationship between the effective leverage of the funds and their yield on net asset value.
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 to review them as a potential “Buy” candidates.
Note: This article was originally published on June 09, 2019, and, as such, some figures and charts might 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.