XFLT - 2 Fat Yields I'm Buying For An Abundant Retirement

2023-12-05 07:35:00 ET

Summary

• We're getting focused on capping out the year on a high note with high levels of recurring income.
• I am buying up these great funds offering yields up to 14%.
• An abundant retirement is marked by income that greatly exceeds your expenses.

Co-authored by Treading Softly

The year comes closer and closer to an end. We're shifting our perspective from being thankful for what we have to the idea that we have so much that we can be grateful by giving gifts to others – since we moved from the Thanksgiving season and into the Christmas season. Even if you're not exceptionally religious or religious at all, the vast majority of Americans still celebrate the Christmas or holiday season by gift-giving as a sign of gratitude to one another. Ironically, amid those two periods of time, is a commercial holiday of Black Friday designed to help you spend that money you were just being thankful for, and potentially buy gifts for the people to whom you eventually express gratitude.

When it comes to the market, investments don't typically fall into the Thanksgiving or Christmas category. For investors, the time between Thanksgiving and Christmas is often rife with a large amount of selling due to tax loss harvesting. That creates a period that professional income investors like myself are extremely grateful for – irrationally high yields due to other people's tax planning, and not because of any fundamental flaws. This allows me to pick up income more rapidly than before for no other reason than other people are selling things to avoid taxes. You're able to achieve rapid income growth in a short period of time because of others' actions. You can rapidly turn a retirement from one that may not have an excessive amount of income to one that is marked by abundance.

Today, I want to look at two great funds that I think are well worth holding and allowing them to pay you strong income for years to come.

Let's dive in!

Pick #1: XFLT – Yield 14.8%

XAI Octagon Floating Rate & Alternative Income Term Trust ( XFLT ) is a CEF (Closed-End Fund) that invests in "leveraged loans". Leveraged loans are senior secured loans to companies with balance sheets that are just shy of investment grade. Typically, companies that get leveraged loans have public credit ratings of B/B+.

XFLT invests in these loans in two ways: Holding them directly and holding them through CLOs (Collateralized Loan Obligations). The breakdown is roughly 50/50. Source

Despite being a floating rate, leveraged loans have not been immune to the broad sell-off of all things debt caused by the Federal Reserve's aggressive hiking campaign. The yield-to-maturity of leveraged loans has exceeded 10%, about on par with where they were during COVID, except for a much longer period of time. Source

XFLT's response to these low prices for loans has been to back up the truck and grow.

XFLT grew aggressively in late 2020/early 2021, which led to its dividend raise in 2023 to a level 16% higher than it paid pre-COVID. By buying at low prices today, XFLT is positioning itself for more dividend growth and growing NAV/share.

Originally, XFLT was designed to be a "term" fund. This means that at the end of its term (December 2029), the fund would be liquidated, and investors would receive NAV. However, Octagon's parent company, Conning Holdings, is being acquired by Generali Investment Holdings. As part of this acquisition, shareholders will need to approve a new advisory agreement, and the Board has approved an amendment that would remove the term date and make XFLT a perpetual fund.

With the new advisory agreement, there will be no change to the management of the fund, its policies, or goals. With the amendment, we will see the term date removed. This means that XFLT will remain a fund in perpetuity, and shareholders will not receive NAV on a certain date. If an investor wishes to exit the investment, they will have to sell at market price.

The benefit of a term date to investors is that it provides a date by which an investor can expect to get their principal back. This could be positive or negative, depending on whether conditions are favorable to redeploy capital at the term date. However, it does provide a certain stability. In theory, a term date should limit how far below NAV the share prices will go, especially as the term date gets near. Yet, it also limits how high of a premium it might trade for. In 2029, XFLT would almost certainly trade within a stone's throw of NAV.

Since its inception, XFLT has traded at a premium to NAV more often than not, which is an experience that is similar to other funds that invest in CLOs.

So, as the term date approaches, we would expect XFLT's price to trend lower, and for the premium to NAV to approach 0%. By removing the term date, XFLT will be allowed to trade at as high a premium as investors are willing to pay; 15%+ premiums are not unusual for the sector. A higher premium is great for existing investors, and it is great for the fund to be able to issue equity at a premium to NAV and grow more efficiently.

On the other hand, without a term date, XFLT's share price will be free to trade at a steeper discount to NAV. When we compare XFLT to other CLO funds, we can see that its premium/discount to NAV has been a lot less volatile.

This is in part because XFLT has only half of its assets invested in CLOs, but there is no doubt that the term date plays some role as well in limiting the extremes on both sides.

Since the bias in the asset class is to trade at high premiums due to the high cash flow it produces, we expect that if the amendment passes to remove the term date, the price of XFLT will trend higher than it has been. The average premium it trades at is likely to increase.

Since we already own XFLT, we are happy if the price rises, and we are happy to have the option to continue holding beyond 2029 if we want. Unless, of course, someone offers such an absurd price that we have a moral obligation to realize gains.

Pick #2: JPC – Yield 8.2%

Preferred equity has been heavily impacted by rising interest rates. After all, it is a "perpetual" fixed-income investment that the company can leave outstanding as long as it wants to. Higher interest rates mean that companies are incentivized not to call preferred. As a result, investors are receiving a fixed return indefinitely. This is great for collecting income, but when interest rates are rising, the longer the investment term, the harsher the impact on price. As a result, the past two years have seen the prices of preferred equity investments come down.

I often talk about the core strategy of the Income Method. It involves buying investments that produce a high current level of income and then planning on reinvesting at least 25% of that income. Even when you are withdrawing 75% of your dividends to fund your retirement, you are still a net buyer of stocks. You will own more of the economy every year, and this will help ensure that your income keeps growing.

In any given transaction, who benefits the most from a low price? The buyer or the seller? Obviously the buyer! When you are an income investor who is generating enough cash flow to fund your lifestyle and still have a portion available to reinvest, you will never be forced to sell a stock. You are in the enviable position to always be a buyer of stocks. So when prices are low, you can take advantage and be a buyer.

Nuveen Preferred & Income Opportunities Fund ( JPC ) recently absorbed two similar Nuveen funds: JPS, and JPT. JPC holds a combination of preferred equity and bonds, both of which have been impacted by rising interest rates.

The market frequently overreacts to changes in NAV for CEFs. JPC has seen its NAV decline, and it has seen its discount to NAV steepen. In July 2021, when preferred shares were super expensive, JPC was trading at a premium to NAV. Fast forward two years later, and JPC is trading at a 13%+ discount to NAV!

There is no question that fixed-income investments are selling for the lowest prices seen in decades. If an investor were attempting to follow the creed "buy low, sell high", this fact would encourage the investor to consider buying fixed-income. Yet the market is doing the opposite. It is pricing JPC at a steeper discount than it was when fixed-income prices were the highest they've been in decades. The market bought high and is now selling low.

For investors who are following the Income Method, we have an opportunity to add more shares at a discount to NAV, grow our income, and not worry about whether interest rates fall next year or stay "higher for longer". We don't have to worry because we are buying at a great price and receiving a great yield while we wait for the interest rate cycle to turn. Low prices always benefit the buyer, and fixed-income investments are trading at a low price; JPC amplifies it by trading at a hefty discount to NAV.

Conclusion

With XFLT and JPC, we can take advantage of the weakness in the fixed-income sector to unlock a massive boost of income. At times, I'll refer to some high-yielding investments as "accidental high yielders," simply because there's an irrational level of selling that has pushed down that security and caused it to have a high yield when it typically doesn't. On the other side, as I like to call it, the "income catalyst," stocks with extremely high yields that only take a little bit of it to be able to produce a massive boost to your income stream. Today, we looked at two different funds. XFLT falls into the income catalyst category, and JPC is more of an accidental high yielder because of the sell-off in preferred securities due to high interest rates.

When it comes to your retirement, I want your income stream to be steady, stable, and recurring. I don't want it to be something that you have to worry about each month or each quarter or each year, wondering how you're going to afford the basics of life. I want all of those basics of your life to be fully covered without question, leaving you the only consideration of what you're going to do with your excess free time. I want each day to be one where you wake up and have endless possibilities of things that you can do and that your financial future isn't in question and isn't restricting you from achieving your desires. That is true financial freedom. It's a truly abundant retirement.

That's the beauty of my Income Method. That's the beauty of income investing.

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