With the discount rate reduction announced late last week, we are slowly changing our fixed-income or balanced accounts to take more interest rate and credit risk, after keeping all of our fixed-income money in a higher-yielding Schwab money market the last year. Thanks to the inverted yield curve, there was little incentive to take either interest rate or credit risk, a strategy that has paid off handsomely the last eight weeks.
However, with the discount rate announcement, the unlocking of the credit spreads and the expected new liquidity from coming fed funds rate reductions should have a beneficial effect on credit instruments, so here are two closed-end funds we have been buying for client accounts:
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The DUC or the Duff & Phelp's Utility and Corporate Bond Trust is a closed-end utility and corporate bond fund that is currently trading at a 7% discount to NAV (as of this posting) and is yielding north of 7%. The chart is WAY interesting (to paraphrase a West Coast Valley girl): on a monthly chart (attached and compliments of http://www.wordencom/) DUC has historically bottomed with the end of Fed tightenings: in November and December, 1994 DUC bottomed at $10.25 and $10.50 per share which marked the end of the 1994 round of tightenings by then-Chairman Alan Greenspan, and then again in March and June of 2000, DUC bottomed at $10.69 and $10.56, and on both occasions, DUC - over the next two years - traded from these fed-induced lows to a high of $15 per share as the Fed reversed course and provided for an easier monetary policy. (See attached monthly chart above, and note the low coincident with Fed tightening cycles.)
Fundamentally, DUC's holdings consist of a 10 3/8th's Treasury maturing on 11/15/12 (essentially a 5-year Treasury) which is 8% of the closed-end fund, with 33% of the corporate's being utility credits and 28% financial credits. From a rating perspective, 18% of the funds credits are AAA/AA, and 48% are BBB+ or below. (Statistics compliments of etfconnect.com).
The monthly distribution is $0.065 per share (six and a half cents).
Our target price is between $14 - $15 per share, which given historical technical patterns, DUC should make easily. The DUC fund is WAY (!) oversold on the daily, weekly and monthly charts, so the technicals and fundamentals are lining up nicely.
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The second interesting closed-end fund we have been buying is the JRO, or John Nuveen closed-end leveraged loan fund. The JRO is trading between a 3% - 4% discount to NAV, and its current distribution rate is close to 10% (again, the current stats courtesy of ETFconnect.com).
20% of JRO's credits are from the media sector, with the 2nd largest holding at 3% of the fund being a Chicago Tribune credit, which saw its acquisition by Sam Zell close yesterday.
Consider this closed-end ETF to be a spicier credit play on the CLO/CDO, leveraged-loan lock-up frenzy, thus be more careful with JRO and buy in over time as we are doing. ETFconnect.com did NOT provide a ratings distribution on JRO as of this posting so assume that all credits are below investment grade.
Last week, just prior to the Fed's discount rate announcement, JRO fell below the late 2005 lows of $12.15 - $12.17 per share and gapped down to as low as $10.74 on the illiquidity issues surrounding high yield paper. The fund has subsequently bounced and will benefit handsomely from the slow unlocking and re-pricing of credit spreads over the next 6 months.
Our price target is alos $14 - $15 per share. The JRO fund is now very oversold on a weekly chart and can bounce nicely with further fed rate cuts in our opinion.
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To conclude, I think these closed-end funds provide a diversified vehicle to add credit risk to client accounts and yet remain diversified and liquid. Right now, the two aforementioned funds are a couple of our favorites, but we're always looking for more.
We'll try and keep readers updated on our thoughts on these funds but we may sell out entirely or even add more to the positions without updating the blog. However, we'll do our level best to keep readers updated. I think these two funds are better longer-term plays on what we hope will be improving liquidity and credit spreads in the corporate bond markets.
position in DUC, JRO
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio manager
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