Time to Consider Leveraged Corporate Bond Funds

By Bryan Perry

The primary takeaway from last week’s slowdown in inflation for the U.S. economy per the Personal Consumption Expenditures (PCE) Index report is that a rate cut in September is very much on the table, but don’t count out the outside possibility of a cut at the July 31 Federal Open Market Committee (FOMC) meeting. Four more weeks of disinflationary numbers could prompt the Fed to consider starting the easing process, even though the CME FedWatch Tool is showing a nearly 90% probability of no cut in store.

This week, investors will digest the release of the S&P Global U.S. Manufacturing PMI-Final for June, the ISM Manufacturing Index for June, the JOLTS Job Openings for May, the ADP Employment Change for June, the Weekly Initial Unemployment Claims, the S&P Global U.S. Services PMI-Final for June, the Factory Orders for May, the ISM Non-Manufacturing Index for June, the Non-Farm Payrolls and the Unemployment Rate for June. It’s a big week for data the market will certainly trade off of, and because of summer light volume, volatility will likely be elevated.

Assuming the pipeline of data continues to demonstrate disinflation at work, where the economy experiences slowing growth, but no recession, it might behoove income investors willing to go out on the risk curve to take a hard look at high-yield bonds, and specifically leverage high-yield bond closed-end funds that pay double-digit-percentage yields. Following a cycle of 11 rate hikes, this asset class is selling well off the 2022 highs right before the Fed embarked on its tightening cycle.

The investment proposition is a trifecta of catalysts for leveraged junk bond funds. The first being the Fed beginning a cycle of sequential rate cuts that occur over the next 18 months. The second is the cost of leverage declining meaningfully, and the third is the historical price appreciation for fixed income assets in a market where rates are on the decline.

Take for instance one of the largest high-yield corporate bond funds that has $5.2 billion in assets that controls $8.4 billion marketable securities, implying 38% leverage. The PIMCO Dynamic Income Fund (PDI) is one of the most aggressive strategies in the space, and because of its outsized leverage, lost 52% of its value from just before the pandemic to Q4 2023, when the market rallied on hopes of Fed easing.

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Since then, the fund rallied on renewed hopes of rate cuts and the fact that the economy didn’t slide into recession, thereby providing a backdrop of improving creditworthiness and more constructive corporate balance sheets for low-rated and non-rated debt. It should be noted that money flow into this fund has been bullish since the beginning of 2024, implying that, though rates have been higher for longer, institutional investors believe that lower rates are indeed forthcoming.

Shares of PDI pay an annual distribution rate of 14.08%, whereas a closed-end fund such as the BlackRock Corporate High Yield Fund (HYT) with $1.4 billion in assets is using 30% leverage to control $1.9 billion in corporate debt securities and pays 9.84%. Both funds pay monthly payments. It is vital that investors do their own due diligence to understand the risks of such funds, but as is with any asset class, timing is everything, and now might be the time to consider the potential for total return.

This is a compelling set up in a market with opportunities to take full advantage of what could be a bullish trend. Professional bond investors have been patiently waiting for when to increase bond weightings in both investment grade and non-investment grade fixed income assets, and just maybe, a trend is developing following the head-fake bond rally earlier this year. If so, this sector gives investors the chance to lock in inflation-crushing yields coupled with capital appreciation.

More light will be shed on this trade during the next four weeks of economic data points released and how the high-yield bond market responds to earnings season. There are times when bond returns can be very impressive, and this might be one of them. To learn more about leveraged corporate bond closed-end funds and other high yield investments paying double-digit-percentage yields, visit my website at www.bryanperryinvesting.com and become a member of Cash Machine, which is beating inflation hands down and providing investors with an amazing stream of steady 10%+ stream of income.

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