2023-10-30 17:32:12 ET
Summary
- Nuveen Credit Strategies Income Fund offers a high level of current income with a yield of 13.42%.
- The JQC closed-end fund primarily invests in senior loans, high yield corporate debt, and collateralized loan obligation debt.
- The JQC fund employs leverage to boost its effective yield, but its leverage ratio is relatively high at 38.81% of its portfolio.
- The fund has the flexibility needed to benefit in any monetary environment, which is good for investors who do not want to constantly change their debt funds.
- The fund is currently trading at an enormous discount to its intrinsic value, so it might be worth considering today.
The Nuveen Credit Strategies Income Fund ( JQC ) is a closed-end fund, or CEF, that specializes in providing a high level of current income to its investors. This should be immediately apparent simply by looking at the name of the fund. It should also be quite apparent by looking at the fund’s yield, which at 13.42% is substantially higher than just about anything else in the market. In fact, the fund’s yield is so high that the market appears to be implying that it may have to cut the payout in the near future. After all, as I have pointed out numerous times in the past, any time a fund’s yield gets into the double digits, it is a sign that the market expects a cut at some point. However, that may be a bit less true than it once was because there are a lot of fixed-income funds today that have double-digit yields:
Fund | Current Yield |
Nuveen Credit Strategies Income Fund | 13.42% |
Apollo Tactical Income Fund ( AIF ) | 11.96% |
PIMCO Dynamic Income Opportunities Fund ( PDO ) | 14.29% |
Ares Dynamic Credit Allocation Fund ( ARDC ) | 11.82% |
There are several other funds that have comparable yields, most of which are in the fixed-income space. This comes from the fact that high-yield bonds and similar junk-rated debt securities have yields above 9% right now and these funds are able to boost that somewhat simply through the use of leverage. With that said though, we do certainly want to take a look at the finances of this fund in order to ensure that its current distribution is sustainable in the long term.
As long-time readers may recall, we last discussed the Nuveen Credit Strategies Income Fund back in August. The fund’s performance since that time has been fairly respectable, as it actually managed to beat the S&P 500 Index ( SP500 ), although it did slightly underperform the Bloomberg U.S. Aggregate Bond Index ( AGG ):
However, it is important to note that the Nuveen Credit Strategies Income Fund has a higher yield than either of these two indices. When we include the distributions in the calculation of the fund’s performance, it actually managed to beat both of the indices over the period. This is not entirely unusual right now as the current market environment is somewhat more favorable for debt securities than it is for most common stocks. This is especially true for floating-rate securities that do not see their prices negatively affected by rising interest rates. This fund can include some of those securities, which gives it the ability to perform fairly well in the current market environment.
About The Fund
According to the fund’s webpage , the Nuveen Credit Strategies Income Fund has the primary objective of providing its investors with a high level of current income. This fits pretty well with its name as well as with its strategy. The website explains the strategy thusly:
The Fund’s primary objective is high current income; and its secondary objective is total return.
The Fund primarily invests in senior loans, high yield corporate debt, and collateralized loan obligation debt. The Fund may invest without limitation in instruments rated below investment grade but no more than 30% in investments rated CCC/Caa or lower at the time of investment (or unrated but judged to be of comparable quality). The fund may invest up to 25% of its Managed Assets in collateralized loan obligation debt securities. The Fund uses leverage.
As the description suggests, the Nuveen Credit Strategies Income Fund is a bond fund, which is confirmed by the fact that 98.32% of its portfolio is currently invested in bonds or other debt instruments:
However, the twist with this fund comes from the fact that the fund invests mostly in senior loans, high-yield corporate debt, and collateralized loan obligation debt. Senior loans and collateralized loan obligations are usually floating-rate debt securities—the interest rate paid by these securities changes based on some interest rate benchmark, such as LIBOR. I explained how this works in a previous article on another one of Nuveen’s funds. This variable interest rate gives these securities an advantage during periods of rising interest rates because their price tends to be very stable in such an environment. That is because these securities will always deliver a competitive interest rate to other securities in the market. As we can see here, the Bloomberg U.S. Floating Rate Note < 5 Yrs. Index ( FLOT ) has been almost perfectly flat over the past decade:
Thus, this fund should not be as affected by interest rates as other funds whose portfolio consists entirely of traditional fixed-rate bonds. However, unlike a fund like the Nuveen Floating Rate Income Fund ( JFR ), the Nuveen Credit Strategies Income Fund only has 80.5% of its assets invested in senior loans:
Unfortunately, the fund’s webpage does not explicitly state what percentage of these securities are floating-rate versus fixed-rate. Senior loans are usually floating-rate, but this does not necessarily mean fully 80.5% of the fund’s assets are invested in floating-rate debt securities. The fund’s annual report states that 82.1% of the fund’s net assets are variable-rate debt securities. That report is dated July 31, 2023, so it is a bit older than the data on the fund’s webpage and may not be fully accurate anymore. Nevertheless, it seems likely that somewhere between 80% and 85% of the fund’s net assets are invested in floating-rate debt securities with the rest in fixed-rate junk bonds. That is a reasonable allocation right now given that interest rates continue to rise.
The difference between the Nuveen Credit Strategies Income Fund and the Nuveen Floating Rate Income Fund is that this one can invest in fixed-rate debt. This could be advantageous during periods in which interest rates decline. This is because floating-rate securities do not increase in price when rates decline. That is the big disadvantage to them, as the coupon adjusts downward in such an environment preventing the bond’s price from appreciating. After all, the reason why ordinary bonds go up when interest rates fall is that the bond will have a higher interest rate based on the face amount than a brand-new bond at the time of issuance. This is never true for floating-rate securities because they always have a face yield that is competitive with a similar brand-new security. Thus, it is best to hold floating-rate securities when interest rates are rising and fixed-rate bonds when interest rates are declining. The Nuveen Credit Strategies Income Fund can hold both types of securities, which works pretty well for an investor who does not want to actively change their portfolio’s allocation in response to interest rates. The fund’s management team will do it for them.
This could be a good thing because the future trajectory of interest rates is uncertain. The median prediction by the members of the Federal Open Market Committee is that rates will slowly decline through 2027:
The market is generally trading based on this prediction, especially the stock market. However, this is the same group who thought that inflation would be transitory back in 2021. The Federal Open Market Committee also has constantly predicted that gross domestic product growth would be much faster than what actually occurred for the better part of twenty years. As such, any predictions from the Federal Reserve about interest rates should be taken with a grain of salt. As I pointed out in various previous articles, there are even signs that the Federal Reserve is losing control over interest rates, as high Federal deficits and limited monetary growth have basically resulted in the Federal Government competing against the private sector for investor money. That causes interest rates to increase due to the economic law of supply and demand. Thus, in the absence of fiscal restraint from the Federal Government, the Federal Reserve will have to either accept high-interest rates or accept high inflation. Right now, tax revenue is actually less than mandatory spending in the Federal Budget, so it is highly unlikely that there will be any sort of fiscal discipline from the Federal Government of the magnitude required to solve this problem. Thus, interest rates could very easily be much higher than the Federal Open Market Committee is projecting. The Nuveen Credit Strategies Income Fund should be reasonably well positioned to handle this though, due to its high allocation to floating-rate debt securities.
The fund’s description of its strategy from the webpage suggests that the Nuveen Credit Strategies Income Fund maintains a significant position in junk-rated debt. As we just saw though, the fund’s allocation to traditional fixed-rate bonds of any sort is less than 20%. However, most senior loans tend to be made to below-investment-grade entities. This is because these securities transfer the interest rate risk from the investor to the borrower. A company that is able to obtain fixed-rate funding will normally do so rather than take on interest rate risk itself. Thus, we can expect that most of this fund’s assets will be invested in securities that have below-investment-grade credit ratings. The fund’s website confirms this:
An investment-grade debt security has a credit quality rating of BBB or higher. As we can clearly see, those securities account for only 10.8% of the fund’s portfolio. The remainder of its portfolio is invested in securities that are below investment grade, what is colloquially known as “junk debt.” This is something that may be concerning to those investors who are highly concerned about the preservation of the principal. After all, we have all heard about how junk bonds and other junk debt tend to have a much higher risk of losses due to defaults. This is a valid concern, but fortunately, the fund is taking steps to protect the investors against it. First of all, the fund has securities from 426 unique issuers as of the time of writing. This means that the securities from any given issuer only account for a very small portion of the fund’s portfolio. Indeed, the largest issuer whose securities are included in the fund only accounts for 1.7% of its total assets:
Thus, a default from any individual company represented in the fund’s portfolio should only have a negligible effect on the portfolio as a whole. After all, everything in the portfolio has a yield well over 2% so the fund’s interest payments alone will more than offset any single default. The only thing that could really present a problem here is if a large number of companies default in fairly rapid succession. In such a scenario, it seems likely that just about every asset class will start handing losses to its investors. Thus, there is no realistic way to protect ourselves from that short of just hiding in cash. This fund appears to be doing a reasonably good job at diversifying away the default risk.
Leverage
As is the case with many closed-end funds, the Nuveen Credit Strategies Income Fund employs leverage as a method of boosting the effective yield of its portfolio beyond that of any of the individual assets in it. I explained how this works in my previous article on this fund:
In short, the fund is borrowing money and using those borrowed funds to purchase debt securities. As long as the yield of the purchased securities is higher than the interest rate that the fund has to pay on the borrowed money then the strategy works pretty well to boost the effective yield of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, this will usually be the case.
However, it is important to keep in mind that this strategy is much less effective today with borrowing rates at 6% than it was two years ago when borrowing rates were effectively 0%. This is because the difference between the borrowing rate and the yield of the purchased securities is going to be much less than it used to be.
Unfortunately, the use of debt in this fashion is a double-edged sword because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much debt because that would expose us to too much risk. I do not generally like to see a fund’s leverage exceed a third as a percentage of its assets for this reason.
As of the time of writing, the Nuveen Credit Strategies Income Fund has levered assets comprising 38.81% of its portfolio. This is well above the one-third maximum level that was just specified. However, it is relatively in line with the 38.48% leverage ratio that the fund had when we last discussed it back in August. Thus, it seems likely that the fund is not actually increasing its debt level by borrowing more money. Rather, what we see is that the fund’s net asset value has declined a bit since we last discussed it:
In the case of static leverage but declining net asset value, the fund’s leverage ratio will increase. After all, it still has to repay the full amount of money that it borrowed even if the assets are no longer worth as much. This is the reason why leverage amplifies losses.
As was the case before, I am not as concerned about this fund’s leverage being over the one-third maximum as I would be with an equity closed-end fund. This is because most of the assets held by this fund are floating-rate securities, and as we have seen the market price of floating-rate securities does not vary very much. Thus, the fund should be able to carry a higher level of leverage than one that invests in volatile common equities. Therefore, everything should be okay here and we probably do not need to worry too much about the fund’s leverage.
Distribution Analysis
As mentioned earlier in this article, the primary objective of the Nuveen Credit Strategies Income Fund is to provide its investors with a very high level of current income. In order to achieve this objective, the fund invests in a portfolio consisting of a combination of floating-rate debt securities and junk bonds. These securities tend to have yields that are much higher than the prevailing risk-free rate in the market due to the fact that they have a higher risk of default. For its part, this fund takes things a step further and applies a layer of leverage to artificially boost the yield of the securities held in the portfolio. The fund simply collects the money that it receives from all of the securities that it holds and pays it out to the shareholders, net of the fund’s own expenses. As such, we can probably assume that this fund will have a remarkably high distribution yield.
This is certainly the case as the Nuveen Credit Strategies Income Fund pays a monthly distribution of $0.0540 per share ($0.648 per share annually), which gives it a whopping 13.42% yield at the current share price. While that is undoubtedly going to be very appealing to income-seeking investors, the fact that this fund’s distribution has varied considerably over the years will not:
That is, to put it mildly, an enormous degree of variation that is more than we typically see in closed-end funds. It does make a certain amount of sense considering that interest rates can have a significant effect on this fund’s ability to generate investment returns. The overall strength of the economy also has a significant impact, as it affects default rates and similar things. While the fund’s distribution variability may be understandable, it will also make the fund somewhat less appealing to any investor who is seeking to earn a safe and consistent income to use to pay their bills or finance their lifestyle expenses. The fact that this fund increased its distribution twice over the past year may be appealing though:
The distribution increase in October likely adds a degree of comfort with respect to the fund’s ability to sustain the payout. After all, it would make no sense to raise the distribution if the fund was already struggling to pay it. However, we should still have a look at its finances to ensure that the fund is not unnecessarily depleting its asset base and is actually generating sufficient investment returns to sustain the payout at the current level.
Fortunately, we do have a very recent document available that we can consult for the purpose of our analysis. As of the time of writing, the fund’s most recent financial report (linked earlier) corresponds to the full-year period that ended on July 31, 2023. This is a much newer report than the one that we had available to us the last time that we discussed this fund, which is quite nice. As everyone reading this likely recalls, the first half of this year saw a market that was generally filled with optimism over the Federal Reserve quickly reversing course with respect to interest rates, which caused investors to bid up the prices of many fixed-income securities. While that did not really benefit the floating-rate securities held by this fund, the Nuveen Credit Strategies Income Fund can switch between floating-rate securities and traditional fixed-rate debt so it still could have had an opportunity to make some trading profits. This report should also give us sufficient insight to determine how sustainable the distribution increase is likely to be.
During the full-year period, the Nuveen Credit Strategies Income Fund received $1,229,727 in dividends and $106,484,359 in interest from the investments in its portfolio. When we combine this with a small amount of income from other sources, we see that the fund had a total investment income of $108,864,619 during the period. The fund paid its expenses out of this amount, which left it with $70,959,243 available to shareholders. That was, unfortunately, not quite enough to cover the $75,059,742 that the fund actually paid out in distributions during the period, but it did get pretty close. However, it is still somewhat concerning that this fund was unable to completely finance its distributions out of net investment income. We typically like that to be the case for a fixed-income fund.
With that said, the fund does have other methods through which it can obtain the money that it needs to cover its distributions. For example, it might have been able to earn some capital gains by unloading appreciated assets during the strong market that existed during the first half of this year. Unfortunately, the fund did not have very much success during the period. The fund reported net realized losses of $77,125,772 over the full-year period, although these were partially offset by $44,153,255 net unrealized gains. Overall, the fund’s net assets declined by $37,073,016 after accounting for all inflows and outflows during the period.
That, unfortunately, suggests that the fund is failing to cover its distribution. However, we need to keep in mind that this was for the full-year period that ended on July 31, 2023. As such, it included the second half of 2022, which was a very weak market for bonds. The fact that the fund managed to cover most of its distributions with net investment income is encouraging. As most of the fund consists of floating-rate securities, the fund’s income is undoubtedly higher now than it was during much of the period that is reflected in this report. Thus, it seems highly possible that the fund is actually just paying out its net investment income right now. If that is indeed the case, then the distribution should be sustainable as long as rates remain at close to today’s levels.
Valuation
As of October 26, 2023 (the most recent date for which data is currently available), the Nuveen Credit Strategies Income Fund has a net asset value of $5.74 per share but the shares currently trade for $4.88 per share. This gives the fund a 14.98% discount on net asset value at the current price. That is an enormous discount that is quite a bit better than the 13.36% discount that the shares have had on average over the past month. Thus, the current price looks like a very decent level at which to acquire shares.
Conclusion
In conclusion, the Nuveen Credit Strategies Income Fund appears to be a very reasonable investment for anyone who is seeking a high level of current income today. The fund is capable of switching its portfolio between floating-rate instruments and traditional fixed-rate bonds, which allows it to navigate through both rising and falling interest rate environments. The biggest downside here is that Nuveen Credit Strategies Income Fund took some hefty losses in 2022 that make the distribution look less sustainable than it probably is right now. Overall, this fund may be worth considering for anyone who is seeking income.
For further details see:
JQC: A Tactical Bond Fund That Could Be Worth Considering