PHD - Rising Interest Rates Got You Down? Try Floating Above The Fear

2023-09-25 12:00:16 ET

Summary

• Interest rates are likely to remain elevated due to the strong U.S. economy, despite inflation concerns.
• The U.S. debt has reached a record high, and fears of a government shutdown are exacerbating market concerns.
• Investing in CEFs that hold floating rate senior loans can provide a high yield income stream that benefits from rising interest rates.

While inflation continues to dominate the news headlines, and the Federal Reserve chases after the elusive " soft landing ," interest rates remain at elevated levels and are not likely to come down any time soon. At the latest meeting of the Federal Reserve on Wednesday, September 20, Chairman Powell indicated that the strong U.S. economy is responsible for the potential need for another rate hike this year while leaving rates unchanged for now.

"It's more about stronger economic activity," Fed Chair Jerome Powell said at a news conference Wednesday, when asked about the forecasted need for another rate hike by the end of the year, "if I had to attribute one thing. Broadly, stronger economic activity means we have to do more with rates."

While this may be seen as bad news for the overall stock market, this can be viewed as good news from the standpoint of the US consumer and business growth. Even though inflation is still not under control and interest rates may continue to rise the economy is still growing and we are not in a recession and do not appear to be heading for one, just yet.

Meanwhile, Treasury yields are at the highest rate since 2007 and the US debt hit a record $33 trillion for the first time. The government faces a shutdown if a budget deal is not reached by September 30, further exacerbating fear in the markets. While the month of September has already been undergoing a correction, losing -3% in the past month, the worst of the declines in the market indexes may not be over just yet.

As a long-term income-oriented investor seeking steady growth in my future income stream, I view this downturn as an opportunity. While investors in growth stocks like Nvidia (NVDA), Super Micro (SMCI), and Apple (AAPL) are gnashing their teeth and losing sleep, I remain committed to my Income Compounder strategy for growing my future income stream to support my needs in retirement. And one way that I make progress towards that goal is by investing in CEFs (closed-end funds) that offer a high-yield income stream that actually benefits from rising interest rates.

The types of CEFs that I am referring to include those that invest in floating rate securities such as senior secured loans and corporate bonds. One reason to invest in CEFs that hold floating rate senior loans is because those loans sit at the top of a company's capital structure. In the event of a default, senior loans are paid off first before any corporate bonds or equity positions. Loans also have less credit risk and no duration risk because the loan coupons adjust with short-term rates.

In fact, there are several of those floating rate senior loan CEFs that have recently increased the monthly dividend payouts that they offer, and in some cases have raised the distribution multiple times over the past year. In this article, I am going to briefly review five of them for your consideration.

AFT

First up is Apollo Senior Floating Rate F und (AFT). AFT offers an annual yield of 11.5% after announcing its most recent raise to the monthly dividend on September 11. The dividend increased from $.126 per share to $.129. That increase represents the fourth increase in the monthly dividend in 2023, following 5 increases in 2022. Despite the high yield and growing dividend, the fund currently trades at a discount to NAV of nearly -11%.

The fund's performance resulted in a total return of more than 18% over the past one-year period with dividends reinvested. You can read more details about the fund in this recent article , "AFT: Senior Loan CEF, Double-Digit Distribution Yield And Discount," from fellow SA analyst, Juan de la Hoz, who offers his review and Buy recommendation. There is also a sibling fund from Apollo, Apollo Tactical Income Fund (AIF), that invests in senior loans and corporate bonds that is worth consideration as well. There is an excellent article , "Apollo Tactical Income CEF: Top Of The Capital Stack, Paying 11%," from fellow analyst Steven Bavaria, that covers AIF in more detail.

BGT

Next on my list is a fund offering from BlackRock. The BlackRock Floating Rate Income Trust Fund ( BGT ) offers investors a yield of 11% monthly and trades at a -6% discount to NAV. BGT has raised the distribution 3 times in the past year as shown in this chart from CEFConnect, most recently in June.

The BGT fund performance has offered a total return of more than 21% over the past year. The Floating Rate Income Trust | BGT has about $287M in net assets, has a 5-star rating from Morningstar, and invests at least 80% of assets in floating and variable rate instruments. As of July 31, the distribution coverage from UNII was 91% with only about 2% of the distribution estimated to be ROC.

And, like Apollo, BlackRock offers a sibling fund that also holds floating rate securities that are quite similar to BGT, BlackRock Floating Rate Income Strategies fund (FRA). I currently prefer BGT because it trades at a slightly wider discount and has slightly better distribution coverage.

JFR

Nuveen offers its floating rate senior loan fund, Nuveen Floating Rate Income Fund (JFR), which is the resulting fund after completing a merger on July 31, 2023, with 3 other funds that Nuveen previously offered (NSL, JRO, JSD), making it now the largest fund in its class with nearly $2B in assets under management.

Also, as a result of the merger the monthly distribution was increased by 14% from $0.074 per share to $0.085 payable September 1. The annual yield based on the increased distribution amounts to nearly 12.5% annually and the fund currently trades at a discount of more than -10% to NAV.

Despite the increased assets and raised distribution, the market has not recognized the opportunity that the merger offers, and the discount remains near its 52-week historical average as illustrated in the chart from CEFConnect, which presents a buying opportunity in my opinion. The discount is likely to narrow as more investors gain confidence in the management of the merged fund and their ability to continue to pay the high-yield distribution.

PHD

Another floating rate fund that I own and have previously covered , most recently in December with "PHD: Leverage Rising Interest Rates With This High-Yield Floating-Rate Fund," is Pioneer Floating Rate Fund, Inc. ( PHD ) from fund manager Amundi. What I wrote back in December was summarized in the bullet points for that article:

• The Pioneer Floating Rate Trust trades at a discount of -11% and pays a monthly distribution that has been raised 5 months in a row.
• The current annual yield exceeds 11.5% and benefits from rising interest rates due to its mostly floating rate senior secured loans that it holds.
• The fund manager, Amundi, has managed Pioneer Floating Rate Trust since inception in 2004 and has successfully navigated multiple recessions and bear markets during that time.

Today, the same fund still trades at a discount of -11%, pays an annual yield exceeding 12%, and has raised the monthly distribution 4 more times this year. The most recent increase was announced on July 6 when the monthly distribution was raised from $0.090 to $0.0925. This is what the distribution history looks like for PHD over the past year.

PHD is one of the smaller floating rate senior loan CEFs with about $130M in AUM and only employs about 5% leverage, which I believe is one reason for the ongoing discount. The management fee is only 1.04% plus 0.3% in other expenses and interest expense of about 1.1% for total expenses of 2.45%, which is on the smaller side for an actively managed CEF as well. PHD seems to be a well-run, reasonably priced CEF that offers a healthy distribution and is poised to offer attractive returns in the rising rate environment that we continue to experience.

VVR

And my final recommendation for a CEF that holds floating rate securities is the Invesco Senior Income Trust (VVR). On September 22, VVR announced a 10% increase in the monthly distribution, from $0.039 per share to $0.043 per share. That results in a forward yield of about 13%, the highest yielder of the group discussed herein. Yet the fund still trades at a discount to NAV of about -4%.

I previously owned VVR last year but sold it when the discount essentially disappeared back in March, and I felt that the fund was overvalued. Right after that, and around the time of the SVB bank failure, the share price dropped precipitously and returned to a wide discount as shown in this chart from CEFConnect.

With the recent narrowing of the discount and the announcement of the increased monthly distribution, I am now back in the fund with a small position that I intend to hold for as long as interest rates continue to rise. VVR paid a special distribution in December 2022 which may have been at least partly responsible for the rapid increase in share price, along with the first distribution raise of 2023 that was announced back in February.

The fund distributions included a small amount of ROC for the months of May and June but have otherwise been 100% income for the remainder of 2023, which leads me to believe that distribution coverage has improved and that is why the recent increase was announced.

Summary

It looks as though interest rate cuts are not coming any time soon much to the despair of many growth-oriented investors who were hoping to see a Fed pivot occur. In fact, unless the economy suddenly sours, which could happen if the government fiscal impasse is not resolved by September 30, or if other events cause a recession to rear up sooner than most are now expecting, another rate increase is likely.

This predicament creates an opportunity for income investors who can take advantage of discounts on CEFs that offer high-yield distributions from floating rate senior loans. While those discounts persist and the distributions are being increased, the opportunity to generate increasing passive income from those CEFs is available for those willing to take on the risk.

It has been my experience that credit markets reward those investors who are willing to take some risk when the fear from the market pushes down the prices of the funds that invest in floating rate instruments while the loans continue to pay the coupons each month. Default rates remain at historically low levels and there is nothing to indicate that will change any time soon with the economy in the US still showing signs of strength.

Please do your own due diligence and perform more research on any of the funds that interest you before investing. My investment goals and objectives may not align with yours, but if they do and you like what you read, please add your comments below. I am also interested in hearing from those readers who disagree with my point of view because I am always open to learning more about my investments. Thanks for reading, and good luck whatever you decide!

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