Summary
- JQC invests in a portfolio of fixed-income assets to provide its investors with a high yield.
- The majority of the fund's assets are invested in floating-rate bank loans, although the fund trades like a bond fund.
- The fund is very well diversified and should have very little exposure to defaults.
- The fund is generating enough income to cover its distribution and will probably continue to increase the payout as rates rise.
- The fund is trading at a reasonably attractive discount to net asset value.
One of the biggest challenges facing average Americans today is the pervasive inflation that the country is currently enduring, especially in food and energy. This has become so bad that many people have been forced to take on second jobs just to keep feeding the family. Fortunately, as investors, we have other options available to us to increase our incomes. One of these methods is buying shares of a closed-end fund that specializes in the generation of income. These funds provide easy access to a diversified portfolio of assets that enjoys professional management and the ability to utilize certain strategies that can increase the portfolio yield over that of any of the underlying assets. In this article, we will discuss the Nuveen Credit Strategies Income Fund ( JQC ), which currently yields 10.94%. I have discussed this fund before but that was over a year ago, so naturally, quite a few things have changed. This article will therefore focus specifically on these changes and provide an updated analysis of the fund’s finances so that we can determine its ability to be a reasonably solid investment.
About The Fund
According to the fund’s webpage , the Nuveen Credit Strategies Income Fund has the stated objective of providing its investors with a high level of current income. The fund’s secondary objective is total return, which sadly might be a little hard to achieve with a bond fund in a rising interest rate environment. The fact that the fund is focusing on current income is hardly surprising, though. This is because fixed-income securities such as bonds deliver most of their investment return through the interest payments that they make to investors. As interest rates have been increasing since March, we can expect that these payments have increased since that time. Unfortunately, bond prices tend to move inversely to interest rates. This is because the value of bonds issued with a lower interest rate declines until a new purchaser will receive the same interest rate as a brand-new bond with similar characteristics will. Thus, we have seen bond prices decline year-to-date, which has of course had a negative impact on the fund’s share price. The Nuveen Credit Strategies Income Fund has declined 19.85% year-to-date:
This is quite a bit worse than the 14.42% decline that was suffered by the Bloomberg US Aggregate Bond Index ( AGG ), although the Nuveen fund’s higher yield helps to offset this performance difference somewhat.
The Nuveen Credit Strategies Income Fund does not invest solely in bonds, however. The fund also invests in senior loans, which are a somewhat different type of fixed-income security. The biggest difference is that senior loans tend to be floating-rate instruments. Thus, the interest rate that gets paid to the investors increases as the Federal Reserve hikes rates. This is exactly the kind of security that we want to be holding right now as it's highly unlikely that the Federal Reserve will stop hiking rates until inflation gets down to the bank’s target level. We have begun to see inflation decline, but it's still well above its normal level and well above the Federal Reserve’s 2% target:
There are numerous predictions that the Federal funds rate will be above 5% by the end of 2023, which would be well above today’s 3.75% to 4% rate. Thus, the outlook for bonds is still somewhat bearish, but senior loans like the ones held by the Nuveen Credit Strategies Income Fund should deliver even higher income. The fund will likely still see a price decrease though since it tends to move similarly to bond prices, even though 81.51% of the portfolio consists of senior loans.
As is the case with many closed-end bond funds, the Nuveen Credit Strategies Income Fund is primarily invested in high-yield bonds. We can see this by looking at the credit ratings of the bonds in the portfolio:
Anything below BBB is considered to be a below-investment-grade bond. As we can see, that category accounts for nearly all of the fund’s portfolio. This is something that may concern those risk-averse investors that are concerned with the preservation of principal. This is because high-yield bonds are commonly believed to be at a fairly high risk of default. However, we can see that 68.15% of the fund is invested in securities with BB or B ratings. These are the two highest junk bond ratings and do not have much more default risk than investment-grade bonds. In fact, according to the official bond rating scale, companies whose bonds with these ratings do have the ability to meet their financial commitments but may be vulnerable to prolonged downturns or similar events. Thus, these bonds should not default even in a recession as long as the recession is not a particularly long one. We have not really had any extended recession since World War II so this is likely to be a relatively low risk. We thus should not really have to worry too much about losing money due to default here.
Another way that the fund can reduce its default risk is by ensuring that it has a large number of assets in its portfolio. This way, only a very small total proportion of its assets will be impacted if any individual issuer goes into default. The Nuveen Credit Strategies Income Fund currently has 405 open positions so it's certainly doing it, although it admittedly does not have nearly as many positions as some other bond funds possess. As a result of the sizable number of positions, no asset accounts for a significant percentage of the portfolio. In fact, even the largest position in the fund is only 1.26% of the portfolio:
These holdings are very different than the last time that we looked at the fund. In fact, only Argos Holdings was on the largest positions list a year ago. This may cause investors to believe that this fund has a very high turnover. This is something that could be concerning because trading bonds or other assets costs money, which is ultimately billed to shareholders. This creates a drag on performance because management must earn enough money to cover these expenses and still deliver a return that the investors find acceptable. However, this fund only has a 33.00% annual turnover, which is not too bad. It's still higher than an index fund would be, which may explain some of the performance differences between this fund and the index. An index fund generally does minimal trading and has very minimal expenses so those do not have the same hurdle for management to jump over. In the case of this fund, there are other factors at play (such as leverage) that also account for some of the performance difference. We will discuss that later in this article.
One of the things that can cause a fixed-income fund’s portfolio to change over time apart from trading is debt maturity. After all, bank loans and bonds are not like equities. These things must be paid off eventually, and when they're paid off, they no longer generate income for the fund. Currently, most of the fund’s assets mature within the next few years:
The fact that many of the fund’s assets mature in less than five years is fairly nice to see. This is because a lot more can happen in 10 years (for example) than can happen in five years. The sooner we get our money back, the less of the risk of a default or a serious loss. This is why long-term bonds tend to move much more in reaction to interest rate changes than short-term bonds. When we combine this short-term maturity profile with the fund’s diversity and the fact that its below-investment-grade debt is still fairly high-quality means that this fund should generally be very safe and have a low risk of loss because of a default.
Leverage
As mentioned earlier in this article, closed-end funds like the Nuveen Credit Strategies Income Fund are able to use certain strategies to boost their yields beyond that of the underlying assets. One of these strategies is the use of leverage. Basically, the fund borrows money in order to purchase bonds and loans. As long as the yield on the purchased assets is higher than the interest rate on the borrowed funds, this strategy works quite well to boost the fund’s portfolio yield. As the fund can borrow at institutional rates, this will usually be the case. However, the use of leverage is a double-edged sword because it boosts both gains and losses. Thus, we want to ensure that the fund is not using too much leverage because that would expose us to too much risk. I do not generally like to see a fund’s leverage above a third as a percentage of its assets for this reason. Unfortunately, the Nuveen Credit Strategies Income Fund is above this level as its leverage is currently 39.88% of its assets. This is probably OK given the relatively low-risk nature of the assets that the fund is invested in but it will likely cause the fund to continue to decline more than the index for as long as index rates continue to rise. The income and yield of the fund should increase in such a situation though so it will be a trade-off.
Distribution Analysis
As stated earlier, the primary objective of the Nuveen Credit Strategies Income Fund is to provide its investors with a high level of current income. The fund invests generally in high-yield bonds and corporate loans to accomplish this, which deliver most of their investment return through the interest payments that they make to investors. As such, we might assume that the fund boasts a fairly high distribution yield. This is indeed the case as the fund currently pays a monthly distribution of $0.0475 per share ($0.57 per share annually), which gives it a 10.94% yield at the current price. The fund’s distribution has varied considerably over the years but it has generally correlated with interest rates:
The fact that the fund has changed its distribution quite a lot over the years may not appeal to those investors that are looking for a safe and secure source of income with which to pay their bills. However, the fund has increased its distribution twice year-to-date as interest rates have increased, which does allow it to help offset the higher bills that we're all facing. This also helps the fund to be a way to play rising interest rates for those that expect rates to continue rising, such as yours truly. A non-negligible portion of the fund’s distributions are classified as return of capital, which also may be concerning:
The reason that this may be concerning is that a return of capital distribution can be a sign that the fund is returning the investors’ own money back to them. This is obviously not sustainable over any sort of extended period. However, there are other things that can cause a fund’s distribution to be considered a return of capital, such as the distribution of unrealized capital gains. As such, we want to investigate exactly how the fund is financing these distributions as part of our attempt to determine how sustainable they're likely to be.
Fortunately, we do have a fairly recent financial report to consult for that purpose. As of the time of writing, the fund’s most recent financial report corresponds to the full-year period that ended July 31, 2022. This is nice because it will give us a great deal of information on how well the fund performed during the first few interest rate hikes. During the full-year period, the Nuveen Credit Strategies Income Fund received a total of $67,019,669 in interest and dividends from the investments in its portfolio. The fund also received another $1,270,114 in fees, although it does not specify what these fees were other than they were not charged to the shareholders. This gives the fund a total income of $68,289,783 during the period. It paid its expenses out of this amount, leaving the fund with $47,060,156 available for the shareholders. This was more than enough to cover the $45,941,374 that it actually paid out in distributions during the period. Thus, it does not appear that the fund is paying out more than its income despite the tax classification of its distributions. Overall, it does appear that this distribution is quite secure.
Valuation
It's 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 generate a suboptimal return on that asset. In the case of a closed-end fund like the Nuveen Credit Strategies Income Fund, the usual way to value it's by looking at the fund’s net asset value. The net asset value of a fund is the total current market value of the fund’s assets minus any outstanding debt. It's 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 acquire 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's fortunately the case with this fund. As of November 15, 2022, the Nuveen Credit Strategies Fund had a net asset value of $5.87 per share but it only trades for $5.22 per share. This gives the fund a discount of 11.07% to the net asset value at the current price. That's nowhere near as attractive as the 13.25% discount that the fund has traded at on average over the past month but it's still a very nice discount. Although the fund is not as attractively valued as its historical price, it's still trading for a very reasonable price in the current environment and there is no reason to be unwilling to pay today’s price if the fund looks interesting.
Conclusion
In conclusion, the Nuveen Credit Strategies Fund may have a lot to like given today’s rising interest rate regime. The fund’s assets primarily consist of floating-yield loans that should hold their price much better in such an environment, although the fund still trades in line with bonds. The fund has been actively raising its distribution as the rising interest rates are causing it to receive more money from the assets in the portfolio. The valuation is also rather attractive today. Overall, one could do worse than this fund but admittedly the price of it in the market probably will decline over the next year or so.
For further details see:
JQC: An Attractive Fixed-Income Fund For Today's World