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Income Investors: This Attractive 6.9% Yielder Just Sold-Off

If you are an income-focused investor, there are lots of reasons to consider making an allocation to this attractive high-yielder (such as the high yield, monthly payments, attractively discounted price, skilled management team, hard to access investments, and its potential to be a very attractive hedge against rising interest rates). But before you dive in headfirst, you should also consider the costs and risks (such as the leverage, the expenses, and the main focus on income instead of price appreciation). This type of investment is not for everyone, but if you like high monthly income, this one is worth considering, especially after the recent big and unwarranted sell-off.


Nuveen Floating Rate Income Opportunity Fund (JRO), Yield: 6.9%

JRO is a closed-end fund (“CEF”), and its main objective is to achieve a high level of current income. The fund invests at least 80% of its assets in adjustable rate loans, mainly senior bank loans secured by specific collateral.

4 Reasons Why JRO Is Attractive

Healthy Monthly Yield:

Perhaps the first reason why anyone would consider investing in JRO is because of the big monthly income payments. This CEF currently offers a 6.9% yield (paid monthly), and the payments have been composed almost entirely from income, NOT a return of capital.

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Return of capital is an important topic for closed-end funds because in most instances it is your own money being returned to you, and this can lower your cost basis which has tax implications. In JRO’s case, the dividend is simply the income generated from it’s underlying holdings being passed on to you.

Interest Rate Hedge:

JRO’s floating rate securities are another reason why this fund is attractive. As mentioned earlier, most of this fund’s assets are invested in adjustable rate loans, mainly senior bank loans secured by specific collateral. This is particularly attractive in our current rising interest rate environment. If you don’t know, as interest rates rise, fixed income securities prices fall, all else equal. This is a huge risk for income investors because the value of many of their investments (e.g. bonds, preferred stocks) will fall over time as interest rates keep rising. This is essentially the opposite of the situation we’ve experience since the 1980’s where interest rates were rising. Only recently have interest rates started rising, and the risk of falling asset prices is a big risk for investors. Fortunately, JRO has the potential to eliminate most of this risk because as rates rise—so to do the income payments from the underlying bank loans (this is one of then beauties of most bank loans).

Discounted Price (It Just Sold-Off):

As the following chart shows, JRO is currently trading at a large discount (-11.4%) relative to its net asset value (i.e. the aggregate value of its underlying holdings), and in this case that is a good thing.

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This discount is good not only because investors may experience some price appreciation as the discount dissipates (more on this later), but it is also good because it means you are buying this fund’s big yield at a discount (i.e. you’re getting more income for less money).

There are two main reasons why this fund trades at a larger than normal discount, in our estimation, and both are based on market inefficiency. Fist, this fund raises and lowers its income payments regularly as it’s just passing through whatever income is paid by its underlying holdings (and there is some timing logistics involved too). The historical distributions for JRS are shown on Nuveen’s website, and they have gone up and down over time, they have recently gone down, and it seems investors put unwarranted selling pressure on the shares when the dividend goes down (usually followed by unwarranted buying pressure when it goes back up). This is a good chance to buy low (i.e. at a big discount).

Next, Nuveen notes in its recent fund literature that the spread investors are willing to pay for its floating rate CEFs has some volatility to it. And as we can see in the below price versus NAV performance chart, that spread has moved in the favor of buyers, as evidenced by the larger discount to NAV.

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Hard to Access Investments:

Another reason this fund is attractive is because it invests in assets that are normally difficult for non-professional investors to access. First, you need to be a professional to buy bank loans (the documentation required is a nightmare, unless you have the vast resources of a big firm like Nuveen). Bank loans are a particularly attractive asset class right now because of the floating rate characteristics. Second, this fund uses some leverage (it borrows money to invest—more on this later in the risks section), and the fund is able to borrow at attractively low interest rates that are generally not available to ordinary retail investors.

3 Risks To Be Aware Of

Leverage:

As mentioned above, this fund uses borrowed money. Currently, the leverage ratio is 36.9%. Using leverage can increase returns (in this case yield) in the good times, but it can also magnify losses in the bad times. The good news is that the underlying holdings (mostly bank loans) are relatively low risk (especially because it’s a diversified portfolio of bank loans), and the floating rate feature makes the price significantly less volatile (even with the leverage) relative to other asset classes. We are comfortable with this leverage ratio (it mainly just magnifies the yield).

Expenses:

The management fee and expenses on this fund are 1.41%, a not insignificant amount. And the cost of leverage adds another 1.58% (Not a small amount either, but still far lower than the rate at which most individual investors could borrow at). The good new is that even after these expenses, the fund still delivers attractive yield. Since inception in 2004, this fund has averaged a total return (dividends plus price appreciation, but in this case mostly dividends) of 6.02%. However, it more attractive now because it trades at a big discount to NAV (this was not the case at inception), and the current yield is 6.9%.  

Income-Focus (Not necessarily price appreciation):

Perhaps the biggest misunderstanding of this fund by many investors is that it is focused mainly on generating income, NOT share price appreciation. That means if you don’t reinvest the dividends (for example, you may need the income to cover living expenses), then the value of your investment will likely not rise dramatically over time. We believe there is currently some attractive price appreciation potential (because it currently trades at a relatively large discount to NAV, which we expect to shrink over time), but in the long-term this fund is about generating income. Nonetheless, the potential long-term yield on your investment is attractive right now considering JRO’s currently discounted price.

Conclusion:

If you like buying high income when it is on sale, consider investing in JRO now. We’re not saying the discount to NAV can’t get bigger (it can), but it is still unusually large right now, and it will likely shrink over time. There are a variety of additional very attractive qualities to this fund, as well as risks, as described above. However, if you are an income-focused investor, this is a good time to consider buying if you’re looking for healthy yield at a discounted price.

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