Summary
- The JQC fund invests primarily in senior secured and second lien loans.
- The fund pays a high monthly distribution, currently yielding 10.5%.
- However, JQC's long term performance shows a declining trend in NAV and distributions; clear indicators of a 'return of principal' fund that does not earn its distribution.
The Nuveen Credit Strategies Income Fund (JQC) provides high current income from a portfolio of senior secured and second lien loans. Although the fund pays a high distribution yield, currently set at a forward yield of 10.5%, I worry about the long term sustainability of its distribution. Looking at JQC's long term performance, the fund is clearly an amortizing 'return of principal' fund where both NAV and distributions decline over time. I would avoid this high yield trap.
Fund Overview
The Nuveen Credit Strategies Income Fund is a closed-end fund ("CEF") that aims to provide high current income and total returns. The fund mostly invest in floating rate senior secured and second lien loans, but may invest up to 30% opportunistically in other income-oriented securities. The JQC fund may employ leverage to enhance returns.
JQC is a fairly large fund with $780 million in net assets and $1.3 billion in managed assets for effective leverage of 39.7% (Figure 1). It charges a 1.33% management fee and a 2.75% total expense ratio, according to the latest factsheet .
Portfolio Holdings
The JQC fund contains 400 holdings with average maturity of 4.5 years and average duration of 0.8 years. Figure 2 shows the fund's asset allocation. 81% of the fund's assets are invested in senior loans and 15% are invested in corporate bonds.
Figure 3 shows the fund's credit quality breakdown. The JQC fund's investments are predominantly non-investment grade, with only 14% of assets rated BBB or higher. 35% of assets are rated BB, and 45% are rated B.
Returns
Figure 4 shows the JQC fund's historical returns. Overall, the fund has delivered modest absolute returns, with 3/5/10Yr average annual returns of 0.1%/1.8%/3.2% respectively to January 31, 2023.
The JQC fund's modest returns is not atypical of its asset class, senior secured loans. For comparison, the Invesco Senior Loan ETF ( BKLN ) has returned average annual returns of 1.5%/2.4%/2.5% over a 3/5/10Yr timeframe to January 31, 2023 (Figure 5).
Distribution & Yield
The JQC fund pays an attractive monthly distribution, currently set at $0.0475 / month, as of January 2023, or a forward yield of 10.5%. On NAV, the forward yield is 9.6%.
The JQC fund adopted a 'level distribution' policy in October 2021 whereby the fund provides shareholders with stable, but not guaranteed, monthly cash flow. The fund distributes substantially all of its net investment income and realized capital gains through its distributions. In months where there is a shortfall in net investment income and realized capital gains, the fund may utilize return of capital ("ROC") to fund its distributions.
Looking at the fund's annual report , we can see the JQC fund have utilized ROC extensively to fund its distributions (Figure 6).
Heavy use of ROC could be problematic in the long-run as it suggests the fund is not earning its distribution. Instead, it must liquidate NAV to fund the distribution. Over time, this shrinks the NAV, leaving less income earning assets to fund future distributions, creating a negative spiral. Funds that do not earn their distributions are called 'return of principal' funds.
Visually, we can confirm the 'return of principal' issue with the JQC fund, as its NAV has declined from over $15 in 2004 to $5.95 currently (Figure 9).
Due to the shrinking nature of JQC's NAV, its distributions has also shrunk, because there are not enough income earning assets. The fund's annual distribution has declined from $1.19 in 2004 to $0.49 in 2022 (Figure 10).
Long-term investors who held onto JQC would have seen both their principal and income decline over time.
Conclusion
The JQC fund invests primarily in senior secured and second lien floating rate loans. The fund pays a high distribution yield, currently set at a forward yield of 10.5% of market price and 9.6% of NAV. Although the yield is attractive, I believe it is a mirage, as the fund clearly earns less than its distribution and must liquidate its investment portfolio every month. I would avoid this high yielding trap.
For further details see:
JQC: A High Yield Trap