2023-06-29 15:17:35 ET
Summary
- Investors today are desperate for income due to the rapidly rising cost of living in most developed nations.
- abrdn Income Credit Strategies Fund invests in a portfolio of bonds from around the world in an attempt to provide investors with this high level of income.
- The fund's portfolio is very nice for American investors that need to increase their foreign exposure.
- The fund yields 17.54% at the current price, but this might not be sustainable.
- The fund is more expensive than normal, so it is probably best to wait for a price decline.
There can be little doubt that one of the biggest problems facing the average American today is the rapidly-rising cost of living. This is evidenced by looking at the consumer price index, which claims to measure the cost of a basket of goods and services that is regularly purchased by the average American household. As we can see here, the index has increased by far more than the 2% year-over-year rate that is considered healthy during each of the past twelve months:
We do see that the inflation rate has come down somewhat in recent months, but this was mostly caused by the fact that energy prices have been consistently lower this year than they were during the equivalent month last year. As I pointed out in a previous article , the consumer price index is actually showing a much higher increase year-over-year when food and energy are removed from the basket. In fact, the core consumer price index shows that there has been almost no progress made in the Federal Reserve's fight against inflation. As I noted numerous times in previous articles, the Federal Government has been draining the Strategic Petroleum Reserve in an effort to hold energy prices down. As we can see here, the amount of oil in the nation's storage has gone down for thirteen straight weeks:
Zero Hedge
This is offsetting the fact that the fundamentals are pointing toward an energy shortage and thus rising prices. As the Strategic Petroleum Reserve only contains a very limited remaining stockpile of crude oil, it is unlikely that this can go on for too much longer, and the inflation rate will go up once the Federal Government can no longer artificially suppress prices.
This high level of inflation has caused real wage growth to be negative for 26 straight months and has obviously challenged the budgets of many households. In fact, we have seen a surge in the number of people taking on second jobs or entering the gig economy just to get the extra money that they need to make ends meet. This may be one reason why the employment numbers are holding up fairly well despite every other economic indicator pointing to a recession.
As investors, we are certainly not immune to the ravages of inflation. After all, we all have bills to pay and require food just like anyone else. We do have other methods that we can employ to obtain the extra money that we need to maintain our standard of living in the face of today's high inflation, however. For example, we can put our money to work for us earning an income. One of the best ways to do this is to purchase shares of a closed-end fund, or CEF, that specializes in income. These funds are unfortunately not very well-followed in the financial media and many advisors are unfamiliar with them, so it can be difficult to obtain all the information that we would like to make an investment decision. This is a shame because these funds have a number of advantages over open-ended and exchange-traded funds. Most importantly, a closed-end fund has the ability to employ certain strategies that can boost its effective yields well beyond that of any of the assets in the fund's portfolio.
In this article, we will discuss the abrdn Income Credit Strategies Fund ( ACP ), which yields a whopping 17.54% at the current price. This yield will certainly grab the attention of just about anybody that desires income, but generally speaking, the market only assigns yields this high to things that are expected to have to cut their payouts. So this is something that we will want to investigate as we research this fund. Let us proceed onward and see if this fund could be a good addition to a portfolio today.
About The Fund
According to the fund's webpage, the abrdn Income Credit Strategies Fund has the stated objective of providing its investors with a very high level of current income. The fund's webpage appears to be somewhat buggy, as Mozilla Firefox actually blocked it on security grounds, but it worked fine with a browser running the Chromium engine so if the webpage fails to work for you, that might be the reason. The focus on current income is not particularly surprising considering that the fund's name implies that it invests primarily in fixed-income securities. CEF Connect confirms this, as 90.77% of the fund's portfolio is invested in debt securities:
CEF Connect
This is in line with the fund's description on its webpage, which states,
The fund seeks to achieve its investment objectives by opportunistically investing primarily in debt and loan instruments of issues that operate in a variety of industries and geographic regions. The fund may invest, without limitation, in credit obligations that are rated below investment grade by a NRSRO such as S&P or Moody's or unrated credit obligations that are deemed by the Advisors to be of comparable quality.
The fund is thus clearly a debt fund, and this is why the focus on current income as an investment objective makes sense. After all, bonds are by their very nature an income vehicle. An investor will purchase a bond at face value, receive a regular interest payment from the bond issuer, and then receive the face value of the bond back at maturity. Thus, over its lifetime, the only investment return that a bond will deliver is the interest payment. There are no capital gains because a bond has no inherent link to the growth and prosperity of the issuing company.
With that said, it is possible for a bond investor or fund to earn some profit by trading bonds prior to maturity. This comes from the fact that bond prices vary with interest rates. It is an inverse relationship, so when interest rates go up, bond prices decline. This has certainly been the case in the United States as the Federal Reserve started aggressively raising interest rates in March of last year as part of an effort to combat the incredibly high rate of inflation in the nation. As we can see here, the effective federal funds rate went from 0.08% in February 2022 to 5.06% today:
This is one of the steepest rate increases of all time, which was probably necessary to undo all the damage that was done by keeping rates at near zero for fifteen years. The bond market certainly reacted to these rate hikes as the Bloomberg U.S. Aggregate Bond Index ( AGG ) delivered a -13.01% total return in 2022, although it has rebounded since then due to the market's optimism that the Federal Reserve will cut rates at the first sign of a recession.
The Federal Reserve has been more aggressive than most central banks when it comes to rate hikes, but it has certainly not been alone. As of today, the only two central banks whose nations are in the G20 that have not raised their benchmark rates over the past twelve months are the Bank of Japan and the People's Bank of China. This is important because, like most abrdn funds, the abrdn Income Credit Strategies Fund is a global fund that purchases assets from all over the world. The fund's own description (quoted earlier) directly states this and the fund's fact sheet confirms it by stating that only 53.1% of the assets in the portfolio are issued by entities within the United States:
Fund Fact Sheet
This is very unusual for a global bond fund as normally the United States accounts for a much higher percentage of total assets. The United States has the largest bond market in the world, due both to the size of its economy and its outsized level of government debt. As of the third quarter of 2022, the United States accounted for $51.3 trillion of the $113 trillion global bond market. That works out to 45.40% of the total. However, the second-largest bond issuer, China, is very rarely included in global bond funds. We also do not normally see large issuers like South Korea that have a very high rate of personal savings (because their own citizens buy most of the bonds that are issued) in funds like this. As a result, the United States usually accounts for a huge proportion of most bond funds simply due to the size of its market and the availability of bonds from American issuers. This is a problem for American investors, as most of them are far too exposed to the United States. The fact then that this one appears to be making a concerted effort to diversify its portfolio internationally is thus a very real advantage. This fund could be particularly useful for American investors, who tend to have a difficult time getting foreign bond exposure and have considerable exposure to their home nation.
The fund is also interesting because the majority of its assets are denominated in euro, not in U.S. dollars:
Fund Fact Sheet
This is interesting because of the currency exposure. The euro and the British pound both outperformed the U.S. dollar over the past year, despite the fact that inflation in both regions is higher than in the United States and both the European Central Bank and the Bank of England have been far less aggressive about hiking interest rates than the Federal Reserve. Thus, the fact that this fund has some foreign currency exposure could provide an added boost to the investment return because the interest payments made by the foreign currency bonds have a higher value when converted back into U.S. dollars. Unfortunately, the fund's most recent annual report states that it hedged all foreign currency exposure during the full-year period that ended last October. From the report:
Over the reporting period, the Fund hedged all currency risk back to U.S. dollars, which protected further downside for the Fund given the strong underperformance of the euro and sterling against the U.S. dollar. During the reporting period, the Fund's performance benefited approximately 12.66% from hedging the currency risk.
The euro and sterling are actually outperforming the dollar nowadays though, so if the fund is still using these hedges then it is going to have the opposite effect and be a net drag on its overall performance. The fund does not specifically state that it will always hedge its currency exposure, only that it was fully hedged during the period in question. It would be fortunate if the fund is unhedged now, as that would provide a real boost to its performance. Regardless, the fact that the fund appears to have the option to run unhedged is something that we should be able to appreciate as investors.
Leverage
In the introduction to this article, I stated that closed-end funds have the ability to employ certain strategies that allow them to earn a higher yield than the underlying assets actually possess. One of the strategies that are employed by the abrdn Income Credit Strategies Fund is the use of leverage. Basically, the fund borrows money and then uses that borrowed money to purchase high-yielding bonds and other assets. As long as the interest rate that the fund has to pay on the borrowed money is lower than the yield of the purchased securities, it works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing at institutional rates, which are considerably lower than retail rates, this will normally be the case.
However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund does not employ too much leverage since that would expose us to an excessive level of risk. I normally like a fund's leverage to remain under a third as a percentage of its assets for this reason. Fortunately, this fund appears to be satisfying that requirement. As of the time of writing, the abrdn Income Credit Strategies Fund has an effective leverage of 26.29% of its assets. Thus, this fund appears to be running a reasonable balance between risk and reward.
Distribution Analysis
As mentioned earlier in this article, the primary objective of the abrdn Income Credit Strategies Fund is to provide its investors with a high level of current income. In order to achieve this objective, it invests in bonds issued by entities all over the world and then applies a layer of leverage to boost the effective yield that it receives from these assets. It then aims to pass most to all of its income to its investors. As such, we can probably assume that the fund will have a very high yield. This is certainly the case as the abrdn Income Credit Strategies Fund pays a monthly distribution of $0.10 per share ($1.20 per share annually) to its shareholders. This gives the fund a whopping 17.54% yield at the current price. Unfortunately, the fund has not been especially consistent with its distribution over the years, as it has gradually declined with time:
With that said though, this is a much better history than most fixed-income funds possess and it does appear that this fund is making a lot of efforts to maintain a steady distribution over time. As such, it may still appeal to those investors that are seeking a safe and secure source of income to use to pay their bills and finance their investments. The biggest concern here is that anytime we see the market assign a double-digit yield to a fund, it is a sign that the distribution is at risk of being cut. As such, we want to investigate that, particularly since most bond funds did take very high losses over the past year and have cut their distributions in response.
Unfortunately, we do not have an especially recent document that we can consult for the purposes of our analysis. The fund's most recent financial report corresponds to the full-year period that ended on October 31, 2022, so it will not have any information about the fund's performance over the past eight months. It also includes information just for the old fund prior to the merger with Delaware Ivy High Income Opportunities Fund that occurred earlier this year. With that said, the two funds were very similar and the fund's strategy and management did not really change post-merger so most of what the report discusses should be applicable to the combined fund. The only difference of note is that the fund is much larger now. During the full-year period, the abrdn Income Credit Strategies Fund received $52,328 in dividends and $28,462,718 in interest from the assets in its portfolio. This gives the fund a total investment income of $28,515,046 during the period. It paid its expenses out of this amount, which left it with $20,875,496 available for shareholders. Unfortunately, this was not nearly enough to cover the $28,744,450 that the fund actually paid out in shareholder distributions during the period. This is concerning, particularly for a fixed-income fund. We ordinarily like to see these funds pay their distributions entirely out of net investment income.
With that said, the fund does have other methods that it can employ to obtain the money that it needs to cover the distribution. For example, it might be able to earn gains by taking advantage of changes in bond prices. Unfortunately, the fund failed miserably at this task during the period, which was probably expected considering the overall market weakness that we saw during 2022. The fund did manage to achieve net realized gains of $3,902,028 but this was more than offset by $84,502,480 net unrealized losses. Overall, the fund's assets declined by $76,427,099 after accounting for all inflows and outflows, including a $13,839,680 capital raise. The fund's assets at the end of the period were in fact lower than they were on November 1, 2020, so the fund failed to sustain itself over the trailing two-year period. This is a concerning sign and it clearly indicates that this fund may have to cut its distribution in the near future. The market appears to be correct here with regard to its fears.
Valuation
It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the abrdn Income Credit Strategies Fund, the usual way to value it is by looking at the fund's net asset value. The net asset value of a fund is the total current market value of all the fund's assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.
Ideally, we want to purchase shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are acquiring the fund's assets for less than they are actually worth. That is, fortunately, the case with this fund today. As of June 28, 2023 (the most recent date for which data is currently available), the abrdn Income Credit Strategies Fund has a net asset value of $6.89 per share but the shares currently trade for $6.83 each. That gives the fund a 0.87% discount on net asset value at the current price. This is much less attractive than the 2.64% discount that the shares have traded for on average over the past month and implies that it would be best to wait for the price to drop a bit before buying shares. It may also be a good idea to wait until after the fund releases an updated financial report so that you are not buying based on outdated information.
Conclusion
In conclusion, the abrdn Income Credit Strategies Fund certainly has a great deal of potential. The fund's attractive yield and international exposure in particular could offer a lot for an American investor that is seeking a high level of income. The biggest problems here are that the fund is more expensive than normal and its financial information is a bit outdated. It is probably a good idea to wait for a price decline in order to reduce the overall risks that come with the fund. The distribution also may not be sustainable, but that appears to be priced in and even if the fund does cut it, the yield will probably still surpass most other things in the market.
For further details see:
ACP: International Exposure With A High Yield