JLS - JLS: This 9.1%-Yield Higher-Quality CEF Clocks In Another Net Income Rise

2023-09-22 00:40:00 ET

Summary

• Nuveen Mortgage and Income Fund trades at a 14% discount and offers a 9.1% current yield.
• JLS has seen a 13% increase in net income, leading to steady distribution hikes.
• The fund's outperformance, rising net income, attractive valuation, and consecutive distribution hikes support holding JLS.

In this article we highlight the Nuveen Mortgage and Income Fund ( JLS ) which trades at a 14% discount and a 9.1% current yield. JLS allocates primarily to mortgage and securitized assets with a significant holding of floating-rate assets. JLS recently released its semi-annual shareholder report so we take this opportunity to provide an update.

The latest semi-annual report shows the fund registered a 13% increase in net income - a trend we have seen since 2021 and one which explains steady distribution hikes.

The current environment of an inverted yield curve, relatively tight corporate credit spreads and a resilient household sector favors a position in the fund in our view.

Moreover, the fund's outperformance since 2022, a rising level of net income, attractive valuation and three consecutive distribution hikes support our view. We continue to hold JLS in our Defensive Income Portfolio.

Fund Snapshot

As highlighted above, within the broader Multi-sector credit space, JLS has two relatively distinct features - its credit allocation is up-in-quality with a majority investment-grade profile and its duration is quite short at just 2. This combination means the fund has been relatively resilient since the end of 2022 as the following chart shows.

JLS allocates primarily to securitized assets such as mortgage-backed and asset-backed securities. These span the gamut of residential and commercial mortgages, credit card, auto, aircraft ABS and others.

Although these assets are not your typical assets like bonds and loans, they are very popular assets in the institutional investment space. JLS is also far from the only CEF that allocates to securitized assets - they make up about half the portfolios of PIMCO taxable CEFs.

About half the fund is in floating-rate assets.

Income Profile

The fund has $145m of total assets. With around half in floating-rate exposure that equates to around $73m of floating-rate assets. This is against $41m of repo which is also floating-rate for a net amount of $32m of net floating-rate assets or about a third of its NAV. In other words, for a 1% rise in base rates the net income of the fund should rise by 0.3%. This explains why the fund's net income has risen alongside the rise of short-term rates over the past year.

If we break down the fund's semi-annual net income figures this is indeed what we find. Over the past three years, net income has more than doubled. It accelerated in late 2022 because of the lagged effects of a jump in Libor over the middle of 2022.

In our last update we said net income should keep rising and this is indeed what has happened with a 13% rise from the previous semi-annual period. While net income should rise slightly from here, we don't expect to see another large jump as base rates have flatlined somewhat in expectation of the Fed going on pause or only hiking for one more time.

Fiscal-year-to-date, the fund has distribution coverage of 93.2%. This is understated given the lag with which base rates translate into net income so we expect current coverage to be closer to 100%.

The fund has a modest duration of about 2 - about half that of corporate bond funds and about a quarter of leveraged Muni funds. This is one reason why it's held up relatively well in the most recent rise in Treasury yields. It carries leverage of around 28%.

The fund's borrowings have remained fairly steady, in contrast to many other funds, most notably PIMCO CEFs, which have shed borrowings. JLS borrowings have been relatively stable for three main reasons: its relatively low NAV beta (which lessens the risk of a forced deleveraging), its relatively low starting leverage (leaving room for leverage to rise in case of NAV drop) and its rising net income (so that maintaining leverage actually makes sense).

Takeaways

We continue to hold JLS in our Defensive Income Portfolio. One key risk for the fund is a blow-up in the commercial mortgage space. Worries about the sector have fallen considerably over the last few months and, in any case, the fund's higher-quality holdings should hold up well even in a tough scenario for commercial real estate. Another risk is a sharp drop in short-term rates which would reverse some of the net income gains the fund has enjoyed over the past year. However, this is mitigated by the fund's relatively low beta to short-term rates as well as its relatively low leverage.

JLS discount has remained wide even as the rest of the sector valuations have tightened, adding to its attractiveness.

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