Nuveen Credit Strategies CEF (JQC): Great idea for higher rates

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Written by Nick Ackerman, co-produced by Stanford Chemist

The Nuveen Credit Strategies Income Fund (JQC) is a fund that I have followed, but in which I have never invested. If there was a time to invest, it looks like it would be now, as the fund’s haircut has increased significantly. Overall volatility and lower distribution are likely a factor. That being said, the distribution’s coverage is lacking and is around the weakest relative to its peers.

In the grand scheme of things, the capital return program was a rather neutral event. The COVID pandemic has also disrupted what I believe to be their intention. Discount has never tightened too much. They also suspended the return on capital program a little earlier, but only a few months instead of ending it the rest of the year.

It was intended to pay a higher distribution amount than what was sustainable which would end until 2021. It was definitely wound up in 2021. However, 2020 also saw several adjustments that were not planned. It was also about repurchase of shares.

This was noted in September when they announced the adoption of the future split.

Nuveen Credit Strategies Income Fund (JQC) (NYSE: JQC) announced today that the Board of Trustees of the Fund has approved the suspension of the Fund’s previously announced capital return plan and has approved the adoption of a new level distribution policy.

(Source)

The basics

  • Z score over 1 year: 0.89
  • Discount: 5.08%
  • Distribution yield: 7.43%
  • Expense ratio: 1.44%
  • Leverage: 30.25%
  • Assets under management: $ 1.471 billion
  • Structure: perpetual

JQC investment objective is “high current income; and its secondary objective is total return ”. To achieve this, “under normal circumstances, the fund will invest at least 80% of its ‘assets’, at the time of purchase, in loans or securities superior to its ordinary shares in the capital structure of the issuing company. , including, but not limited to debt securities and preferred securities.

They also add; “Invest at least 70% of its ‘assets under management’ in adjustable rate senior and second secured loans, and up to 30% opportunistically in other types of securities through the capital structure of ‘a business, primarily income-oriented securities such as high yield debt, convertible securities and other forms of corporate debt. “

Essentially, the fund is a senior loan fund. We hedged them frequently throughout the year as they should benefit from rising interest rates. In fact, this fund was mentioned in our selection of the top loan funds for the best valuation space. This is still true and perhaps even more relevant now that there are indications that we will get three rates hikes in 2022.

Despite the fund’s return on capital program, it is still a large fund. They operate with over $ 1.47 billion, thanks to their significant leverage. However, this is pretty standard in the senior lending space and is even lower than its peers.

The expense ratio of the fund amounts to 1.44% and, including leverage costs, amounts to a total of 2.03%. As rates rise, their borrowing costs will also rise, which can be a negative headwind in the short term, until the underlying floating rates start to rise and rise.

Performance – In line with peers

JQC’s performance was nothing short of spectacular, but they lived up to what their peers delivered. The senior lending space has certainly been under pressure as rates since 2008 have been essentially close to 0%. There was a brief period from 2015 to 2019 that saw high rates targeted by the Fed, but nothing substantial.

Graphic
Data by YCharts

This has resulted in lower underlying returns and therefore lower returns. With rates expected to rise in the future, we might see better returns in the future. That being said, I’m not sure we ever see “normal” rates. So, I would always keep well-founded and realistic expectations.

Below is a comparison of the total return performance between JQC, BlackRock Floating Rate Income Trust (BGT) and Apollo Senior Floating Rate Fund (AFT). For reference, I have also included Invesco Senior Loan (BKLN), a non-leveraged ETF. As we can see, the leveraged CEFs all pretty much line up with each other.

Graphic
Data by YCharts

What sets JQC apart at the moment is the fairly significant discount from the fund that has opened up. The market has been quite volatile lately, which has pushed funds towards deeper discounts. This had pushed JQC below its long-term average since its inception. This discount quickly tightened but remains at a fairly attractive level.

Graphic
Data by YCharts

It may not be impressive in itself. However, when put into context with its peers, we get a better picture. As of December 31, 2021, the senior loan fund space stood at an average haircut of just 0.90%.

Distribution – Managed Plan implemented

The current distribution of the fund is established at a rate of 7.06%. Based on NAV, this amounts to 6.71%. In September, when they announced the end of the comeback program, they also announced managed distribution. This is a rate that should be paid for a period of time until it is changed. It is common among CEFs to pay uniform rates to investors.

(Source – CEFConnect)

In my previous coverage in early 2021, I expected distributions of around $ 0.0325 to be set. This could have been supported by net investment income [NII] at this moment.

The other problem here is that we are still seeing the results of a period when rates weren’t cut to 0% by the Fed. This means that income will likely drop even more from that point on – so, in other words, $ 0.39 could still be too high. Even if we take that number, it looks like they could support a distribution of $ 0.0325 per month. This actually makes sense, because before this cut they were paying around a payout amount of around $ 0.038. Now rates have come down since that time, as well as their assets through the return program. Therefore, a much lower rate could be expected if they set it at an amount close to what they earn.

The $ 0.0385 ad was obviously better than I expected. Although I don’t think he is supported, at least not at the moment. I think the fund’s coverage will be low after seeing the updated numbers.

For the fiscal year 2021, they reported an TIN of $ 0.32. As I suspected, this was a drop from $ 0.39, although it was a bigger drop than I expected. It just means that it’s even more puzzled as to why they choose to go for a higher distribution than what they could support. The only thing that supported the distribution this year was the large gains in the underlying portfolio which rebounded from the large losses last year.

(Source – Annual report)

At the current payout rate, they pay $ 0.462 per year while earning $ 0.32. This puts their coverage at around 70%, among the lowest in the group of senior loan funds.

Higher rates would improve this coverage in the future, but this is something to consider before investing.

JQC portfolio

Besides the attractive discount of the fund, I would say that another strong point of the fund is the fund portfolio if you are a more tactical investor. Almost 88% of the portfolio is invested in senior loans, which should allow a large majority of the portfolio to benefit from increased rates. There is only a small round right now in corporate bonds, those positions that will be under more pressure during rate hikes.

(Source – Fund website)

The duration of the fund bears witness to this; the effective duration of the fund is only 0.65 years. The effective maturity of the fund is 4.72 years. At the same time, the average bond price stands at $ 98.86. This indicates that JQC is on a discount and its underlying portfolio is also slightly below par. All of this data is reported at the end of November 30, 2021. All of this makes JQC’s portfolio quite attractive.

The fund is also quite diversified. Not only do they have 388 positions in total, but the top positions are not too large an allocation. The largest positions in the fund represent only 1.4% of allocations.

(Source – Fund website)

That being said, we can see that some of the portfolio’s positions will be COVID sensitive. In particular, if the Omicron variant persists as it has already done for several weeks. Being a highly transmissible strain, we are already seeing some European countries add restrictions.

CSC Holdings, its largest position, is a cable and telecommunications services company. It is a subsidiary of Altice after they bought Cablevision. Altice always seems to make an appearance when we discuss senior high yield loan funds. For JQC, CSC Holdings’ exposure comes from three different senior loans.

(Source – Annual report)

These are not the highest paying positions, but they are relatively more stable, being rated BB than some of the other lower rated positions in the fund.

Where we have a position that COVID could have a direct impact, that would be United Airlines (UAL). This comes from two different positions, a debt issued by the airline itself and another from its subsidiary.

(Source – Annual report)

As we can see, UAL is not the only exposure to airlines that this fund carries. He has several positions that could be negatively impacted.

For sector allocations of the fund, we have media and hospitality, catering and leisure as the largest industries. In particular, the hotels, restaurants and leisure category emphasizes its weighting to that which could be the most impacted.

(Source – Fund website)

The credit quality of the fund reflects that it is most certainly invested in lower rated companies. Senior loans are often given to companies rated as garbage, so it’s not too surprising.

(Source – Fund website)

Conclusion

JQC has come to a more attractive valuation. We also have more clarity on the future of the fund with the closure of the return on capital program. This means that we know what the distributions will be, at least for a little while. The distribution of a managed plan can be changed at any time. It’s just an indication that they plan to do this monthly distribution for now. I would be more careful about the lack of coverage of the fund’s distributions at the rate they set. It places its hedge on the lower end of its peer group, which will put additional pressure on eroding NAV if they continue to overdistribute. On the other hand, they might anticipate that as next year approaches, they will improve this coverage with higher rates. Which it probably does, it will get better, but I’m not sure enough to close the gap.


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