There can be little doubt that one of the biggest problems facing the average American today is the rapidly rising cost of living. We can quickly see how severe this problem is by looking at the consumer price index, which claims to measure the cost of a regular basket of goods that is purchased by the average person. As we can see here, there have only been two months in the past year in which the consumer price index increased by less than 6% year-over-year:
Although we have seen the reported rate of inflation decline in the past few months, this appears to be somewhat misleading. As I pointed out in a recent blog post, the decline has been caused by lower energy prices. The core consumer price index, which specifically excludes volatile food and energy prices, has not declined at all. Thus, the cost of living is a bigger problem than policymakers want to believe. It is almost certainly one reason why consumer debt just hit a record $17 trillion. It is clear that people are desperate for additional sources of income just to maintain their standard of living.
As investors, we are certainly not immune to this as we need to eat and pay bills too. We do, however, have more options than the average person to obtain the additional income that is needed to maintain our current standard of living. After all, we have the ability to put our money to work for us to earn an income. One of the best ways to do this is to purchase shares of a closed-end fund, or CEF, that is focused on income. These funds are unfortunately not discussed very often in the investment media, so it can be difficult to find the information that we need to make an informed decision. That is unfortunate because these funds offer a number of advantages over open-ended or exchange-traded funds. Perhaps the most significant of these is that they are able to use certain strategies that boost the effective yield of their portfolios far beyond that of anything else in the market.
In this article, we will discuss the Nuveen Credit Strategies Income Fund (NYSE:JQC), which is a closed-end fund that is designed to provide its investors with a high level of income. This is showcased by the fact that this fund yields 11.54% at the current price, which is certainly high enough to please any income investor. I have discussed this fund before, but several months have passed since that time so obviously a great many things have changed. This article will therefore focus specifically on those changes as well as provide an updated analysis of the fund’s financial condition. Let us investigate and see if the Nuveen Credit Strategies Income Fund could be a good addition to a portfolio today.
About The Fund
According to the fund’s webpage, the Nuveen Credit Strategies Income Fund has the stated objective of providing its investors with a high level of current income. This is not surprising considering that this is a debt fund. The webpage specifically explains that,
“The fund will invest at least 80% of its assets in loans or securities that are senior to its common equity in the issuing company’s capital structure, including but not limited to debt securities and preferred stock.”
The fund’s name likewise implies that the fund is going to focus its efforts on investing in debt securities. Currently, the fund is almost entirely invested in bonds, although it naturally has a small amount of cash on its books:
The chart shows that the fund is 97.68% invested in bonds, but these are not ordinary bonds. The fund’s webpage specifically states that this fund will invest at least 70% of its assets into adjustable-rate senior secured and second-lien loans. Those are different from traditional bonds and are a much better asset to hold in today’s market.
One of the most important characteristics of bonds is that prices vary inversely to interest rates. In short, when interest rates go up, bond prices drop. Over the past year, the Federal Reserve has been aggressively raising interest rates in an effort to combat the incredibly high inflation in the economy. As we can clearly see here, a year ago the effective federal funds rate was 0.33% but today it is 4.83%:
This has caused bond prices to decline, as I have pointed out in numerous previous articles. This is because a bond’s coupon yield will be based on the prevailing market interest rate at the time of issuance. With a normal bond, the coupons do not change over the life of the bond, so a bond that was issued last year would have a much lower coupon yield than a bond that is issued today. It, therefore, makes no sense for any investor to buy a year-old bond in the secondary market when they could buy a brand-new bond and get a higher yield. The price of the older bond must therefore fall until it delivers the same effective yield as a brand-new bond with identical characteristics.
The loans that Nuveen Credit Strategies Income Fund purchases are very different, though. These securities have a coupon rate that goes up when interest rates go up. Thus, they should hold their value much better than traditional bonds during periods of increasing rates. That has certainly proven to be the case, as the Bloomberg US Floating Rate Note < 5 Yrs. Index (FLOT) has been almost perfectly flat over the past year:
Contrast this to just about any other bond fund in the market and the advantages of these securities will be immediately obvious. Unfortunately, the Nuveen Credit Strategies Income Fund’s market price has not kept up with the index as it has fallen just like a traditional bond fund. The fund is down 8.02% over the past year:
As I have pointed out in a few previous articles though, it is quite possible for the shares of a closed-end fund to deliver a different performance than the portfolio underlying the shares. This is because the fund is not constantly issuing and redeeming shares like an open-ended or exchange-traded fund. In the case of this fund, the portfolio did indeed deliver a much better total return than the shares:
As we can see, during the full-year period that ended April 30, 2023, the fund’s net asset value declined less than the shares did in the market. In the past three months, the shares actually delivered a negative total return, but the portfolio delivered a slight profit. The portfolio has delivered a higher total return than the shares did as well. It is important to note that these are total returns, which assume that the distributions are being reinvested in the fund. That will naturally help to offset some of the declines that the shares experienced over the period. The important takeaway here is that the fund actually performed better than its share price would imply and as we will see later in this article, that provides investors an opportunity to acquire the fund’s assets for less than they are actually worth.
One of the characteristics of adjustable-rate bank loans, such as the ones found in this fund, is that they tend to be issued by companies that already have substantial amounts of debt or fairly weak balance sheets. This is because investment-grade companies can usually issue traditional bonds at a fixed rate, and they will usually opt to do that because those bonds are cheaper for the issuing company. This is something that may concern investors that are risk-averse, such as most retirees, due to the risk of defaults. After all, we have all read in the media that junk bonds have very high-interest rates because of the risk that the issuing company will default on the bonds. Fortunately, in this case, we can draw some comfort by looking at the credit ratings of the securities in the fund’s portfolio. Here is a high-level summary:
An investment-grade security is anything rated BBB or higher. This chart, therefore, confirms that the majority of the securities are junk-rated as investment-grade securities only account for 13.0% of the fund’s total assets. However, we can see that 80.3% of the fund’s assets have a BB or B rating. These are the two highest possible ratings for speculative-grade debt securities. According to the official bond rating scale, companies whose securities carry these weightings have sufficient financial capacity to meet their current debt obligations even through a short-term economic shock. Thus, the default risk of these securities is only marginally higher than that of investment-grade bonds. As such, the overall risk of losses due to defaults is not really very high here.
In addition, this fund has 402 unique positions so any individual issuer will only represent a very small portion of the portfolio and a single default will not have any real effect on the portfolio. Thus, it does not appear that we have too much to worry about here.
In the introduction to this article, I stated that closed-end funds like the Nuveen Credit Strategies Income Fund have the ability to employ certain strategies that boost their yields beyond that of any of the underlying assets. One of these strategies is the use of leverage. In short, the fund is borrowing money and using that borrowed money to purchase floating-rate debt securities and other income-producing assets. As long as the purchased securities have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing money at institutional rates, which are substantially lower than retail rates, this will usually be the case.
However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not using too much leverage because that would expose us to too much risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for this reason. As of the time of writing, the Nuveen Credit Strategies Income Fund has levered assets comprising 39.16% of its portfolio so it is well above the desired level right now.
This could be a sign that the Nuveen Credit Strategies Income Fund is taking on too much risk, but fortunately, debt funds can usually handle higher leverage than equity funds because of the lower volatility of their assets. This is particularly true for a fund that buys floating-rate securities because they are very stable in terms of price, which can be seen by looking at the floating-rate index over the past year. With that said though, I would still like to see lower leverage here to improve the balance between risk and reward.
As stated earlier in this article, the primary objective of the Nuveen Credit Strategies Income Fund is to provide its investors with a high level of current income. In order to achieve this, it primarily buys floating-rate debt securities, which usually have a yield that is a few percentage points above LIBOR, the federal funds rate, or some similar risk-free benchmark. The fund then applies a layer of leverage to boost the effective portfolio yield above that of the securities that are included in the portfolio. As such, we can probably assume that the fund will have a very high yield. This is certainly the case as the fund pays a monthly distribution of $0.0475 per share ($0.57 per share annually), which gives it an 11.54% yield at the current yield. Unfortunately, the fund has not been very consistent with its distribution over the years. In fact, it has varied quite a lot:
This variable distribution history will undoubtedly reduce the fund’s appeal in the eyes of those investors that desire a stable and secure source of income to use to pay their bills or finance their lifestyles. However, it is not unexpected as the income that this fund receives will vary a great deal with the prevailing interest rate in the market. The fund has increased its distribution twice in the past year, which lends a degree of support to this statement. These distribution increases are also nice considering that the rising cost of living has been causing budgetary pain for many people and the fund giving us more money will help to offset this somewhat. Of course, the most important thing is how well the fund can sustain its current distribution since anyone buying today will receive the current distribution at the current yield and does not have to worry about the fund’s past history.
Fortunately, we have a very recent document that we can consult for this purpose. The fund’s most recent financial report corresponds to the six-month period that ended on January 31, 2023. This is a much more recent report than we had available to us the last time that we discussed this fund and as such we should be able to get greater insight into how the fund performed in the second half of 2022, which is when the bulk of the Federal Reserve’s interest rate hikes occurred. During the six-month period, the fund received $51,014,824 in interest and dividends from the assets in its portfolio. When we combine this with a small amount of income from another source that the financial statements simply classify as “fees,” the fund had a total investment income of $51,964,991 during the six-month period. It paid its expenses out of this amount, which left it with $34,401,848 available for shareholders.
That was, unfortunately, not enough for Nuveen Credit Strategies Income Fund to cover the $36,411,094 that the fund paid out in distributions during the period. It did manage to get very close, but it is still concerning that the fund did not manage to completely cover its distributions out of net investment income.
Fortunately, the Nuveen Credit Strategies Income Fund does have other methods through which it can obtain the money that it needs to cover the payouts. For example, it might have managed to earn some capital gains that can be paid out. The fund had mixed results at this as it had net realized losses of $42,903,161 but these were partially offset by $24,061,293 net unrealized gains. Overall, the fund’s assets declined by $20,851,114 during the period after accounting for all inflows and outflows. While this is concerning, the fund probably can maintain its current distribution. As we just saw, its net investment income is pretty close to the amount needed to accomplish that task and it seems likely that the interest rate increases that occurred this year boosted its income somewhat.
We will certainly want to keep an eye on its finances going forward, but this fund’s distribution is probably going to be fine unless the Federal Reserve pivots in the near future. Over the past few weeks, a few officials have said that such a scenario is highly unlikely so for now we should be able to enjoy the income here.
It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the Nuveen Credit Strategies Income Fund, the usual way to value it is by looking at the fund’s net asset value. The net asset value of a fund is the total current value of the fund’s assets minus any outstanding debt. This is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.
Ideally, we want to purchase shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are buying the fund’s assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of May 17, 2023 (the most recent date for which data is available as of the time of writing), the Nuveen Credit Strategies Income Fund has a net asset value of $5.72 per share but the shares trade for $4.93 each.
This gives Nuveen Credit Strategies Income Fund shares a 12.94% discount on the net asset value at the current price. This is relatively in line with the 12.86% discount that the shares have averaged over the past month, and it is a very large discount in general. Thus, the price certainly looks to be acceptable today.
In conclusion, the Nuveen Credit Strategies Income Fund appears to be a reasonable way for investors to obtain a high level of income from their portfolios today. The fund is invested in floating-rate securities, which have proven to be better than traditional bonds over the past year. It is uncertain what the Federal Reserve will do with interest rates going forward, as there is some risk that a surge in energy prices will rekindle inflation and force it to raise rates even as the economy falls into a recession.
As a result of interest rate uncertainty, this fund’s floating-rate securities could provide a useful hedge. The distribution appears to be sustainable and the fund also has an attractive valuation, so Nuveen Credit Strategies Income Fund could be worth considering overall.
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