HYT - HYT: Moving From Buy To Hold On This High Yield CEF

Summary

• BlackRock Corporate High Yield Fund is a fixed income closed end fund.
• We own the name and have put a Buy rating next to it in several past articles.
• For active investors it is time to take some risk off the table here, with fundamentals in the HY market still deteriorating while credit spreads have tightened too much.
• The fund has also recorded a 6% narrowing in its discount to NAV since the October lows.
• This article covers CEFs and related analytics.

Thesis

BlackRock Corporate High Yield Fund ( HYT ) is a fixed income closed end fund. The vehicle focuses on U.S high yield debt, and has a middle of the road credit risk composition. We have covered this fund a number of times, re-iterating our Buy rating:

The fund has provided for a very nice return profile since the rights issuance, and has seen its discount to net asset value narrow as the market has rallied. We feel everything is priced for perfection these days in the high yield space, although fundamentals are deteriorating:

“Fitch sees clear signs of loan credit deterioration, with rating downgrades picking up in 4Q22. Loan issuers in the ‘CCC’ category increased to 9% of the market versus 7% in 3Q22. The population of issuers rated ‘B-‘ and below rose to 47% from 43%,” said Fitch Ratings Senior Director Eric Rosenthal. Institutional leveraged loans logged only $250 billion of gross issuance in 2022, well below 2020’s $420 billion and 2021’s $831 billion. Net new money registered only $13 billion in 4Q22. Anticipation of a recession propelled flight to quality, with 44% of issues rated in the ‘BB’ category, up from 29% in 3Q22. LBO volume was muted as underwriters continued to focus on offloading funded loans amid volatile markets. Despite widening spreads, re-financings accounted for one-third of 4Q22’s issuance.

Source: Fitch Ratings

Bear markets are characterized by very long and substantial bear market rallies, and we feel we are witnessing one now. We are not out of the woods yet, and we are yet to see that substantial spread widening stemming from pure fundamental factors (default worries, maturity wall, etc). Just like with any other asset class high yield should be traded around. That means that within a longer term trend, an active investor can increase or decrease risk appetite to a certain risk factor. We own HYT and we like HYT, however it is time to lighten up on some of the exposure here:

We are back to 'Extreme Greed' due to J. Powell not being hawkish enough. Read that again. The Fed did not say they will pivot or decrease rates this year. The Fed was just not hawkish. Classic bear market rally. The markets have front-run themselves, and although the fundamental picture is deteriorating, credit spreads are trading like we are out of the woods:

As we can see from the above graph, U.S. Corporate High Yield Average Option Adjusted Spreads are now lower than in August 2022. That is a very significant move that would signal all fundamental problems are over. We are not there yet.

Premium/Discount to NAV

The fund's discount to NAV has tightened considerably in the past month:

We can see a nice discount to net asset value tightening of 6% over the past month. Please note that the CEF recorded a flat level to NAV during the August risk-on rally, and we are getting quite close to that, but with fundamentals in the market deteriorating. Expect the discount to widen over -8% again during the next risk sell-off.

Conclusion

HYT is a fixed income closed end fund. The vehicle focuses on U.S. high yield debt, and we have covered it before with Buy ratings. Since the rights offering in 2022 which we analyzed on Seeking Alpha, HYT is up substantially. Although credit spreads have tightened and rates are lower, the fundamental picture is still deteriorating, with defaults set to increase this year. We are now in full 'Extreme Greed' mode by looking at the 'Fear & Greed Index', a position which historically has signaled tops during bear markets. We like HYT and its composition, but after the substantial run-up since our last Buy rating on the name it is time to take some risk off the table. Active investors should be able to trade around this environment a bit, given the substantial volatility driven by bear market rallies. We have not bottomed yet, and it would be wise to reduce some risk here. We are therefore moving from Buy to Hold on HYT.

For further details see: