BIT - BIT: Some Attractive Characteristics But The Market Has Overbid The Shares

2023-12-14 12:55:14 ET

Summary

• The BlackRock Multi-Sector Income Trust offers a reasonable 9.80% yield for income-focused investors.
• The fund invests in safer securities than other funds with higher yields, making it attractive for risk-averse investors.
• The fund's recent performance has been decent, but its strength relies heavily on the Federal Reserve cutting interest rates, which seems unlikely.
• The fund appears to have failed to cover its distribution during the most recent fiscal year, although it has been pretty good for the first month of FY2024.
• The fund's share price appears to have gotten ahead of itself. It is trading at a pretty large premium.

The BlackRock Multi-Sector Income Trust (BIT) is a closed-end fund that income-focused investors can employ in the pursuit of their goals. The fund performs reasonably well at this task, as its 9.80% yield is quite reasonable for a fixed-income fund. It is not nearly as attractive as the double-digit yields being offered by some junk bond funds or leveraged loan funds, however. This alone is not necessarily a reason to avoid this fund, particularly for investors who are somewhat risk-averse. After all, the BlackRock Multi-Sector Income Trust invests in somewhat safer securities than most of the funds with more attractive yields. As we will see in this article, this fund includes some bonds that are quite safe from default risk and that could make it easier to sleep at night as news headlines about economic weakness hit the ticker.

As regular readers may recall, we last discussed the BlackRock Multi-Sector Income Trust in early August with a Hold rating. The fund’s performance since that time has been quite decent, as its share price is up 1.75% compared to a small decline in the Bloomberg U.S. Aggregate Bond Index ( AGG ):

This is somewhat surprising, particularly since both funds invest in bonds. We do see that the general course followed by each fund has been pretty similar though, although the BlackRock Multi-Sector Income Trust has generally moved a bit further during both the downward trend that lasted until mid-October as well as the upward trend that has been prevalent since that time. This is probably due to the closed-end fund’s use of leverage. We will discuss this later in this article.

Unfortunately, there could be reason to doubt that the fund will be able to sustain the strength that we have seen over the past month or so. This is because this strength is highly dependent on the Federal Reserve cutting interest rates dramatically next year. That seems to be very unlikely to actually happen unless something breaks and sends the economy into a very severe recession. However, if the headlines about consumers continuing to spend with wild abandon and jobs being plentiful are actually correct, such a recession seems unlikely. As such, it might not be the best time to purchase this fund unless you plan to hold it for long enough that the distributions are sufficient to offset the share price declines.

About The Fund

According to the fund’s webpage , the BlackRock Multi-Sector Income Trust has the primary objective of providing its investors with a very high level of current income. This is not particularly surprising considering that this is a bond fund. The website states as much in its description of the fund:

"BlackRock Multi-Sector Income Trust’s primary investment objective is to seek high current income, with a secondary objective of capital appreciation. The Trust seeks to achieve its investment objectives by investing, under normal market conditions, at least 80% of its assets in loan and debt instruments and other investments with similar economic characteristics. The Trust may invest directly in such securities or synthetically through the use of derivatives."

This description directly states that at least 80% of this fund’s assets are invested in bonds or other debt securities. CEF Connect confirms that this is indeed the case, as 131.89% of the fund’s assets are invested in bonds alongside much smaller allocations to preferred stock, common stock, and convertible fixed-income securities:

Thus, the fund’s objective of focusing on current income appears to make sense. As I pointed out in my previous article on this fund:

"It is not surprising that a debt fund would be focused on the generation of income. After all, debt securities are income vehicles. They have no net capital gains over their lifetimes. An investor purchases a bond at face value, receives regular coupon payments from the bond, and then receives the face value back from it. Thus, there are no net capital gains over the bond’s lifetime. This makes sense because a bond has no inherent link to the growth and prosperity of the issuing entity. After all, a company will not increase the amount that it pays to its creditors just because its profits went up."

As such, the fund’s secondary objective of delivering capital appreciation does not make a great deal of sense. Bonds do not deliver capital appreciation indefinitely. Bond prices do go up when interest rates go down, but that is about it. There is a limit as to how far interest rates can decline since nobody will ever lend money at a negative nominal rate. In fact, after the problems that have been caused by the easy money policies of the past two decades, it seems rather unlikely that the central bank will ever let the real interest rate drop below zero percent. Politicians might push their central banks in that direction though, as inflation is an easy way to reduce the burden of carrying the national debts in most developed nations.

The point though, is that there is a limit as to how low interest rates can possibly go. Thus, there is a limit to how high bond prices can get. As such, long-term capital appreciation makes little sense as an objective for a bond fund. Investors in the fund can, of course, reinvest the distributions and grow their own wealth that way. As this fund currently pays a 9.80% yield, anyone who just sticks this fund into a tax-advantaged account (such as most retirement accounts) and just lets the distributions automatically reinvest will find that they have managed to amass a fairly impressive amount of money over time. After all, the Rule of 72 states that money compounding at a 9.80% annual rate should double about every 7.3 years or so. Thus, we do not need much in the way of capital gains in order for this fund to grow your wealth.

One of the nice things about the BlackRock Multi-Sector Income Trust is that it manages to achieve its respectable yield without needing to load up on junk bonds or similar high-risk securities. We can see this quite clearly by looking at the credit ratings that have been assigned to the securities held by the fund. Here is a summary:

An investment-grade bond is any bond rated BBB or higher. As we can see, that accounts for 43.13% of the fund’s total assets. This is a much higher percentage than the other closed-end bond funds that we typically discuss in this column, and it is something that might help risk-averse investors sleep at night. After all, investment-grade companies are generally considered to be at very low risk of defaulting on their obligations. This is especially true for the AAA securities here, as that is actually higher than the credit rating of the United States government (which is AA+ rated by both S&P and Fitch, although the market treats it as AAA).

In addition to the investment-grade securities, we can see that 57.72% of the securities in the fund are rated either BB or B by the major rating agencies. These are the two highest possible ratings for speculative-grade securities, and they are generally safe enough that risk-averse investors should not need to worry too much about holding them. According to the official bond ratings scale , companies with a BB or a B credit rating have the financial capacity to carry all of their existing debt even in the event of a short-term economic shock or a recession. These companies obviously are not quite as robust financially as an investment-grade company, but the overall risk of default should be reasonably low. These securities combined with the investment-grade ones account for nearly the entire portfolio, so that should be enough to keep an investor’s stress level down.

Interest Rate Mispricing

The biggest risk here appears to be interest rate risk, and that is a risk that the market appears to be mispricing right now. As everyone reading this is likely aware, the bond market has been fairly strong for the past two months or so due to expectations that the Federal Reserve will shortly pivot and reduce interest rates. Over the past two months (since October 12, 2023), shares of the BlackRock Multi-Sector Income Trust have gained 5.78%. That is quite a bit better than the 4.53% gain of the Bloomberg U.S. Aggregate Bond Index.

The expectation here is that the Federal Reserve will cut the federal funds rate by 125 basis points over the next twelve months. That is, to put it mildly, highly unlikely.

First, let us have a look at inflation, which was the main reason why the central bank raised interest rates at one of the fastest paces in history last year. Earlier today, the Bureau of Labor Statistics published the November consumer price index, and it came in much hotter than expected. Economists expected a flat month-over-month print, but it actually came in at 0.1%, which puts the headline consumer price index at +3.1% year-over-year:

This certainly weakens the narrative that the Federal Reserve has won the inflation fight. We can see in the chart above that the year-over-year increase in the consumer price index is actually higher than the level seen in June. The Core Consumer Price Index was up 4.0% year-over-year, and the Core Consumer Price Index ex-Shelter (SuperCore) number came in very hot at +0.5% month-over-month and +4.08% year-over-year:

Notice how all of these numbers are far above the Federal Reserve’s 2% year-over-year target. In fact, the SuperCore inflation numbers seem to be getting worse.

The numbers in this recent report, as well as the most recent jobs report, do not support the belief that the Federal Reserve will cut interest rates next year. Indeed, the Federal Reserve itself has advised that the federal funds target rate will be at 5% to 5.25% next December. The market, meanwhile, is pricing bonds and bond funds as though the rate will be at 4% in December 2024.

This means that there is a very real possibility that the BlackRock Multi-Sector Income Trust will give up its recent gains in the near future. With that said, I have seen a few comments posted here on Seeking Alpha that basically suggest that the market is betting on a severe recession next year. I have pointed out myself that such an event seems to be the only real possibility that the market will get the interest rate cuts that it is hoping for.

If a severe recession does hit, there is still a chance that this fund’s shares will get dumped due to panic selling, although such a decline would likely only be temporary.

Honestly, buying the BlackRock Multi-Sector Income Trust today probably only makes sense if you are planning to hold it for long enough for the distributions to offset the near-term price decline that seems pretty likely next year due to the Federal Reserve not accommodating the market.

Leverage

As shown earlier, the BlackRock Multi-Sector Income Trust employs leverage as a method of boosting the effective yield of its portfolio. This is why the fund’s bond allocation can be over 100%, and also partly explains why it has been rising more rapidly than the Bloomberg U.S. Aggregate Bond Index. I explained how this works in my previous article on this fund:

"In short, the fund is borrowing money and using that borrowed money to purchase bonds and other debt securities. 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 return of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, so this will usually be the case.

It should be mentioned though that this strategy is not as effective today with borrowing rates at 6% as it was two years ago when borrowing rates were effectively nothing. This is because the difference between the rate that the fund borrows at and the rate that it receives from the purchased assets is much less than it used to be.

Unfortunately, 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 leverage since that would expose us to an excessive amount of risk. I generally like to see a fund’s assets remain under a third as a percentage of its assets for this reason."

As of the time of writing, the BlackRock Multi-Sector Income Trust has leveraged assets comprising 33.87% of its portfolio. This is slightly higher than the 33.70% leverage ratio that the fund had the last time that we discussed it. That is quite surprising considering the fact that the shares are up.

However, this can be explained by the fact that the fund’s net asset value is actually down. As we can see here, the fund’s net asset value per share is down 0.83% since the last time that we discussed the fund:

This certainly explains why the fund’s leverage went up over the past four months. After all, the lower net asset value means that the fund’s debt now represents a higher proportion of the overall portfolio. The leverage is still reasonable for a fixed-income fund though, and we should not really worry about it too much.

The biggest concern here is the fact that the shares have shot up in price but the portfolio itself has actually declined in value. We will discuss this in the valuation section below.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the BlackRock Multi-Sector Income Trust is to provide its investors with a very high level of current income. In pursuance of this objective, the fund purchases both investment-grade and speculative-grade bonds from a variety of issuers. These bonds provide it with a source of income via their coupon payments, and this fund employs leverage to receive payments from more bonds than it can own with just its own equity. This results in the fund having a higher yield on equity than would be possible from an unleveraged bond portfolio. The fund pools all of the payments that it receives from these securities and combines them with any profits that it might be able to obtain by exploiting the changes that regularly occur in bond prices. The fund then pays out all of this money to its investors, net of its own expenses. When we consider where bond yields are right now and the fact that leverage is enhancing these yields, we can assume that this fund would have a pretty high yield itself.

This is certainly the case, as the fund currently pays a monthly distribution of $0.1237 per share ($1.4844 per share annually), which gives it a 9.80% distribution yield at the current share price. This fund has been quite reliable and consistent with its distribution over the years. As we can see here, the fund has never cut its distribution, and it raised it once:

This is a much more attractive history than most bond funds possess, especially for retirees or other investors who are seeking a safe and consistent source of income to use to pay their bills or finance their lifestyles. However, there are very few bond funds that have such a consistent track record, so we want to investigate this fund’s finances closely. After all, it seems quite strange that it has been able to accomplish a feat that few peers have been able to accomplish.

Unfortunately, we do not have a particularly recent document to consult for the purpose of our analysis. As of the time of writing, the fund’s most recent financial report corresponds to the six-month period that ended on April 30, 2023. This is rather disappointing, especially from BlackRock. As regular readers likely know, most BlackRock funds operate under a calendar year period so their reports would normally be for January to June and then January to December. It appears that this one is an exception to this policy. This is rather unfortunate because this report will not include any information about the fund’s performance over the past seven months. This means that we will not have any information about how well the fund handled the July to October period which was characterized by rising interest rates and falling bond prices. We will need to wait a few more weeks until the fund releases its annual report to have that information.

During the six-month period, the BlackRock Multi-Sector Income Trust received $437,924 in dividends along with $26,203,882 in interest from the investments in its portfolio. When we combine this with a small amount of income from other sources, we see that the fund had a total investment income of $26,647,407 during the six-month period. The fund paid its expenses out of this amount, which left it with $16,532,975 available for shareholders. This was, unfortunately, nowhere close to enough to cover the $27,982,395 that the fund paid out in distributions during the period. At first glance, this is likely to be concerning as we would normally prefer to see a closed-end fund fully cover its distributions out of net investment income.

However, the fund does have other methods through which it can obtain the money that it needs to cover the distributions. For example, it might be able to earn some money by exploiting fluctuations in bond prices. After all, bond prices were rising during the early stages of 2023 as long-term interest rates declined. The fund might have been able to earn some profits from this.

Fortunately, the fund did have some success in obtaining money from these alternative sources. During the six-month period, it reported net realized losses of $9,751,641 but these were more than offset by $23,481,492 net unrealized gains. Overall, the fund’s net assets increased by $2,898,459 after accounting for all inflows and outflows during the period.

Thus, it appears that the fund did technically cover all of its distributions during the period, but it had to rely on unrealized capital gains to accomplish this. As everyone reading this is likely aware, unrealized gains can be very quickly erased by a market correction. Unfortunately, it appears that this was the case for this fund. Over the full-year period that ended on October 31, 2023, the fund’s net asset value per share declined by 6.13%:

That strongly suggests that the fund will report a failure to cover its distributions when it releases its annual report in a few weeks. The fund’s net asset value per share is up 3.90% since November 1, 2023, though, so it appears that it is doing okay in the first half of its 2024 fiscal year so far.

Valuation

As of December 11, 2023 (the most recent date for which data is available as of the time of writing), the BlackRock Multi-Sector Income Trust has a net asset value of $14.40 per share but the shares currently trade for $15.09 each. This gives the fund’s shares a 4.79% premium on net asset value at the current price. This is slightly better than the 4.96% premium that the fund’s shares have averaged over the past month, but that is still a very high price to pay for this fund’s shares.

As mentioned earlier in this article, the fund’s shares have recently been outperforming its actual portfolio and we see that reflected here. It appears that the fund’s shares may have gotten ahead of themselves. As such, it might make sense to wait until a better price comes along.

Conclusion

In conclusion, the BlackRock Multi-Sector Income Trust certainly appears to be a very good fund for risk-averse income seekers, as it has a very high percentage of its assets invested in reasonably safe securities yet still manages to boast a fairly attractive distribution yield. The real problem here is that the fund’s price appears to have gotten ahead of itself. There is a very real risk that the market is wrong about the near-term interest rate outlook and the fund’s shares could give up their recent gains when it realizes this. When we consider that the fund’s shares are currently trading at a premium, it seems that the risk may not be worth it.

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