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Bonds are ultimately an intriguing place for retirement income.
Safe Treasuries still pay a respectable (by their standards, at least) 3.7%. But we mavericks can do better.
Today we’re going to discuss three bond funds poised to bounce back. They pay 8.6%, 9.1% and, hold on, 9.6% a year.
These are not typos. These are scary big yields.
Yes, these bond yields are real. And they are spectacular.
Bond fund returns
And even better, you can buy these bonds for as little as 90 cents on the dollar! How is it? Well, the cheapest fund trades for just 90% of its net asset value (NAV).
That’s NAV is the public price of the safe bonds he owns. If the fund was terminated today, it would return 100% of net asset value. But it’s a bear market, so bargains abound. And we can buy it for only 90% of net asset value, or 90 cents on the dollar.
Why? Thank our intrepid Fed.
The Fed’s bet
Bonds took an absolute beating in 2022 amid a year of aggressive interest rate hikes by the Federal Reserve, part of Chairman Jerome Powell’s action plan to extinguish runaway inflation.
For example, the iShares 7-10 Year Treasury Bond ETF (IEF
EIF
I emphasize “near” because bonds have rallied lately. A temporary snapback? Maybe. But that comes amid budding, albeit uneven, optimism over the past month or so, just maybe the Fed’s rate hike is about to slow.
Just a week ago, the Fed released the minutes of its last FOMC meeting showing that a “substantial majority” of central bank officials think it would “probably soon be appropriate” to slow its hikes. rate.
And on Wednesday, Powell added more credence to the idea, saying smaller rate increases “could come as early as the December meeting.”
Bonds are not a monolith either. Short-term and long-term rates can indeed move in different directions, and this matters in determining your bond buying strategy. Remember what I said a few weeks ago:
“The ‘short end’ (maturities closer to today) of the yield curve is climbing because the Fed chief has said he still has work to do. the 2-year Treasury tends to lead the fed funds rate as it anticipates the Fed’s next move…. The “long end” (further maturities) of the yield curve, meanwhile, catches its breath as t weighs the lesser of two evils: inflation today or a recession tomorrow.
If we’re at a point where perhaps Powell doesn’t have as much work to do as before, that could be an inflection point for short-term bond rates and an inflection point for funds. shorter maturity bonds.
In other words, the window could close on our chance to buy low.
Fortunately, we can make the most of this opportunity by buying not bond mutual funds or bond exchange-traded funds (ETFs), but closed-end bond funds (CEF). Indeed, in addition to buying while the short-term bonds are against the strings, many of these CEFs are also trading below their net asset value, which means that we are buying the bonds even cheaper than we are. could by purchasing them individually.
While the fate of these funds ultimately hinges on the Fed, here are three intriguing opportunities right now: 3 CEFs yielding 8.6% to 9.6% trading at high single-digit and double-digit discounts compared to the net asset value:
PGIM Short Duration High Yield Opportunities Fund (SDHY)
Distribution yield: 8.6%
Remittance to NAV: 10.1%
As crazy as it sounds, you can snatch nearly 9% returns—paid monthly, no less—from a bond portfolio with an average maturity of less than three years!
The PGIM Short Duration High Yield Opportunities Fund (SDHY) is a relatively new fund created in November 2020, so most of its short life has been spent wobbling and wobbling. SDHY invests primarily in below investment grade fixed income securities, and will generally maintain a weighted average portfolio duration of three years or less and a weighted average maturity of five years or less – the latter being considerably longer shorter than its current target, at 2.9 years.
The short maturity helps dampen volatility, but SDHY is not your average short-term bond fund, including a bit more movement.
SDHY offers an average yield partly due to its low credit quality. Only 11% of its portfolio is investment grade; another 34% is in BB debt (the top tier of junk), and another 35% is in B-rated bonds.
A decent amount of leverage also helps – 17% at last check, which isn’t exceptionally high, but still a good amount of extra juice for performance and yield.
This juice works both ways, hampering SDHY’s performance in a bearish climate for bonds. But clearly, given its recent performance, it has significant potential once the Fed begins to slow its pace of hikes (and especially once it cuts rates).
A nearly 10% discount to NAV is also enticing, implying that you are buying SDHY bonds for 90 cents on the dollar. Granted, that’s not much more than its historic discount since inception of 10.3%, but it’s still a bargain no matter how you slice it.
Western Asset High Income Opportunity (HIO)
Distribution yield: 9.1%
Remittance to NAV: 8.9%
The Western Asset High Income Opportunity (HIO) is a bit further down the maturity spectrum, at an average of 7.3 years, but it’s another compelling high-yielding game worth watching in today’s environment.
HIO is a classic junk-bond fund whose management team looks for particularly attractive stocks. But its focus on value doesn’t translate to more credit risk than its contemporaries – sure, its 34% BB exposure is well below its benchmark (50%), but that’s offset by a certain high-quality debt (2% A, 13% B). (The rest of the portfolio is similar to its benchmark.)
Also, while this CEF is allowed to use leverage, it currently does not. So the above-average yield you see (also paid monthly!) is simply the result of its management’s bond selections.
Although it does not use leverage, the performance of this CEF is much more volatile than that of regular ETFs, historically for the best, although the past year has been miserable for shareholders.
HIO’s 8.9% discount to net asset value is attractive, at least in a vacuum, but it’s a bit of a wash given that on average over the past five years, the fund has traded at a discount of 9.1%.
BlackRock Credit Allocation Income Trust (BTZ)
Distribution yield: 9.6%
Remittance to NAV: 5.7%
There is hardly a “last word” with this Fed. Yes, Powell gave his strongest signal yet that rate hikes will slow. But the Fed has already surprised some economists with its aggressiveness on rate hikes and other quantitative tightening – and if high inflation persists, short-term bonds could stay in the niche longer than expected.
But longer-dated fixed-income securities, especially with decent credit quality, might do the trick.
The BlackRock Credit Allocation Income Trust (BTZ)which invests primarily in bonds but also other fixed income securities such as securitized products and bank loans, is an attractive choice here, with a great balance sheet, especially if you can handle deeper valleys with those higher peaks students.
The average maturity of BTZ’s portfolio is a hair’s breadth over 18 years, not enough at the threshold of 20 years for “long”, but nevertheless very long. However, credit quality is an optimal mix: 55% is investment grade (most, 42%, in BBB-rated bonds), another 22% in BB-rated bonds, and most of the rest in B-rated bonds etc. .
This fund is an ideal example of how CEFs benefit from active management and more tools to work with. Managers can hunt down value-priced bonds rather than just plugging in whatever an index tells them, and they’re also able to scour the credit world for other attractive instruments at times when bonds are not the best option.
Additionally, BTZ is at the higher end of the leverage usage spectrum, at over 28% currently. This box weigh on performance given a high cost of debt, but it can also significantly improve performance during a rise in bonds – and that’s how its monthly payment stretches to almost 10%!
My only complaint right now? BTZ isn’t exactly a bargain right now, with its ~5.7% discount on NAV coming upper than its 5-year average of around 8%.
But it is always better to buy these bonds individually.
Brett Owens is Chief Investment Strategist for Opposite perspectives. For more income ideas, get your free copy of his latest special report: Your early retirement portfolio: huge dividends, every month, forever.
Disclosure: none
