Summary
We highlight why one should invest in this senior loan CEF.
Now is a great time to buy this well-established fund.
Doing so will lock in a high yield as well as future capital gains.
naphtalina/iStock via Getty Images Main Thesis
In this article, we review the Nuveen Floating Rate Income Fund ( JFR ). Fund Overview
JFR factsheet This fund invests in floating rate securities that are short-duration and senior in the capital structure. With the Fed expected to raise short-term rates, the idea is to capture a high-yield with inflation protection. It must be noted, however, that the underlying portfolio companies have poor credit and may have trouble supporting higher debt payments. In an effort to hedge that risk, the fund is well diversified between many industries and portfolio companies. Why You Should Invest For the Dividend
Seeking Alpha As with most closed-end funds, this fund is meant to deliver a high current income. Indeed, with a current yield of 7.06%, it can indeed be a solution to income starved investors. Notwithstanding the high current yield, you can see from the above chart that the fund had to cut distributions in the wake of the Covid crash. While it’s darn near impossible to predict black swan event like that, we’d like to see more consistent distributions. To their credit, it has almost recovered to pre-pandemic levels. The takeaway is that investors should be able to expect consistent cash flow on a monthly basis. But is it sustainable?
In spite of the impressive dividend yield, it behooves us to take a look under the hood to determine whether or not this is a junk yield that won’t deliver an acceptable total return. One reason is because this fund uses leverage to enhance the dividend. In other words, they borrow money at short-term rates and use the proceeds to invest in senior loans. This is significant because it makes the fixed income portfolio even more sensitive to interest rate changes. JFR annual report An analysis of the fund’s financial statements displays somewhat mixed results. While Net Investment Income has steadily trended upward, that growth hasn’t quite kept pace with the distributions. The net coverage ratio is still highly competitive for the CEF universe but it is something for prospective investors to be aware of as a potential future risk. Price Action and Volatility
As previously mentioned, this fund uses leverage to enhance the yield. The ramification of that on price action is that it results in higher volatility and greater opportunities for gains or losses. TradingView To demonstrate, consider the above chart of JFR’s performance relative to its unleveraged counterpart FLOT before and after the Covid Crash.
As you can see, it experienced much more aggressive drawdowns, much greater gains during the recovery, and generally higher volatility. What prospective investors should decide is whether their financial plan suits investing in JFR. That is, can you stomach the inevitable ups and downs and have the needed time to let it grow? Diversification and Asset Allocation
To that end, we highly recommend having a diversification plan in place to properly invest in JFR. Here a few reasons why:
> It can be difficult to achieve an acceptable total return
The steep drawdowns can test your patience and make you sell at the bottom
Diversification lets you take advantage of the drawdowns
In our view, the best way to hedge volatility without sacrificing too much yield is to have exposure to long duration treasury bonds such as ZROZ
Because of the poor credit quality, floating rate corporate bonds usually display negative correlation to treasury bonds that are backed by the U.S. Government and are theoretically exempt from defaults. Our suggestion is to pick an allocation that allows you to earn a fair current yield while also giving you protection from drawdowns. This will thus allow you to book your profits (selling high) and reinvesting in what’s down (buying low). TradingView Conclusion
All things considered, we recommend buying JFR and ZROZ in a diversified portfolio to safety of principal, high income, as well as strong potential for capital gains. It is not a perfect fund as the distribution does have weak points and is susceptible to a slowdown in the economy.
This article was written byMy goal is to find tax-efficient investments that can help people achieve their financial goals. I believe that you can achieve superior risk-adjusted returns without having to take on undue risk. Disclosure: I/we have no stock, option or similar derivative […]
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