All Sorts Of Reasons To Avoid This 10% Yielder In The Current Environment
Conditions Dictate Everything
Every week, we’ll profile a high yield investment fund that typically offers an annualized distribution of 6-10% or more. With the S&P 500 yielding less than 2%, many investors find it difficult to achieve the portfolio income necessary to meet their needs and goals. This report is designed to help address those concerns.
The fixed income market remains a complicated playground for investors right now. Even with yields sitting several percentage points higher than they did two years ago, it’s credit risk that makes this group vulnerable now. Credit conditions have tightened in most countries across the globe and the fallout from existing rate hikes and the higher cost of borrowing have made already risky debt even riskier. Closed-end funds that focus on high yield fixed income often dive deep into the lowest credit tiers to maximize the income they produce, a fact which makes it vitally important that investors know what they’re getting themselves into.
The Nuveen Global High Income Fund (JGH) is a good example. Its worldwide diversification should help spread some of the risk around, but it may not help much if the low grade debt it holds is already at higher risk of defaulting. Diversification across fixed income asset classes may also help, but that again ignores the obvious question - can the portfolio limit default risk in this high risk environment?
Fund Background
JGH seeks to deliver high current income through a diversified portfolio of global high-income securities that may span the capital structure and credit spectrum, including high-yield bonds from the U.S. and developed & emerging markets, as well as preferred and convertible securities. Its managed assets will include at least 65% in securities rated below investment grade, at least 40% in securities issued by non-U.S. entities, and up to 25% in debt obligations from issuers located in emerging market countries. The fund also uses leverage to enhance yield and total return potential.
There’s really no magic formula to this fund’s strategy. It’s simply trying to identify the (mostly) junk bonds with the highest potential from around the world. We’ll get into the composition of the fund in a moment, but the one thing that immediately stands out as a red flag to me is the cost. JGH’s total expense ratio of 1.4% is a little on the high side, but not atrociously unreasonable. When you add in the cost of leverage, however, the overall expense ratio jumps to an enormous 3.61%! This is going to be a big problem for any fund using leverage nowadays. Since interest rates are significantly higher than they were before, the cost of implementing leverage has gotten much more expensive as well. The cost of overlaying 30% leverage on top of the fund’s assets makes it incredibly difficult to beat any standard benchmark when you’re starting with that kind of deficit.
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