CUKPF - EFT: This Floating-Rate CEF Looks Like A Great Way To Earn An Income Today

2023-04-11 12:37:47 ET

Summary

• Investors today are in desperate need of income as the rising cost of living is making everything much more expensive.
• Eaton Vance Floating-Rate Income Trust invests in a portfolio of floating-rate securities that should hold their value regardless of interest rates and actually benefit from rising rates.
• The closed-end fund is extremely well diversified, which should protect us from risks involving defaults.
• The EFT fund currently yields 11.54%, and this will probably be sustainable as long as interest rates remain at today's levels.
• The fund is trading at a very attractive valuation, so certainly may be worth buying today.

It seems essentially certain that the biggest problem facing most Americans today is the rapidly rising cost of living. This is illustrated by the fact that the inflation rate is currently at the highest level that we have seen in more than forty years, which has been the case for nearly eighteen months now. In fact, over the past twelve months, there has not been a single month in which the consumer price index appreciated by less than 6% year-over-year:

This inflation has been mostly centered on food and energy, which are necessities for our modern way of life. As such, people of lesser means have been particularly devastated by this, as the rising prices of necessities make it much more difficult for them to enjoy some of the niceties of life. As I discussed in a recent blog post , many people have been depending on borrowing money and drawing down their savings just to maintain their lifestyles. This cannot go on forever and we are now seeing some very real signs that the United States will soon enter a recession.

As investors, we have certainly not been spared from the ravages of inflation. After all, as prices increase, it requires more of our income to sustain our lifestyles. Those of us that are dependent on our portfolios to provide our incomes have certainly been affected as the stock market and bond market have both fallen over the past year, resulting in us having fewer assets that can be spent. Fortunately, it is still possible to put our money to work for us in order to generate income. One of the best ways to do that is to purchase shares of a closed-end fund, or CEF, that specializes in the generation of income. These funds are admittedly somewhat underfollowed by the media and investment advisors, which is unfortunate as they offer a great way to obtain a diversified portfolio of assets that can usually deliver a higher yield than pretty much anything else in the market.

In this article, we will discuss the Eaton Vance Floating-Rate Income Trust (EFT), which is one fund that investors can use for the purpose of income generation. The fund certainly does fairly well in this respect, as its 11.54% yield is substantially higher than the S&P 500 Index ( SP500 ) or any of the major fixed-income indices. I have discussed this fund before, but that was a few months ago, so naturally quite a few things have changed. This article will, therefore, focus specifically on those changes as well as provide an updated analysis of our thesis and the fund's finances. Therefore, let us investigate and see if this fund could be a good addition to your portfolio today.

About The Fund

According to the fund's webpage , the Eaton Vance Floating-Rate Income Trust has the stated objective of providing its investors with a high level of current income. This is not especially surprising considering that this is a fixed-income fund. According to CEF Connect, the fund currently has 96.27% of its assets invested in bonds:

However, these are not typical bonds. As the name of the fund suggests, the Eaton Vance Floating-Rate Income Trust invests in floating-rate loans. The fund's fact sheet describes the fund's portfolio thusly:

"Provides broad exposure to the floating-rate loan market, providing diversified exposure to the asset class. Provides exposure to the loan markets' many sectors, credit tiers and issuers."

The securities that comprise the majority of the fund's portfolio are basically securitized bank loans made with floating interest rates. As of December 31, 2022, these loans accounted for 87.72% of the portfolio. This gives the fund a certain level of protection against rising interest rates, which have been the cause of most of the weakness in the traditional bond market over the past year. As everyone reading this is certainly well aware, the Federal Reserve has been aggressively raising rates in an attempt to combat inflation. This is evident in the federal funds rate, which has risen from 0.20% a year ago to 4.65% today:

Traditional bonds have an inverse relationship to interest rates. In short, when interest rates rise, bond prices decline, and vice versa. This is because newly issued bonds will have a yield that corresponds with the market interest rate at the time of issuance. As such, during periods of rising interest rates, brand-new bonds will have a higher yield than bonds that already exist in the market. There is therefore no reason for anyone to purchase an existing bond when they could purchase a brand-new one at a higher rate. Therefore, the price of existing bonds has to decline (which causes the effective yield to increase) in order to induce anyone to purchase them. This is the big reason why most bond funds have suffered losses over the past twelve months.

The Eaton Vance Floating-Rate Income Trust is a bit different though because the securities in its portfolio have a payment that increases alongside interest rates. They will normally adjust based on some benchmark, such as LIBOR, on a regular basis. In theory, they should hold their prices much better than traditional bonds during periods of rising interest rates because the floating rate ensures that the security will always deliver a competitive yield to its investors. This certainly holds true across the market, as the iShares Floating Rate Bond ETF ( FLOT ) has been almost perfectly flat over the past year:

Unfortunately, the same is not true for the Eaton Vance Floating-Rate Income Trust. This fund is down 14.65% over the same period:

The Eaton Vance fund does have a substantially higher yield, which evens things out somewhat, but it has still underperformed the index over the period. One possible reason is that the closed-end structure sometimes results in inefficiencies. The total return of the fund's portfolio over the one-year period that ended on March 31, 2023, was -1.01% but the total return of the shares in the market was -5.37% over the same period. Note that in this case, total return refers to the actual performance that an investor would see if the distributions were completely reinvested. That explains why the two numbers that I just provided are vastly different than the fund's market return. We can still see though that the fund's market performance was worse than the actual performance of its portfolio over the period. This is something that is not atypical for closed-end funds, and it can sometimes provide us with an opportunity to purchase a fund for less than its assets are actually worth. We will discuss this later in this article.

A look at the largest positions in the fund reveals a number of companies that most investors are probably not that familiar with, although there are a few well-known names:

This illustrates one of the defining characteristics of floating-rate securities. This is that many of the companies that take these loans already have significant amounts of debt or have somewhat insecure balance sheets. For example, Uber Technologies ( UBER ) is a unicorn that has long experienced some problems turning a profit as it attempts to expand and scale its operations. Carnival Corporation ( CCL ) was devastated by the coronavirus-related lockdowns, just like all cruise lines, and it has had negative net income for the past three years. The same can be said for most of these companies, which is something that certainly may be concerning to those investors that are concerned about principal protection.

Fortunately, we do see that the fund is incredibly well-diversified. As my regular readers on the topic of closed-end funds are no doubt well aware, I do not generally like to see any individual asset in a fund account for more than 5% of the fund's portfolio. This is because that is approximately the point at which a given asset begins to expose the fund to idiosyncratic risk. Idiosyncratic, or company-specific, risk is that risk that any asset possesses that is independent of the market as a whole. This is the risk that we aim to eliminate through diversification, but if the asset accounts for too much of the portfolio, then it will not be completely diversified away. Thus, the concern is that some event may occur that causes the price of a given asset to decline when the market does not, and if that asset accounts for too much of the portfolio, then it may end up dragging the entire fund down with it in such a scenario. As we can see above though, there is no individual asset that accounts for such a large position in this fund so that is not something that we really need to worry about. More importantly for our purposes here, the fact that the largest position in the fund only accounts for 1.08% of its total assets means that even a default should not have a noticeable impact on the fund as a whole. While widespread defaults across a variety of sectors certainly would, in such an event we probably have much more to worry about than just a few investors taking losses.

One major way in which the Eaton Vance Floating-Rate Income Trust differs from the index is that it engages in significantly more trading of assets. The fund had a 53.00% annual turnover over the most recent year, which is higher than many other fixed-income funds, although not as high as we see with certain equity funds. The reason that this is important is that it costs money to trade any type of security and these expenses are billed directly to the shareholders of the fund. This results in a drag on the portfolio's performance and makes management's job more difficult. After all, the fund's managers need to generate a sufficiently high return to both cover these added expenses as well as still deliver a return that is acceptable to the fund's shareholders. This is a task that very few management teams manage to achieve consistently, and it is one reason why most actively managed funds fail to beat their benchmark indices over the long term. The fact that this fund has a higher turnover than the floating-rate securities index could be one reason why this fund underperformed over the past year.

Leverage

As stated in the introduction, closed-end funds such as the Eaton Vance Floating-Rate Income Trust have the ability to produce a higher yield than that possessed by any of the underlying assets. One of the ways through which this is accomplished is the use of leverage. In short, the fund borrows money and then uses that borrowed money to purchase floating-rate loans and other assets. As long as the yield of the purchased assets is higher 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. As this fund is capable of borrowing at institutional rates, which are considerably lower than retail rates, this will usually be the case.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. This could, therefore, be another reason why this fund declined more than the floating-rate index did over the past year. As a result of this, we want to ensure that the fund is not using too much debt since that would expose us to too much risk. I do not generally like to see a fund's leverage exceed a third as a percentage of assets for this reason. The Eaton Vance Floating-Rate Income Trust, unfortunately, exceeds this level, albeit not by very much. As of the time of writing, the fund's levered assets comprise 34.94% of the portfolio. This is above a third, but in this case, it is probably okay. As these are floating-rate securities, they are generally going to be reasonably stable in terms of price and the fund's diversification means that it should be reasonably well-protected against problems at any specific company. Thus, the fund can probably carry a bit more leverage than a common equity fund, and considering that this one is not really employing too much leverage over our limit, it is probably fine. This is, therefore, a reasonable balance between risk and reward.

Distribution Analysis

As stated earlier in this article, the primary objective of the Eaton Vance Floating-Rate Income Trust is to provide its investors with a very high level of current income. In order to achieve this objective, the fund purchases floating-rate loans and similar securities that typically have reasonably high yields. It then applies a layer of leverage to boost the effective yield further. Thus, we can assume that this fund will probably have a pretty high yield itself. This is certainly the case as the fund currently pays a monthly distribution of $0.1110 per share ($1.332 per share annually), which gives it an 11.54% yield at the current price. The fund's distribution has exhibited substantial variation historically, although it has been increasing over the past several months:

The fact that the fund's distribution has varied so significantly over the years could be a bit of a turn-off to those investors that are looking for a safe and secure source of income to use to pay their bills or otherwise finance their lifestyles. However, this fund can be thought of at least partly as a play on interest rates. As we can see above, rising interest rates do allow the fund to boost its distribution somewhat. This is hardly surprising since the amount of money paid by the securities held by the fund should increase as rates do, thus boosting the fund's income. We can therefore assume that it is probably going to be able to sustain the current distribution for as long as interest rates remain at today's levels but let us analyze its finances anyway.

Unfortunately, we do not have an especially recent document to consult for the purposes of our analysis. The fund's most recent financial report corresponds to the six-month period that ended on November 30, 2022. As such, it will not include any information from the past few months. That could be critical since the fund increased its distribution four times in the past twelve months and three times since the date of this report. Thus, we will not know for certain how the fund is financing the current distribution. Nevertheless, during the six-month period, the Eaton Vance Floating-Rate Income Trust received $443,762 in dividends along with $21,606,741 in interest from the assets in its portfolio. This gives the fund a total income of $22,050,503 during the period. It paid its expenses out of this amount, which left it with $15,054,964 available for shareholders. That was more than enough to cover the $13,556,133 that the fund actually paid out in distributions during the period. Thus, it appears that the earlier statement was correct. In short, the fund appears to be simply paying out its net investment income so the current distribution will probably be sustainable as long as interest rates remain at the current level. The distribution will likely vary alongside the federal funds rate.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the Eaton Vance Floating-Rate Trust, the usual way to value it is by looking at the fund's net asset value. The net asset value of a fund is the total current market value of all the fund's assets minus any outstanding debt. This is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to buy shares of a fund when we can acquire them at a price that is less than the net asset value. This is because such a scenario implies that we are purchasing the fund's assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of April 10, 2023 (the most recent date for which data is available as of the time of writing), the Eaton Vance Floating-Rate Income Trust had a net asset value of $12.93 per share but the shares currently trade for $11.54 each. This gives the fund's shares a 10.75% discount to the net asset value at the current price. That is relatively in line with the 10.50% discount that the shares have averaged over the past month, and it is a reasonable price to pay for any fund anyway. Thus, the price certainly appears acceptable here.

Conclusion

In conclusion, the Eaton Vance Floating-Rate Income Trust certainly looks like a reasonable way for any investor to generate a high level of income today, particularly since the Federal Reserve has stated that it will not be cutting interest rates anytime soon. The fund boasts a very high yield that appears to be sustainable for the time being and it is well-positioned to benefit if rates actually go a bit higher. The price today is also more than acceptable, so overall Eaton Vance Floating-Rate Income Trust fund might be worth considering today.

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