Volatility Breeds Opportunity: Closed-End Fund Income Ideas at a Discount

Recent volatility has created opportunities to invest in high yielding leveraged credit closed-end funds trading at a discount to net asset value.

2018 can be summed up in one word—volatility. To some, that word may have negative connotations. At BlackRock, we embrace volatility and look for opportunity. In our view, leveraged credit focused closed-end funds (“CEFs”) may present an opportunity for income investors seeking attractive yields.

Recent economic data confirms that the global growth is slowing, inflation remains moderate, and financial conditions have tightened. As a result, the Federal Reserve may be nearing its neutral policy rate. This Fed “pause” should benefit leveraged credit focused CEFs that have been adversely impacted by higher borrowing costs in addition to the confluence of geopolitical tensions, growth fears and overall negative market sentiment for risk assets.

Patience can pay with a long-term income strategy

In today’s fixed income landscape, we see opportunities to construct a much more efficient portfolio compared to a year ago to drive high income. Income can be an especially impactful force in some of these higher-risk asset classes, and price return appears considerably less important in today’s post-Quantitative Easing world (see Figure 1 below). Over a long enough time horizon, income can over-power the periodic draw-downs that credit markets may endure. When we look over a period of many years, we find that the vast majority of returns in major bond indices come from income, or coupon. Crucial to our philosophy in managing the portfolios is our prudent, disciplined, and steady approach to helping generate solid, reliable, and durable income over a longer-run investment window.Vital Component for Bond Market Total Return

Investors with a greater risk tolerance may want to consider leveraged credit focused CEFs to achieve higher income with potential upside given attractive valuations. Within credit markets, we believe high yield fundamentals are improving with higher rated credits driving new issuance volume and interest coverage at post-crisis highs. Meanwhile, technical factors remain supportive as the high yield market has shrunk and valuations are looking more attractive following recent outflows. Similarly, emerging market debt valuations are starting to look attractive following significant underperformance in 2018 and the technical backdrop has become more supportive.