2023-08-24 14:04:45 ET
Summary
- Nuveen Credit Strategies Income Fund (JQC) is undergoing a transition with a new portfolio manager and several investment policy changes.
- The fund's discount to NAV has been persistent, but the current discount may make it an attractive choice as it could suggest limited downside from further discount expansion.
- Along with the investment policy change of the fund, it will remain a primarily floating rate-focused CEF, and they also bumped up their monthly distribution.
Written by Nick Ackerman, co-produced by Stanford Chemist.
Nuveen Credit Strategies Income Fund ( JQC ) recently announced a new portfolio manager, an investment policy change, and an increase in its distribution. This closed-end fund is primarily a floating rate-focused fund with a heavy weight on senior loans. After this transition, the fund will still focus primarily on floating rate securities, but will now include more collateralized loan obligation debt or CLOs. The investment policy changes actually seem to show more policy removals than actual additions.
It has been a while since we've taken a look at JQC, and the fund continues to trade at an attractive discount. However, the discount for this fund has been quite a regular feature.
In fact, it was over a year ago since we gave this fund a look, and at that time, the discount to NAV was around 14%. The current discount could make it a fund worth considering as flexibility opens up in this underlying portfolio. Given the fact that interest rates are expected to be higher for longer, floating rate investment exposure can still be fairly attractive.
The Basics
- 1-Year Z-score: -0.30
- Discount: -12.89%
- Distribution Yield: 12.78%
- Expense Ratio: 1.47%
- Leverage: 38.47%
- Managed Assets: $1.395 billion
- Structure: Perpetual
With the fund's transition, no change in the investment objective has been announced. The primary investment objective remains as "high current income; and its secondary objective is total return."
The fund is highly leveraged, and that's something one would have to consider before investing, given that it increases the risks and makes the fund more volatile.
The total expense ratio climbs to 3.74% when including the fund's leverage expenses. This fund has had to deal with higher borrowing rates as the Fed raised interest rates. The costs of their leverage have ballooned to 6.41% based on the latest monthly data provided below. That is up from the 2.86% at the end of their last fiscal year .
In addition to the leverage, there are variable rate preferred issuances. The outstanding borrowings pay is based on SOFR plus 1.10%, and the taxable fund preferred shares or TFP shares are in a variable rate demand mode or VRDM.
VRDM means that:
Dividends for TFP Shares designated in this mode will be established by a remarketing agent; therefore, the market value of the TFP Shares is expected to approximate its liquidation preference. While in this mode, shares will have an unconditional liquidity feature that enable its shareholders to require a liquidity provider, which each Fund has entered into a contractual agreement, to purchase shares in the event that the shares are not able to be successfully remarketed. In the event that shares within this mode are unable to be successfully remarketed and are purchased by the liquidity provider, the dividend rate will be the maximum rate which is designed to escalate according to a specified schedule in order to enhance the remarketing agent’s ability to successfully remarket the shares. Each Fund is required to redeem any shares that are still owned by a liquidity provider after six months of continuous, unsuccessful remarketing.
With all that being said, the fund's variable rate debt isn't as damaging to JQC because its own portfolio is a natural hedge due to the floating rate exposure.
New Manager Added To The Team
It was probably safe to assume, but the new portfolio manager joining the team on JQC, Himani Trivedi, has a background in CLOs. She is the head of structured credit at Nuveen and, besides a background with CLOs, is involved with other various fixed-income strategies.
Investment Policy Shift
With this transition, the fund is actually eliminating more policies than it's really adding. This is because they had previously stipulated that it will invest "at least 70% of its managed assets in adjustable rate senior loans and second lien loans." That has been eliminated.
They also eliminated the "may invest up to 30% of its managed assets" into a broad array of other securities. Some of those listed were non-investment grade debt securities, fixed-rate senior loans, mortgage-related and other asset-backed securities or debt securities and other instruments issued by the government, government-related or supranational issuers. It even included domestic and international equity securities.
Additionally, they did remove the fund's policy that limited the duration to two years or less. The policy shift is also seeing the elimination of investing in inverse floating rate securities.
Finally, the big change is that there is currently no CLO investment policy and going forward, the fund now may invest up to 25% in CLOs.
There were other minor changes as well, so reading the press release can provide some of the smaller details.
Overall, the transition of the fund shouldn't be all that material in terms of massive alterations and expectations for the fund. That even includes the removal of the two years or less duration language. This is because the fund will still overweight senior loans within the portfolio.
Additionally, CLO debt is also a floating rate in nature as its pooled senior loans into one securitized package, which is then broken down and sold into different rated tranches. In this case, they specifically mention the debt and not the equity positions.
This means that JQC is investing in relatively safer tranches while still being mostly exposed to investments that should continue to keep duration fairly minimal.
Distribution Bump
JQC has had many adjustments over the years in terms of its distribution. So the latest 14% increase in the payout from $0.0475 to $0.054 is yet another change.
The large bump in the payout in 2019 was the result of a capital return program that was put into place to reduce the fund's discount. That capital return program was something we've touched on in the past.
The idea with the increase from the fund is seemingly an assumption that net investment income could climb from where it is now. This is because the average earnings of the fund come in at $.0454, meaning that NII distribution coverage would be at around 84%.
That being said, even the prior distribution means that coverage wasn't exactly at 100% either, with its $0.0475 payout. However, NII had been rising materially as the floating rate portfolio started to receive boosts as the Fed was raising rates. In their last semi-annual report , NII was $0.25 per share. The current monthly NII, if it were to continue for the next six months, would come in at $0.27. If we combine these figures, the annualized figure would dwarf what was $0.35 for the entirety of the fiscal year 2022.
Similar Peers Going Forward
Given this change, the fund is setting itself up more similarly to XAI Octagon Floating Rate & Alternative Income Term Trust ( XFLT ). However, XFLT includes mostly CLO equity over CLO debt exposure.
Another fund that comes to mind with this more hybrid approach is Ares Dynamic Credit Allocation Fund ( ARDC ). However, ARDC's main difference is that they actually don't invest as heavily in floating rate instruments. Instead, only around 55% is based on floating rates, and they favor a heavier relative allocation to bonds.
Historically speaking, XFLT and ARDC have both been better performers than JQC. The funds will still provide different tilts in their approach, but perhaps this should bode well for JQC going forward. The historical total return performance comparison is limited due to XFLT's launch being in September 2017.
Conclusion
JQC announced a new manager would be joining the fund's team, a manager with CLO experience. With that taking place, the fund has also implemented the addition of investing in CLO debt instruments while eliminating some of their other policy investments. Overall, the investment policy changes still leave the fund with a heavy emphasis on floating rate exposure, so it should continue to be a fund that remains relatively limited in terms of interest rate sensitivity. This transition also saw an increase in its monthly distribution - presumably because they anticipate being able to generate more income going forward.
The fund has traded at a deep discount for a considerable period of time. That certainly might not change any time soon, but it also could suggest that further damage from the discount expansion could be limited. XFLT often trades at a premium, but ARDC regularly trades at a deep discount. Given there are some material differences between the funds, it's unclear exactly how investors will value this particular new, but somewhat familiar feeling hybrid approach.
For further details see:
JQC: New Investment Policies, New Increased Distribution And Tempting Discount