Our Playbook In This Wild Income Market

This is an extract from an earlier article at Systematic Income Premium

Some of the recent moves across the income space have been historic. There are loads of unusual metrics we can point to. For the sake of brevity let’s take a look at just a handful. 

The chart below shows that the median discount change we saw on 16-June was only exceeded this decade during the COVID period. 

The median fixed-income CEF sector discount is approaching a double-digit level which has only been exceeded significantly during the GFC, the near-recession Energy crash and the COVID shock.

Finally, weekly CEF volumes have spiked though they are still off the COVID levels. 

What does this mean in terms of allocation across the income investment space?

First, the Fed has tended to adopt a dovish communication posture between meetings (remember that September pause from Bostic?) which supported markets, only to be forced to face the reality of persistent inflation, causing another big drawdown. This means we are adding on weakness rather than chasing rallies

Two, we are playing the long game. The base case appears to be for a recession to arrive sometime in the second half of 2023. If this is right, it suggests that we are unlikely to see a market recovery until we are well into the recession. In short, we could see significantly volatility and lower prices for at least another 12-18 months. Therefore, we are being patient with rotating from our more resilient securities to higher-yielding assets.

Three, because we don’t have a crystal ball of what is going to happen with either the macro picture or inflation, we apply some of the principles of our All-Weather framework, selecting attractively-valued securities across various buckets to make sure our Income Portfolios are not unnecessarily exposed to the luck of any one market outcome. 

Where We See Value

Among some of the many securities where we see value are the following. 

Bank PNC Financial Services 6.125% (PNC.PP) – a 3m Libor + 4.07% floating-rate preferred, trading at a 6% yield as of today’s Libor of 2%. The Fed itself expects to take the policy rate to 3.8% at which point the yield of PNC.PP at current price will be 7.8% – not bad for an investment-grade security. 

Credit Suisse Asset Management Income Fund (CIK), trading at a 10.3% current yield. Our conservative estimate of the fund’s NAV portfolio yield is north of 11% which is higher than its current distribution rate. The fund has been a strong outperformer in the High-yield corporate bond CEF sector. 

Golub Capital BDC (GBDC), trading at a 9.4% dividend yield and a 17% discount to Q1 book value – an unusually big discount for this Business Development Company. GBDC has a higher-quality profile in the BDC sector with a strong secured loan overweight. 

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