HYT: 9.6% Yielding Credit CEF – Not A Time To Buy

Bim/E+ via Getty Images Thesis We have not covered the BlackRock Corporate High Yield Fund (NYSE:HYT) in more than a year. Thus, we feel it is time to re-visit this $1.4 billion AUM fixed income CEF from BlackRock. HYT is a name that we used to hold, having assigned it a ‘Buy’ rating in late 2022 on the back of a rights offering. There have been a number of changes in the market since we last covered this name, with risk free rates peaking and the credit spread environment now pricing an immaculate soft landing. In this article, we are going to look at HYT’s structural features and performance, and outline why the name represents a robust long-term hold, but it is not a name to buy at the present price point. Premium to NAV – close to historic highs Despite risk free rates being over 5%, the CEF has a premium to NAV which is now close to historic highs: Data by YCharts We can see from the above graph courtesy of YCharts that the CEF usually trades at roughly -10% discount to its net asset value. During periods of low risk free rates or periods of very low credit spreads (like today), the fund moves to flat to NAV. In the past decade, we have only seen this CEF trade at above NAV in two instances, once in 2021, and the second one being now. We are ardent believers in mean reversion. Therefore, we see the fund moving to a discount to net asset value during the next risk off event. When things are ‘perfect’ (i.e. soft landing with low credit spreads) they tend to move to more realistic scenarios, even if it takes a while. There will be another risk off event when the market is concerned about an economic factor and drives credit spreads wider. Collateral composition – overweight single-B names The fund is focused on ‘B’ rated credits: Ratings (Fund Website) Single-B rated names make up 54% of the collateral, followed by ‘BB’ names at 26% and ‘CCC’ issuers at 14.7%. This simply translates into the fund’s performance being driven mostly by single-B credit spreads. When spreads widen, the fund loses money. The CEF is a classic one, with mostly fixed rate HY bonds and a small leveraged loan sleeve: Holdings (Fund Website) Leveraged loans make up only 12% of the collateral, with the fund also having a small sleeve for equities, most likely received via restructurings. The fund is granular, with the majority of the underlying names below 2% of the fund: Individual Names (Fund Website) It is interesting to note the CEF owns the debt from ‘Venture Global’, an LNG facility: Venture Global is a long-term, low-cost provider of U.S. LNG sourced from resource rich North American natural gas basins. Venture Global’s first facility, Calcasieu Pass, commenced producing LNG in January 2022. The company’s second facility, Plaquemines LNG, is under construction and expected to produce first LNG in 2024. The company is currently constructing and developing over 70 MTPA of nameplate production capacity to provide clean, affordable energy to the world. Venture Global is developing Carbon Capture and Sequestration projects at each of its LNG facilities. As a reminder, the PIMCO Dynamic Income Strategy Fund (NYSE:PDX) which we covered last here, holds a very large equity position in Venture Global. Robust performance for a rising rates environment The CEF has posted a robust performance in a rising rates environment: Data by YCharts We are comparing the CEF with a number of its peers, namely the PIMCO Dynamic Income Fund (PDI), the KKR Income Opportunities Fund (KIO) and the BlackRock Multi-Sector Income Trust (BIT). While KIO is the outperformer, it is worth noting the fund is overweight CCC names, thus taking significant credit risk. HYT however outperforms the famous PDI fund from Pimco, and has now reached the same total return as BIT. BIT had a solid 2022/2023 due to its rates hedging, thus had a structural aspect that worked in its favor. Analytics AUM: $1.4 billion Sharpe Ratio: -0.12 (3Y) Std. Deviation: 11 (3Y) Yield: 9.6% Premium/Discount to NAV: 0.9% Z-Stat: 1.01 Leverage Ratio: 30% Composition: Fixed Income – U.S. HY Duration: 2 yrs Expense Ratio: 2.38% Distribution coverage Even in today’s high rate environment, the fund does not fully cover its distribution: Section 19 Notice (Fund Website) As of the May 2024 Section 19 notice, the CEF was utilizing 19% return of capital (‘ROC’) to cover its distribution yield. While common, the fund could have lowered some of its expensive leverage in order to reduce ROC utilization, although that would have also resulted in a lower distribution yield. Risk factors going forward We are big believers in mean reversion and a more sinuous path forward than the market is pricing. As of now, credit spreads are at decade long lows, pricing in a perfect soft landing where rates will come down while the economy will not suffer a contraction. Not even a mild one. It is hard to imagine such a scenario, especially when the regulators have proven themselves very inept to manage the forward via monetary policy. We think inflation will be much stickier than anticipated, and the Fed will be forced to hold rates higher for much longer, thus pushing the economy in a mild recession. The timing is nebulous here, but credit spreads will suffer a significant widening once the market prices such a scenario. Wider credit spreads will translate into a lower price for HYT, corroborated with an increase in the discount to NAV. In our mind, it is a matter of ‘when’ rather than ‘if’. Conclusion HYT is a robust high yield fund from BlackRock. The vehicle comes with a 30% leverage ratio and a collateral pool which is overweight single-B credits. The fund has had a robust historic performance given higher rates and the credit spread shock from 2022, but is now stretched. With very low credit spreads in the market, the fund is now priced at a premium to NAV, close to its decade long high in 2021. The CEF is priced for perfection, and the next risk-off scenario in the market will see its NAV move lower and its discount to NAV widen significantly. HYT is a robust long-term hold, but currently does not present an attractive entry point.

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