ARKK - NHS: Time To Reduce Some Exposure To This High Beta HY CEF

Summary

• NHS is a fixed income closed end fund.
• The fund focuses on U.S. high yield bonds, which represent 88% of the portfolio.
• What sets this fund apart in the HY CEF space is its very high leverage ratio of 42%, which magnifies its total returns.
• The fund is up over 23% since its October lows, representing a 5x total return when compared to the unleveraged ETF (JNK).
• This article covers CEFs and related analytics.

Thesis

Neuberger Berman High Yield Strategies ( NHS ) is a fixed income closed end fund. The vehicle invests the bulk of its cash in high yielding fixed rate U.S. bonds. The CEF has a very high leverage ratio which is currently sitting at 42%. A high leverage ratio in the U.S. high yield space translates into a very high beta to market conditions for the fund. In effect, Morningstar actually quantifies this for us:

On a 3-year basis the fund has a beta close to 2, meaning that if the market moves down by -1% (as measured by the U.S. High Yield bond Index), NHS will lose -2%. Close to market tops, or when investors want to take risk off the table, high beta names should be the first ones to be cut. Why? Because they will drag down your portfolio if the market sells-off. This is applicable to any investment across the securities spectrum - equities, fixed income and commodities.

To draw a parallel with the pure equity world, ( ARKK ) for example is a very high beta vehicle - to that end the ETF is up almost 40% this year, but at the same time it is prone to lead on the downside if and when the market resumes its downturn.

Returning to NHS, as per its mandate, at least 80% of the Fund’s total assets will be invested in below investment grade (high yield) debt securities (including corporate loans) of US and foreign issuers. As of its latest fact sheet, the fund has around 88% of its portfolio in bonds:

The fund does not have an overly risky portfolio build, having only 16% of its holdings in CCC names:

However, as we stated above, its very large leverage ratio makes this vehicle move substantially when the market whipsaws.

Performance

The fund is up over 23% since its October lows:

We have included here a credit risky fund, namely KKR Income Opportunity Fund ( KIO ) and a junk bond ETF, namely ( JNK ) for comparison purposes. We can see NHS's high beta nature by its performance arch - the fund has a double total return when compared to KIO, and a 5x return when compared to JNK! That is what leverage tends to do, magnify returns.

On a long term basis leverage magnifies the downside as well, so when looking at a 3-year total return graph we can see all three vehicles with the same figures:

These two graphs should make it clear to a retail investor that NHS is not a true buy and hold instrument. It is more of a high beta play in a recovery or a bear market rally. Extremely volatile CEFs like this one should be used only to magnify market recoveries, not recessionary periods.

U.S. high yield spreads have now retraced a very large portion of their 2022 downside:

We can see how spreads peaked close to 6% in 2022, only to retrace now to a 4.15% level. We are not out of the woods yet in respect to the economy, and weak economic data will translate into higher spreads. As a high beta vehicle NHS will probably give up most of its gains since October, so it would be a sensible idea to take some risk off the table here.

Conclusion

NHS is a fixed income closed end fund. The vehicle invests in mostly 'B' and 'BB' U.S. high yield names. What sets this fund apart is its very high leverage ratio of 42%. That type of leverage translates into a high beta fund, meaning the CEF is set to substantially magnify moves in the market, both on the upside and downside. The fund is up over 23% since its October lows, representing a 5x total return when compared to the unleveraged ETF ( JNK ). We feel the tightening in U.S. credit spreads is overdone given the existing headwinds in the economy, and any re-pricing will affect NHS to a large degree. Having had a strong run since October, it is time to take some risk off the table here.

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