ECCV - IBHD:A Good Place For 8% Yield

2023-07-05 10:59:41 ET

Summary

• Junk bonds are risky at this stage of the economic cycle.
• Smaller company bankruptcy filings are accelerating but publicly-traded high yield credit has stayed buoyant.
• IBHD gives you the right mix to reach for an 8% yield.

Investors who have read our thoughts over the last year know that we hate taking unnecessary risk. Hence the vast majority of our takes land in the "hold" or "sell" categories. This is particularly true with high yield seeking products where you can break a leg chasing that extra few percentage points. That said, not all yield products give you the same risk and a few today are very interestingly setup. We give you one that we can stamp a "buy" on. The fund in question is from the ultra large Blackrock family and is called iShares iBonds 2024 Term High Yield and Income ETF (IBHD).

Methodology Overview

The fund is a term fund and will terminate at the end of 2024. That is now 18 months away and gives investors a rather unique flavor within the high yield space. Surprisingly, there is actually an index that this fund follows called the Bloomberg 2024 Term High Yield and Income Index. Who knew that they would be creating an index designed to be terminated in a specific year, but apparently we have a lot of them. IBHD was started in 2019 and has been tracking this 2024 index with dedication. The fund uses representative sampling, which in simple terms means that about 80% of its portfolio will be comprised of securities from the index. Over the next year, we will have a few more rebalancing events (the fund does one on the last day of each month). The last one though will be done six months before the fund termination and that would be on June 30, 2024. At that point, we start coming out of high yield bonds and start reinvesting the proceeds in cash and cash equivalents. This would be Treasury bills in all likelihood but the fund has some discretion here. The point is that your risk of breaking the buck starts swiftly going to zero at that point.

Portfolio Overview

Now this is still a "high-yield" bond fund, so don't start expecting investment grade bonds to show up here. Most of the portfolio is rated within two rungs of the investment grade rating though, so you are not reaching far into the "Cs".

The fund is heavily exposed to consumer cyclicals, followed by the finance and communications sector.

The fund has basically zero interest rate risk at this point as it will be liquidating within 18 months. You can see the same in the duration risk here of just a shade over a year.

More importantly for investors, the 30 Day SEC Yield is 8.13% and the yield to maturity is 8.23%. Our preferred measure for returns over the next 12 months here is the yield to maturity less the expenses for the fund. Now, this is not a cheap ETF, at least when you benchmark vs other iShares. The 35 basis points comes from the likely smaller size and the more work required to get this to follow a benchmark coming for termination.

But that is still worth paying here as your own slippage is assembling such a portfolio will likely be far higher. So getting back to the effective yield, you would be at around 7.88% (8.23% minus 0.35%). That is great for a fund that is taking no leverage and no duration risk.

Who Stole My Distribution?

Investors who have checked out the fund's yield on finance websites might have noticed that most state it near the 6% mark.

So that might get them to doubt the 7.88% which we see as a likely outcome over the next 12 months. That number comes from the trailing 12 months of distributions and really has no impact on the forward yield. The distributions are rising slowly and you can see that the latest one almost reached 14 cents.

Annualizing the latest number gets us to a yield of 7.22%. Still not at the 7.88% mark, but we expect that to be the total return when all is said and done.

Verdict

We will keep harping on the risks that are present today as investors keep pricing in rosy outcomes as far as the eye can see. The fact remains that we are in the midst of the most aggressive Fed tightening and just because nothing (well, almost nothing) has cracked, does not mean things will not break eventually. Bankruptcy filings are beginning to move up though.

Leveraged loans are off to a very difficult first half of the year.

That is why funds like Eagle Point Credit Co Inc. ( ECC ) and Oxford Lane Capital Corp. ( OXLC ) have basically offset their massive yields with price declines.

There are risks here and while you are getting paid more today than you did at the peak of the ZIRP bubble, odds that you make a double digit total return in junk is next to zero. IBHD is an interesting alternative as defaults over a one-year time frame for a junk Universe tend to be very low. Yes, it can happen, but if things are breaking that badly everywhere, then you can rest assured that your levered high-yield bond funds taking duration out for decades, will be blown to smithereens as well. We rate this a tentative buy and it gets a 4 on our potential pain scale.

We don't own it at present as we have previously shown, there are ways to make close to this much, virtually risk-free if you can find the right company. But those not willing to do a case-by-case due diligence, can consider this for some exposure.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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