OXLC - An Eye-Popping Fully Covered 19% Yield: OXLC

2023-09-25 07:35:00 ET

Summary

• Misunderstandings are prevalent in life, likewise, they exist in the market.
• Many investors bring preconceived notions with them as they approach the market.
• You can profit from those issues and enjoy a great income while doing so.

Co-authored by Treading Softly

You don't have to be in a relationship for long to understand that many fights that occur are due to simple misunderstandings. You think you said one thing, they think you said something different, or they misunderstood what you said, and the meaning was muffled. At the end of the day, you're bickering over semantics, when really the thrust of the matter is completely different.

In most relationships, there is someone who is extremely particular with someone who is much less particular. So, one will use terminology and words with a very narrow meaning, while the other likes to paint with a broader brush – neither is wrong in how they apply their words, but it can often lead to massive misunderstandings.

When it comes to the market, investors will use the same terminology as one another, but have their own homegrown definitions. Unfortunately, there is no dictator of what each definition may mean that all investors will agree on, and therefore, when investors say, "I'm getting a great return," it may mean something different to each and every person who's listening to them.

As an income investor, my priority is income first. I want investments that will pay me dividends that I can then use elsewhere. Each dividend received is a return on my investment that cannot be revoked or taken away from me. Another portion of your total returns is the price change. What investors often mistake – especially novice investors or investors who do not invest for dividends – is that they believe that the dividend portion of the return is meant to augment or replace price change returns – it's not. The dividend should be viewed entirely separately. If a security drops 7% but pays a 9% yield, you should not expect that the dividend will always replace the price change returns.

Today, I want to take a closer look at one specific investment that so many investors misunderstand because they come with their preconceived notions and try to impart their viewpoint on the investment instead of looking at it objectively.

Let's dive in!

The Big Argument

Oxford Lane Capital Corp. (OXLC), yielding 19.3%, is a CEF (Closed-End Fund) that inspires a lot of discussion among investors. Some will point at the charts and declare that OXLC 's net asset value is "eroding". Others will look at the income and point out that the price action is not the same as the realized return.

OXLC's price has fallen a lot since its IPO. Yet if you bought at the IPO and sold your position today, you would have doubled your money.

What accounts for this huge difference? With any dividend investment, you have two sources of return. You have the dividend, which is a realized cash return put into your hands – providing you the option to reinvest or to spend elsewhere. Second, you have the share price, which in the case of CEFs, is frequently related to NAV.

We know that OXLC's dividends are nosebleed high, and OXLC just raised the dividend in July. But what about NAV? OXLC invests in CLO Equity positions. Collateralized loan obligations are entities that "securitize" leveraged loans. This means the CLO buys leveraged loans and then pays out the interest received to various tranches that investors bought in order of priority. Investors pay a premium to be first in line. The senior tranches get paid, then the junior tranches, and the equity tranche gets the excess. Perhaps the easiest way to understand equity CLO tranches is that they are a leveraged investment on leveraged loans.

There isn't an index for CLO equity, but there is an index for leveraged loans. CLO equity returns should generally follow leveraged loan returns in this direction but will be significantly amplified by the leverage.

When we look at Invesco Senior Loan ETF (BKLN), we see a very similar pattern to OXLC. NAV has declined, while total returns have been up.

As BKLN shows, loan prices have generally declined since OXLC had its IPO. In fact, since OXLC's IPO, it has been a pretty tough decade for prices of any debt investment. Investors can buy debt of all types a lot cheaper today than they could in 2012.

In fact, OXLC has dramatically outperformed other debt funds.

Now if you compare it to the S&P 500, OXLC's performance since IPO is not terribly impressive, nor was the performance of any other debt investment over that period. Frequently throughout the history of the stock market, there have been decades where equities outperform debt. There have also been decades where debt has outperformed equities.

I wasn't enthusiastically buying up debt in 2012, but I am enthusiastically buying up debt today. Why? Because today, debt of all stripes is cheap and high-yielding. I'm buying up high-yield bonds, agency mortgages, commercial mortgages, preferred equity, and senior loans.

For income investors, building up exposure to debt investments is going to provide substantial cash flow. OXLC is providing a high yield, has been raising its dividend, and has been seeing its NAV recover. It can be expected to see larger price and NAV swings than most debt investments, while also providing much higher return potential. It is one piece of my overall debt investment strategy.

Conclusion

When we take time to evaluate a holding rationally, as well as the sector in general, we can see that OXLC is extremely cheap here, and that's because debt is cheap in this current high interest rate environment, providing them at par returns upon maturity. With OXLC, we can invest in a swath of debt across the entire U.S. economy, allowing us to generate great income month after month at nosebleed double-digit yields, largely because investors misunderstand what OXLC is doing, but also because of recency bias. Investors misunderstand what is going on in the fixed-income market as well as fear a massive wave of bankruptcies, which they believe will occur because default rates have been extremely low for years. Yes, bankruptcies are coming, but the bankruptcy rate is not expected to be so great that it will cause fixed-income investments to lose value altogether. You need to be selective in what you buy – that is true no matter what environment you're living in.

When it comes to your retirement, you need income to pay your expenses, and investments like OXLC, which are frequently misunderstood and subject to incorrect perspectives, are excellent holdings because you can work against the faulty sentiment to enjoy outstanding income. It doesn't take a lot of this type of income catalyst to see a massive explosion in your income stream.

That's the beauty of my income method. That's the beauty of income investing.

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