The Current Attractive Opportunity in High Yield Fixed Income

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As of this writing, stock markets are in a correction phase due to a host of pressures and fears, such as inflation, rising interest rates and uncertainties caused by the Russian-Russian war. Ukrainian. While war is certainly weighing on investors‘ minds (we recognize the great human tragedy, but we’ll put that aside for this article on investing), it’s inflation and interest rates that are more important for the markets. The 10-year Treasury yield is now 2.11%, the highest since June 2019, see chart below. Inflation and oil prices have risen higher and higher, and markets are waiting to see if inflation falls back to a more manageable ongoing level, even if higher than in the past.

10-year Treasury yield

10-year Treasury yield (Yahoo finance)

The most notable area of ​​correction is in the tech and “hip stocks” sector, where the Nasdaq index is down about 20% and widespread favorites like Tesla (an auto company, whatever whatever its size, should it ever be worth $1.3 trillion?), Facebook and Netflix are down about 35% to 45%. The pandemic’s favorite Zoom video is down about 50%. Large-cap stocks are in correction territory, down about 12%. At the same time, bond indices fell, with the high yield bond index down 7-8% (HYG), the investment grade bond index down 9% (LQD) and the preferred stock index down 10-11% (PFF) . Many popular fixed income funds fell even more sharply, such as PIMCO’s Dynamic Income Fund (PDI) down 14-15% and Doubline Opportunistic Credit Fund (DBL) down 10%.

We believe the current market correction has created windfall opportunities in high yield fixed income securities and presents an opportunity to lock in a high yield portfolio that will be well positioned to handle the rise in rates that may continue in response to higher inflation. We manage portfolios of fixed income securities that protect against rising rates in two ways: (1) invest in short to medium-term instruments and (2) invest in fixed income securities that offer a rate characteristic. variable. The other key ingredient is to select issuers with strong credit quality in the context of high yield fixed income investments. Overall, fixed income securities rated Investment Grade will always be of higher credit quality than high yield fixed income securities, but with proper due diligence and portfolio diversification, the risk/reward ratio of the high yield is generally more attractive.

When we talk about high yield fixed income securities, we mean a wider range of investments than just high yield bonds. Here are the main asset classes that make up our high-yield income portfolios, providing the diversity needed to significantly reduce the risk of a possible poor outcome in a single holding:

1) Traditional high yield bonds sold in the bond market

2) Exchange-traded bonds, typically sold in $25 increments on the stock exchange and often issued by smaller companies

3) Preferred shares, often offering a floating rate or fixed-to-floating rate feature that offers good protection against rising rates

4) Closed-end funds, which are a broad universe of funds that provide investors with access to segments of fixed-income securities only available to institutional investors, such as bank loan funds and mortgage-linked assets ; these funds are often attractive since they trade at a discount

Portfolios can be constructed with a target return in mind based on the return objectives or income needs of the portfolio. Here are some of the opportunities we are currently investing for our clients. (Please note that these are for discussion purposes only and should not be taken as recommendations, as each investor’s needs are different based on a wide range of factors. High Yield Fixed Income Securities are not suitable for all investors. The information provided below is only a summary of the investments and there are many more details which should be taken into account to fully understand and consider the investment):

High yield bonds: Delek Logistics Partners 6.75% from May 15, 2025, trading around par for a yield of 6.75%. Delek (DKL) owns and operates logistics and trading assets for crude oil and intermediate and refined products in the United States. Performance has been strong with 9% EBITDA growth in 2021 and modest leverage in the low 3x range. The three-year maturity is attractive.

Exchange Traded Bonds: Bonds of Eagle Point Income Company, 5.00% dated October 31, 2026, traded under the ticker symbol EICA. The issue is trading at around $23.46, a 6% discount to par ($25), so the yield to maturity is 6.6% (the bonds are technically classified as term preferred shares but act very similarly to a bond with a 2026 maturity date). The issuing company is a closed-end fund that invests in CLO debt tranches. According to the regulations, asset coverage must be maintained at a minimum of 200% offering excellent protection to investors. Current asset coverage is 300%.

Preferred Shares: Dynex Capital, 6.9% Cumulative Fixed to Floating Preferred SharesC series (DX.PC). JThe issue is fixed at 6.9% until 15/04/2025, when it will be converted into a floating rate issue at LIBOR + 5.45%. The issue is currently trading at $24.50, a 2% discount to par ($25). The current yield is 7.00% and if the issue is called in April 2025, it will result in a yield of 8.15% (no way of knowing if this will be called). If not called, investors benefit from a floating rate that protects them against rising rates. Dynex (DX) is a mortgage REIT with 98% of its portfolio in agency securities, which are effectively government-backed and therefore considered nearly risk-free. Although the stock price can fluctuate depending on various factors, the preferred stock enjoys preference over its fixed dividend, so the stock price does not matter much to investors. in preferred shares. DX has handled the pandemic very well and its stock price is now higher than before the pandemic.

Closed-End Fund: BNY Mellon Alcentra Global Credit Income 2024 Target Term Fund (DCF). This closed-end fund belongs to a unique category of funds, as its mandatory liquidation date is December 1, 2024. The fund invests in a variety of income asset classes, with bank loans accounting for 40%, and credits structured and high yield the rest. The fund trades at $8.26/unit, a 5% discount to NAV; for most of 2021, the fund traded at a premium but sank during this correction. In addition to its 7.3% return (which is 100% covered by the net investment based on the latest financial statements), investors will recover any net asset value discount when the fund is liquidated in December 2024, which will further increase yields.

In our experience, these “windows of opportunity” to secure higher returns are limited to a few months at a time that come up every two years, and sometimes less. While we can’t predict how the markets will move in the future, we expect that once the Fed takes action and the situation between Russia and Ukraine moves towards some sort of resolution, many of these problems fixed income securities will return to their 2021 levels or even higher – – particularly those with maturities of less than five years or other characteristics that protect against rising rates.

Please note that the author holds the highlighted investments in personal and client accounts, and may have added/will add positions at any time before or after the publication of this article.

It is important to note that high yield bond investments such as those highlighted in this article are by definition not “investment grade” and therefore only suitable for investors willing to accept a higher bond risk profile. Consider high yield bonds and similar investments only as part of a broader investment portfolio allocation to various assets of all risk profiles.

Please see Downtown Investment Notice profile page for important disclaimer language, which is an integral part of this article.

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