RA - HYB: Attractively Priced For High-Yield Exposure

2023-10-03 11:39:13 ET

Summary

• New America High Income Fund is a high-yield bond fund trading at a deep discount, making it attractive for investors seeking high-yield exposure.
• HYB distribution coverage in their last report comes to around 104%, which this fund has historically focused on paying a rate that they can earn.
• The fund's portfolio is quite diversified and includes holdings in a variety of sectors, as well as exposure to many different companies that can all operate differently during a downturn.

Written by Nick Ackerman, co-produced by Stanford Chemist.

New America High Income Fund ( HYB ) is a fairly straightforward high-yield bond fund. As a leveraged closed-end fund, they've had to deal with the higher costs of their borrowings just as most other CEFs have had to. This has seen the expected decline in income generation that the fund is able to produce. That resulted in the reduction of the distribution heading into this year.

On the other hand, the fund is trading at a deep and attractive discount. It's at the largest discount in the category of high-yield funds. However, Brookfield Real Assets Income Fund ( RA ) slightly beats it out if we were to include them in the high-yield category. RA has its own attractive features at this time, but it is a bit more complicated of a fund. The simplicity of HYB is partially what some investors might find more appealing.

The Basics

• 1-Year Z-score: -1.48
• Discount: -16.99% (based on 9/29/2023 NAV)
• Distribution Yield: 7.44%
• Expense Ratio: 1.40%
• Leverage: 33.27%
• Managed Assets: $268.66 million
• Structure: Perpetual

HYB's investment objective is "to provide high current income while seeking to preserve stockholders' capital." They do this through investing in "a portfolio of "high yield" fixed-income securities, commonly known as "junk bonds." The Fund invests primarily in "high yield" fixed-income securities rated in the lower categories by established rating agencies, consisting principally of fixed income securities rated "BB" or lower by Standard & Poor's Corporation ("S&P") or "Ba" or lower by Moody's Investors Service, Inc. ("Moody's"), and subject to applicable bank credit facility requirements, non-rated securities deemed by the Investment Adviser to be of comparable quality."

The fund is leveraged, and when including the leverage expense, the total expense ratio comes to 4.08%. That's been quite the leap from the 2.48% of the prior year and 1.50% for fiscal 2021. In this case, we've seen operating expenses climb as well as borrowing expenses. However, the borrowing expenses have seen the largest increase by a meaningful degree.

Leverage can generally provide an opportunity for a fund to pay out a higher relative distribution than if it wasn't leveraged. Though with rising interest rates, the borrowings have become less effective, and we've seen that play out, as we'll discuss when touching on the fund's distribution. So, while returns can be enhanced, the opposite is also true. It makes funds more volatile and creates the risk of further downside than would otherwise be experienced. That should always be considered before investing in any leveraged instrument.

Performance - Attractive Discount

In looking at the performance of HYB against some of its discounted peers over the long term, the fund has come out near the top. Beating out many of its high-yield bond fund peers. Credit Suisse High Yield Bond Fund ( DHY ) was one of them able to outpace HYB. This outperformance appears to have been more related to the results in the last year or so is where DHY has really started to peel away. For the most part, these two had correlated quite closely otherwise.

It should be noted that Western Asset High Income Opportunity ( HIO ) is a non-leveraged fund, but I also wanted to include it for some context.

All that being said, where HYB looks the most appealing against these peers is the fund is trading at the largest discount of this basket. DHY, which had shown to be able to top the performance in the long-term, is trading close to a 10% discount relative to HYB's nearly 16% discount.

This not only makes it the most attractively priced relative to its high-yield peers, but it is a deep enough discount that it's attractive relative to its own history. While the fund has sported a deep discount regularly, we are trading meaningfully below the longer-term average. In fact, we are near the deepest discount levels of the last decade, excluding the sharp spike lower during Covid. The discount would be based on the September 29, 2023, NAV provided, as they only report it weekly.

Distribution - Coverage Holds Up

Of course, as we had already mentioned at the open, the fund had cut its payout earlier this year. That could have put some pressure on the fund's discount.

However, several of its peers had also cut, so they aren't alone. In fact, this is one point where HIO is also noteworthy as it doesn't have to grapple with higher borrowing costs; that fund has also increased its distribution recently.

Over time, we can see that HYB has been cut many times if we look at the since inception chart. This is a product of a trending lower and lower Fed Funds Rate over these last decades.

Of course, we are dealing with the sharp reversal of this now, but this has only caused the yield curve to invert, so it hasn't been beneficial yet for most leveraged funds. Additionally, while they hold some floating rate securities, it hasn't been enough to offset and participate positively in the higher rate environment.

This is because the short rates are running up immediately while longer rates are staying more subdued and slower to rise. HYB has seen its borrowing costs rise materially without offsetting higher long-term rates kicking in to offset this trend of lower net investment income ("NII") at this point. NII is simply the interest the fund receives minus the expenses of running the fund, which includes the borrowing costs on their leverage.

This trend of lower NII is something that could reverse in the future if rates stay elevated for longer. We could see the trend of reduced NII turn into some growing NII as the portfolio invests in higher-yielding instruments while its borrowing costs stabilize.

Looking at NII on a per-share basis is probably easier to visualize for investors. We've seen NII at the end of fiscal 2021 at $0.64. That then dropped to $0.56 by the end of fiscal 2022. Now, the latest semi-annual report gives us an NII of $0.25 or what would annualize out to $0.50. Against the annualized $0.48 distribution being paid out, it does mean they are looking at distribution coverage of about 104%.

Historically, the fund has only focused on paying out what it is earning. So, if they start to see coverage slip too much with the latest rate hikes since this report, they would likely cut the distribution again. Of course, that's not generally what investors want to hear, but on the other hand, it also means they aren't paying out excess income that they aren't earning.

In both 2022 and 2021, the entire distribution was classified as ordinary income , which is what we'd expect for a high-yield bond fund. At the end of 2022, the fund had some carryover losses available that would be able to offset any potential gains it could realize in the future.

HYB's Portfolio

Turnover in the fund has been fairly modest in the last year and a half. The latest semi-annual report is showing a turnover of just under 15%. That puts it at a pace lower than last year's ~38%. Both of these figures are below the ~51%, ~53%, ~66% and ~72% seen in the previous 2021, 2022, 2023 and 2024 years, respectively.

Lower turnover would suggest that we wouldn't have seen too many changes since our last update earlier this year. In looking at the fund's sector weightings, energy is the largest exposure. However, even with that, the fund isn't necessarily significantly overweight in any particular category. This is also fairly consistent with what we've seen previously. The energy sector was the largest allocation for the fund at that time as well.

The diversification of the fund could be seen as another benefit. Diversification in sectors and various holdings within each sector can help mitigate some potential losses during an economic downturn. The idea is that not every sector is going to operate terribly in a downturn, as some companies are cyclical, but others are secular.

Besides the fairly broad sector exposure, the fund is invested in 452 holdings. The same idea applies to having different company exposure even within the same sector - not everyone will operate the same through said economic downturn. Some will perform poorly and default, while others will continue to operate and pay debt on schedule.

However, we are still dealing with a high-yield bond fund. They are called as such because of their generally lower credit ratings; companies can have shaky balance sheets for a variety of reasons. Some could be newer businesses with limited cash flows, or some larger companies have just taken out too much debt that starts to put them in a precarious situation.

Either way, these companies are generally seen as being less financially stable. In particular, HYB carries a fairly large weighting to the CCC category. These companies are considered "extremely speculative" and are pretty near default being imminent and then the eventual default.

The weightings here are also mostly similar to what we saw earlier in the year. Additionally, as no surprise given the other fairly static metrics of the fund, the top holdings haven't seen any significant shakeups.

Conclusion

HYB has focused on paying out only what it is earning. That saw a reduction in the fund's payout earlier this year, though several of its leveraged peers have also seen distribution cuts, and it wasn't alone. At the same time, the fund is trading at one of the largest discounts in the space, which makes it particularly attractive for an investor looking to gain some additional high-yield exposure.

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