Summary
- The AIF fund provides high current income through a portfolio of senior loans, corporate bonds, and other credit investments.
- The fund pays a high forward yield of 11.2%.
- AIF has a troubling trend of long-term NAV declines that is not consistent with the mean-reverting nature of credit spreads. This suggests something may be fundamentally wrong with its investment process.
The Apollo Tactical Income Fund Inc. ( AIF ) provides high income through a portfolio of senior loans, corporate bonds, and other credit instruments. Although the AIF fund pays an attractive 11.2% forward yield, I am worried by the fund's long-term NAV declines. While AIF is able to fund its generous distributions from NII, the fund has a troubling trend of realized and unrealized losses, suggesting the fund may be making bad investment decisions in a stretch for yield.
Fund Overview
The Apollo Tactical Income Fund Inc. is a closed-end fund ("CEF") that seeks to provide high current income through a portfolio of senior loans, corporate bonds, and other credit instruments.
The AIF fund has $207 million in asset and charges a 2.95% expense ratio.
Portfolio Holding
The AIF fund's asset allocation is shown in figure 1. The AIF fund has 76% of assets invested in senior loans, 16% in high yield bonds, and 7% in structured products.
The fund's credit quality allocation is shown in figure 2. AIF's portfolio skews to the riskier credits, with 88% rated B or lower.
Returns
Figure 3 shows the AIF fund's historical returns. The AIF fund has generated modest long-term returns, with 3 and 5Yr average annual returns of 1.2% and 3.0% respectively to January 31, 2023. Since inception, average annual returns have been better, at 4.6%.
Distribution & Yield
The AIF fund pays a high monthly distribution, with current monthly distribution set at $0.122 / share. This implies a forward yield of 11.2% on market price or 10.2% on NAV.
AIF's distribution was increased multiple times in 2022, from an initial $0.085 to $0.09 in May, $0.097 in July, $0.11 in September, $0.115 in October, and $0.122 in December (Figure 4).
Generous Distribution Funded From NII
Historically, AIF has funded its distributions from net investment income ("NII") (Figure 5). There is no reason to believe that will not be the case in 2022, despite the rapid increase in distribution rate.
Fully Funded Distribution, But Something Doesn't Add Up
Although AIF is able to fund its distribution via NII, I cannot help but have a nagging feeling that something isn't right. The main problem is that AIF has a long-term declining NAV (Figure 6).
If AIF is able to pay distributions out of NII, then long-term NAV declines should not occur, as loan prices trade inversely to credit spreads and should be mean reverting over the long-run.
A portfolio of prudently selected senior loans may see short-term unrealized declines during stress periods, but in general, the portfolio should pay out at par if held to maturity (less any defaults). The fact that AIF's NAV show a long-term declining trend is perplexing. It is very similar to the declining NAV trend I discussed with the Blackstone Strategic Credit Fund ( BGB ).
Although it is difficult to know for sure without being an insider at the fund, from AIF's published annual report, we can see that the fund has had poor long-term "investment performance," as measured by the cumulative realized and unrealized gains and losses per share. For example, in figure 5 above, we can see AIF has generated a cumulative loss of $2.98 / share in net realized and unrealized gains and losses between the years 2017 to June 2022.
Similarly, between the years 2013 to 2016, the AIF fund lost $1.68 / share in realized and unrealized gains and losses (Figure 7).
So although the fund was able to generate a cumulative $11.83 in NII / share since inception to pay $12.14 / share in fund distributions, the fund also suffered $4.66 / share in realized and unrealized losses to achieve those high yields. This leads me to suspect the investments used to generate those high investment yields were very speculative and may have led to a permanent loss of capital.
Conclusion
The Apollo Tactical Income Fund Inc. provides high income through a portfolio of senior loans, corporate bonds, and other credit instruments. The fund pays an attractive 11.2% forward yield. Although AIF is able to fund its distribution from NII, the fund has a troubling long-term trend of realized and unrealized losses that are not consistent with the mean reverting nature of credit investments. This suggests the AIF fund may be making bad investment decisions in a stretch for yield.
For further details see:
AIF: Fully Funded Yield But Shrinking NAV