This is historic analysis and may no longer be current
The current market environment of rising interest rates and historically low yields can be very dispiriting for income investors. In this note we discuss what we call cross-sector credit CEFs which are funds that allocate across different sub-sectors of the corporate credit space.
Relatively wide investment mandates of these funds allow managers greater leeway in pursuing attractive opportunities, potentially allowing for greater alpha generation in an environment of low forward-looking beta returns. Cross-sector credit CEFs also tend to feature modest duration profiles due to allocations to floating-rate securities which is an attractive feature in the current market environment of steadily rising interest rates. And finally, these funds allocate to CLO debt whose combination of low historic default rates, subordination and still-high yields looks attractive across the credit landscape.
The chart below combines CEFs from these three corporate credit sectors with cross-credit CEFs highlighted. The takeaway is that the worst-performing cross-credit CEF still manages to beat the average CEF in this group of funds and the best performers are right near the top of the broader corporate credit group of CEFs.
In our view this is not a coincidence. There are three reasons that allow cross-credit CEFs to perform well.
First, these funds have relatively broad investment mandates as most funds tend to specialize in one particular type of asset. This allows fund managers wider scope in sourcing attractive investment opportunities.
Secondly, cross-sector funds tend to have a lighter duration footprint than bond-only funds as they also tend to hold floating-rate assets. This is particularly attractive in the current market environment which appears to feature a secular shift away from the historically steady grind lower in interest rates.
Thirdly, these funds also typically allocate to CLO debt tranches which remain attractive and relatively high-yielding in this market, particularly mezz, or lower-rated debt tranches. For instance, while BB-rated corporate bonds are trading at a yield of just 3.5%, BB-rated CLO tranches are trading at yields of 7-8% while also boasting lower historic default rates.
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