Bonds are back, baby Let’s talk about three funds that pay — between 8.3% and 10.9%.
Furthermore, they are trading for less than the fair value of their shares. It’s free lunch in Bondland.
Of course not all bond funds are created equal. ETFs serve their purpose, but closed-end funds (CEFs) are where the party is. Value plus yield in the CEF cafeteria.
Most ETFs are linked to an index. Which means they are governed by rules and robots. Boring.
CEFs tend to be actively managed, meaning that “bond brains” can adjust their portfolio from defensive to offensive as the investment environment changes. They can also use leverage to boost their returns. This can cut both ways, but when money is cheap, we like managers who rise.
CEFs just pay more, too. Let’s choose iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), one of the higher paying ETFs. However, LQD pays barely half of the CEF three-pack we’ll discuss.
Again, these funds each trade at discounts to their net asset value (NAV). Which means we can buy $1 in assets for less than a dollar. Sweet.
First Trust High Yield Opportunities 2027 Term Fund (FTHY)
Distribution rate: 10.8%
The First Trust High Yield Opportunities 2027 Term Fund (FTHY) is more of a tactical play than a long-term hold. It will not exist after 2027!
FTHY’s managers must hold at least 80% of assets in sub-investment-grade (junk) debt. Currently, that number is closer to 85%, with the rest of the assets held in senior loans.
The average maturity of the fund is on the shorter end, at just under 4.5 years, so you won’t necessarily get the same amount of swing that you would from funds more sensitive to the longer end of the yield curve. However, FTHY is not a bad way to trade the shorter end of the yield curve. Especially given that around 20% in debt leverage helps juice its returns.
FTHY is certainly more attractive than plain vanilla short-term bond funds if your goal is to take advantage of lower bond yields (and thus higher bond prices). A 10.8% distribution, paid monthly, isn’t bad either!
FTHY Shows Early Potential of Interest Rate Cut Play
Interestingly, FTHY’s 8% discount to NAV, while nice, is lower than its average — but that’s misleading, because as an ongoing fund, it should close the gap between now and the end of its term in 2027. (In other words, the discount should narrow, bringing prices.) The flip side? “The Fund’s limited term may cause it to invest in lower-performing securities or to hold the proceeds of securities sold near the end of their term in cash or cash equivalents.”
In other words, not only can we not buy and hold FTHY for very long, but the fund’s ability to outperform. could will decrease as we approach its expiration date.
BlackRock Core Bond Trust (BHK)
Distribution rate: 8.3%
The BlackRock Core Bond Trust (BHK) is a “north-south football” type of fund that invests at least 75% of its assets in investment-grade fixed income.
Right now, that’s a mix of corporates, securitized products, agency mortgages, government bonds and some international investment-grade bonds. BHK also currently holds around 20% in scrap.
BHK is where we can start to benefit from an eventual move lower in long-term rates. Almost two-thirds of the fund are bonds with maturities of five years or longer, and more than a third is invested in bonds with 10 or more years remaining. That potential is further enhanced by even more debt leverage than FTHY, at 33% as I write this. It’s a portfolio set up to win, and win big, when interest rates fall, just as BHK did for years until the Fed’s latest rate-hike cycle.
BHK: The Beginning of a Second Rib?
But BHK is not for the faint of heart. we do no want to own a BHK when long term rates rise.
Also, yes, while this BlackRock fund trades at a discount to NAV, it’s a narrow one, at just a hair over 1%. In fact, considering that its long-term average is closer to 3%, we could argue that this CEF is expensive at 99 cents on the dollar.
Brookfield Real Assets Income Fund (RA)
Distribution rate: 10.9%
Brookfield Real Assets Income Fund (RA) it’s cheap… for some reason. We can buy its assets for 87 cents on the dollar, a 13% discount, which seems generous at first glance.
Problem is, despite the name, RA does not invest in “real assets”, but instead in infrastructure credit, real estate and natural resources. About 60% of assets are dedicated to corporate bonds in those three areas, while another 33% is kept in mortgage-backed securities (MBS). Take back another 4% in cash, and the paltry rest is in “real asset” equities.
This used to be a Opposite Income Statement holding, until I sold it in November 2018. At that time I warned:
“The fund’s generous distribution (10%+) and equally generous discount (6% to 9%) gave us a margin of safety while we gave their promising management team time to map out their strategy. But to be blunt, they didn’t did..
Their average coupon today pays just 4.8% while they are on the hook for a 10.4% distribution on NAV. Borrowing cheap money helps fill some of the gap but not enough of it. And the portfolio remains too heavily focused on fixed rates and longer-dated bonds for my liking.”
For the next five years or so, the monthly dividend remained constant while NAV plunged. Shareholders finally paid the piper in August, when the company announced a 41% cut to the distribution since September, sending RA shares crashing.
RA Cut the Dividend, And Cut Many Shareholders Loose With It
What remains is at least, for now, a more sustainable payout. The distribution of RA is now financed by real income. The fund also has less exposure to the ticking time bomb that is commercial real estate. Its commercial MBS make up 10% of assets — better, but not good enough for us careful naysayers.
The Bond Bull: 3 Funds Yielding Up to 12% With Massive Upside Potential
However, if we want to make hay with the coming bond bull, we don’t want to do it in rehabilitation projects.
We want to do it by owning A+ bond funds with sterling records.
The bond market has been pulverized in recent years, with many bonds down 50% or more — just like the Bubble-Bubble bust and Great Financial Crisis!
But fixed income has recently shown glimmers of life–a rapid reversal that could signal the start of a new “bonding bull.”
And I get ready by positioning myself in three funds that not only deliver fat returns of up to 12%but also has massive additional potential.
Bonds are shedding their highest yields in over a decade! The “Agg” index, with a yield of about 5%, pays almost 5x what it did just three years ago.
The Fed has signaled multiple rate hikes – and as you know, when rates go down, bond prices go up.
So now, we have a rare opportunity to lock in very high rates before they disappear, and set us up for price upside when bonds pick up steam. It’s a powerful 1-2 punch that most investors don’t think about when it comes to the bond market!
I’m not the only one who noticed either. Capital Group, PIMCO, BlackRock… all the big names of Wall Street, collectively managing trillions of dollars, is beginning to realize the potential for a sea change in the coming months.
If things go the way the Fed, the major investment firms and I think – well, savvy investors can make a lot of money in the bond market.
Click here to learn how to ride the coming “bond bull”! You can download a FREE Special Report revealing 3 funds giving up to 12%.
See also:
• Warren Buffett Dividend Stocks
• Dividend Growth Stocks: 25 Aristocrats
• Future Dividend Aristocrats: Close Contenders
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.