Where to find 7% yields when bonds pay so little
When yields go up, prices go down. This fundamental but inescapable mathematics of the bond market must be learned by a new generation of investors at each cycle. That includes many of those who have invested nearly $ 350 billion in fixed income funds so far, with returns at historic lows and high bond prices.
It’s a lesson that has been picked up a bit painfully over the past week. The 10-year Treasury note, the benchmark for the investment grade bond market, briefly touched a low yield of 1.125% on August 4, matching a level reached on July 19. At the time, I wrote a column about the ups and downs of Wall Street. warning of the risks posed by the bond market at these rich prices (and therefore low yields.)
But since then, the 10-year yield has reversed course and jumped to 1.316% on Monday night. As a result, the
IShares 20+ Treasury Bond Exchange Traded Fund
(ticker: TLT), a popular game in the bond market, has lost 3.33% of its value from its highest tick on August 4 until the close on August 9. To put this into perspective of the stock market, this would equate to a drop of more than 1,100 points in the
Dow Jones Industrial Average.
Because of this risk in so-called risk-free government bonds, I reiterated a suggestion I made during a previous equity screening earlier this year, for corporate loans at interest rates. variable. These leveraged corporate bonds are expected to benefit from the economic recovery after the downturn caused by the pandemic.
But, because these loans have variable interest rates that float in tandem with short-term rates set by the Federal Reserve, loan values are not affected by rising bond yields. When the central bank finally raises policy rates, perhaps not until 2023, loan interest rates should adjust accordingly. In the meantime, they pay a relatively high rate, typically a five to eight percentage point spread from a base such as the London Interbank Offered Rate (LIBOR) due to borrowers’ generally low credit scores. Such loans, like junk bonds, would be hit in a recession like last year’s brief contraction. But they look pretty safe now.
The dual appeal of raising better economy loans but the lack of risk associated with rising interest rates made them winners this year. Closed funds that invest in loans have benefited even more. The screen released in January showed CEFs trading at a discount of at least 10% to net asset value, a hangover from Covid-induced losses in 2020, and yielding more than 6%. (CEFs issue a defined number of shares and can trade at a premium or a discount to their underlying NAV.)
Since then, these discounts have narrowed sharply, with investors doing good business among loan CEFs. Indeed, an example listed in the January screen,
BlackRock Debt Strategies
(DSU), produced a total return of 20.31% for the year through Monday, according to the Morningstar fund tracker.
A reader has requested an update on the category following last week’s Up and Down Wall Street column. So I put together a new list of loan CEFs, ranked by Morningstar, still trading at a discount and with returns of at least 6% (and over 7%). This is roughly double the return of 3.25% on the
IShares iBoxx $ High Yield Corporate Bond ETF
(HYG) due to the leverage of closed funds. All of the funds here have maintained or increased their monthly distributions and are not increasing payouts with a return of capital. The minimum size was $ 200 million.
|Nuveen Variable Rate Income||JFR||7.09%||-5.31%|
|Nuveen Variable Rate Income Opportunity||JRO||7.09||-5.26|
|Nuveen Income Senior||NSL||7.03||-4.76|
|Apollo senior floating rate||AFT||6.03||-4.38|
|BlackRock Floating Rate Income Strategies||ENG||6.02||-4.45|
|BlackRock Debt Strategies Fund||Memorandum of Understanding||6.39||-2.83|
|Eaton Vance Senior Floating Rate||FRF||6.91||-1.26|
Data as of August 9.
Sources: funds websites, cefconnect.com.
Many bond prognosticators predict that the 10-year Treasury yield could continue to rise, possibly only to return to its 2020 peak of around 1.75% at the end of March, with many looking for a 2% return as the economy continues to recover and the Fed eventually slows down. its massive monthly bond purchases of $ 120 billion. This could produce more painful lessons in bond math due to the resulting declines in long-term securities prices, but the continued stable returns of loan funds.
Write to Randall W. Forsyth at [email protected]