CA - BGH: This Little-Known Bond Fund Has A Lot To Recommend It

2023-09-29 03:29:04 ET

Summary

• The Barings Global Short Duration High Yield Fund offers a competitive 9.98% yield and has delivered impressive performance, outperforming other bond funds.
• The fund focuses on low-duration assets, making it a good option for risk-averse investors concerned about inflation and rising interest rates.
• The fund's portfolio consists of mostly speculative-grade securities, but its short duration and industry weighting in oil and gas companies provide some safety.
• The fund is fully covering its distribution out of net investment income, so it should be sustainable as long as rates remain around today's levels.
• The fund is currently trading at an enormous discount on net asset value.

The Barings Global Short Duration High Yield Fund ( BGH ) is a closed-end fund that focuses on the generation of income for its investors. It does not get the attention of many similar funds from larger fund houses, but there are some reasons to believe that it should. The fund boasts a very attractive 9.98% yield at the current price, which is very competitive with the yields available from other fixed-income closed-end funds, and it has delivered a very impressive performance recently. Over the past year, the fund's shares are up 2.88% and it has delivered a 13.32% total return to its shareholders:

This is a much better performance than many other bond funds have managed to deliver over the period. That makes a lot of sense as the Bloomberg U.S. Aggregate Bond Index ( AGG ) is actually down over the same period, although it too has managed to deliver a positive total return.

This strong performance is driven in part by the fact that this fund does not suffer from many of the same problems as other bond funds. In particular, this fund focuses on low-duration assets, which tend to perform much better than high-duration assets during an inflationary environment characterized by rising interest rates. As such, this bond fund may actually be worth considering even for risk-averse investors who are worried about the potential for a renewed onslaught of inflation and more interest rate increases. I discussed these risks in a recent article .

As is the case with many bond funds right now, the Barings Global Short Duration High Yield Fund is currently trading at an enormous discount on net asset value. As such, the price may be right if you are interested in acquiring some shares. Let us have a closer look at the fund.

About The Fund

According to the fund's website , the Barings Global Short Duration High Yield Fund has the primary objective of providing its investors with as high a level of current income as possible while still preserving the value of the fund's principal. As is usually the case, the website goes into a bit more detail about the fund's overall strategy:

The Barings Short Duration High Yield Fund seeks to generate as high a level of current income as we determine is consistent with capital preservation, and seeks capital appreciation as a secondary objective. The Fund expects to maintain a weighted average portfolio duration of three years or less and a weighted average portfolio maturity of five years or less.

The key here is the short duration of the fund's assets. Duration is the amount of time that it takes for an asset to completely pay back its investors' initial investment. In the case of a bond, this normally means that bonds with higher yields and shorter maturities have a lower duration than bonds with a maturity date years or even decades into the future. It is very important as a measure of the bond's sensitivity to interest rate changes. In short, when interest rates go up, bonds with a high duration will decline much more than bonds with a low maturity. It is also important as a measure of risk. After all, a lot more can happen in thirty years than in two years, and so it is more likely that the issuer of a thirty-year bond will default than a one-year bond. This fund specifically invests in bonds with a low duration, which should therefore give its assets a greater degree of safety than a fund that is investing in very long-term bonds.

The description of the fund's strategy from the webpage states that it will maintain an average duration of three years or less. As of August 31, 2023, the fund's weighted average duration was 2.43 years, so it certainly fulfills this requirement. The overwhelming majority of the fund's assets also mature in five years or less:

As we can see, 58.49% of the bonds in this fund's portfolio mature in less than five years. Thus, the fund does appear to be satisfying the two requirements that its management has provided for the qualification of a bond for inclusion in the portfolio.

One thing that we may immediately notice is that the duration of the bonds in the portfolio is on average much lower than that of the maturity of the bonds. This may seem counterintuitive at first. After all, if the duration is the period of time that it takes for the investors to receive their money back, then we would expect the time until the maturity date and the duration of the bond to be very close together. That is certainly the case with bonds that have a very low-interest rate, but a high interest rate on a bond means that the investor will end up receiving an amount of money equal to their initial investment prior to maturity. For example, a bond with a 100% coupon would have a duration of one year (or less, depending on the time until that coupon payment is made) regardless of the maturity date. The Barings Global Short Duration High Yield Fund has an average coupon yield of 8.79% as of the time of writing, which is far above the 4.65% current yield on the five-year Treasury. Thus, this fund must be investing in things with a much higher default risk than Treasuries or even investment-grade corporates. This is certainly the case, which we can see by looking at the credit ratings of the securities in the fund's portfolio. Here they are:

An investment-grade bond is anything rated Baa or higher, so we can see that this only describes 3.80% of the fund's assets. The rest of its bonds are all speculative-grade securities, which are what are colloquially called "junk bonds." This is something that may concern most investors who are worried about the preservation of the principal, for good reason. After all, the default rate on junk bonds has been rising, with Fitch stating that it may reach 4.5% to 5% by the end of 2023. Fortunately, in this case, the short duration of the bonds in this fund's portfolio is quite helpful. It is difficult to find any hard information on junk bond defaults, but most sources state that comparatively few defaults occur during the early years of a bond's life and the default rate rapidly increases over time. This is probably due to my earlier statement that a lot more can happen in ten years than in five years. The lower risk of short-term bonds is also the reason why short-term bonds almost always have lower yields than long-term bonds.

Another factor that might help improve the fund's safety is its industry weighting. As we can see here, a large percentage of the assets in the fund were issued by companies in the oil and gas industry or companies that posted collateral to back the securities:

In quite a few recent articles, I showed how the world is currently facing a shortage of crude oil relative to demand. This is one of the reasons why crude oil prices have been trending up since July. For the most part, energy is considered a necessity for the economy to function. After all, trucks transporting goods require diesel power, most trains run on diesel fuel, airplanes run on refined petroleum, cars run on refined petroleum, and so on. There is absolutely no chance that the entire transportation sector will fully convert to another source of energy within two or three years. It seems highly unlikely that the production of crude oil will skyrocket within the next two or three years either. Thus, the companies issuing these bonds are almost certainly going to be facing very strong tailwinds and growing revenue and cash flow during the duration of these bonds. This actually reduces their default risks and makes them safer. In the case of CLOs, the company had to post some sort of collateral in order to get the bank loan that then wound up being in the pool of bank loans backing the security. As this collateral can be seized in the event of the company defaulting, these securities are much safer than an unsecured bond issued by a company. The fund also gets an additional margin of safety in the fact that each of these collateralized loan obligations is backed by a pool of multiple loans, not only a single loan made to a single company. Thus, there is a certain amount of diversification here. Those two sectors alone account for 26.72% of the fund's holdings. On top of all of this, the fund has 181 unique issuers represented in its portfolio. As such, the proportion of the portfolio represented by any individual issuer is limited. The largest individual position is in First Quantum Minerals ( FQVLF ), a Canadian copper miner, at 3.13% of the fund's assets. That is not a large enough position to have a major impact on the fund's overall performance.

As such, the biggest risk with this fund appears to be interest-rate risk, and the short duration helps with that somewhat.

Leverage

As is the case with most closed-end funds, the Barings Global Short Duration High Yield Fund employs leverage as a means of boosting its effective yield beyond that of any of the assets in the portfolio. I explained how this works in previous articles. To paraphrase:

Basically, the fund borrows money and then uses that borrowed money to purchase bonds and similar income-producing assets. As long as the purchased assets have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, this will normally be the case. With that said, this strategy is much less effective today than it was two years ago when borrowing rates were at 0%. This is because the difference between the yield on the purchased assets and the interest rate that the fund has to pay on the borrowed money is much less than it once was.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much debt since that would expose us to an excessive amount of risk. I generally do not like a fund's leverage to exceed a third as a percentage of its assets for this reason.

As of the time of writing, the Barings Global Short Duration High Yield Fund has leveraged assets comprising 26.04% of its portfolio. This is well below the one-third limit outlined above, and it is also below what many other fixed-income funds with similar yields possess. As such, the balance between risk and reward appears to be reasonably acceptable here.

Distribution Analysis

As mentioned earlier, the primary objective of the Barings Global Short Duration High Yield Fund is to provide its investors with a very high level of current income while still preserving the value of its principal. In order to achieve this, the fund invests in junk bonds with a relatively short time until maturity. In the current environment, these bonds have very high yields, and this fund takes things to another level by applying a layer of leverage to the portfolio in order to artificially boost the yield. As such, we can probably assume that this fund will have a very high yield.

This is certainly the case as the Barings Global Short Duration High Yield Fund currently pays a monthly distribution of $0.1056 per share ($1.2672 per share annually), which gives it a 9.98% yield at the present share price. Unfortunately, the fund has not been especially consistent with respect to its distribution over the years:

As we can see, the Barings Global Short Duration High Yield Fund has cut its distribution several times over the past decade, although it has been pretty stable since mid-2020. However, the long-term performance here may still be something of a turn-off for those investors who are seeking a safe and secure source of income to use to pay their bills or finance their expenses. This fund has done much better than most other bond funds though, as it has not had to cut over the past year in response to the Federal Reserve's monetary tightening regime.

As is always the case, the fund's past performance is not the most important thing for our purposes. After all, anyone who is purchasing the fund's shares today will receive the current distribution at the current yield. As such, they will not be affected by the past actions of the fund and are simply interested in how well the fund can sustain its distribution going forward. Let us investigate this.

Fortunately, we have a relatively recent document that we can consult for the purpose of our analysis. The fund's most recent financial report corresponds to the six-month period that ended on June 30, 2023. As such, it should give us a good idea of how well the fund performed in the first half of this year, which was a period of time that was characterized by a great deal of optimism that the Federal Reserve would soon cut interest rates. However, as mentioned above, the low-duration bonds in this fund's portfolio would not benefit from that optimism as much as long-duration bonds. As such, the potential that the fund had to make some profits from this situation was not as great as that of some other closed-end funds.

During the six-month period, the Barings Global Short Duration High Yield Fund received a total of $20,338,658 in interest along with $87,862 in dividends from the assets in its portfolio. When we combine this with a small amount of income from other sources, the fund reported a total investment income of $20,426,672 during the period. It paid its expenses out of this amount, which left it with $15,294,064 available for shareholders. This was, fortunately, more than enough to cover the $12,712,749 that the fund paid out in distributions. Thus, this fund is simply paying its distributions out of net investment income. This is generally sustainable over the long term, so long as interest rates remain reasonably high. That will probably be the case for a while, so everything should be fine here. The fund did actually have positive net realized and unrealized gains too, so the net assets went up during the period. Overall, though, there appears to be nothing that we need to worry about here.

Valuation

As of September 27, 2023 (the most recent date for which data is available as of the time of writing), the Barings Global Short Duration High Yield Fund had a net asset value of $14.51 per share but the shares currently trade for $12.73 each. This gives the fund's shares a 12.27% discount on net asset value at the current price. This is a very attractive discount that is quite a bit better than the 10.27% discount that the shares have had on average over the past month. As such, the current price is a reasonable one to pay for this fund.

Conclusion

In conclusion, it is difficult to find fault with the Barings Global Short Duration High Yield Fund. There is a certain amount of risk that comes with the fact that the fund is investing in junk bonds, but the risks here should be much less than in most junk bond funds due to the short duration. The fund's low volume might be a risk, as only about $900,000 worth of shares trade hands every day so it is somewhat vulnerable to share price movements from someone making a large purchase, but that should not really be a problem for a long-term investor. The short duration of the fund's assets is a major advantage right now considering the uncertainty about the direction of inflation and interest rates, and indeed this fund has proven to be far less volatile than most fixed-income funds over the past year. The price of the fund is very attractive right now as is the fact that it is paying its distributions out of net investment income. Overall, this fund might be worth considering for purchase right now.

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