BGH: High Yield, Short Duration – Is This The Place To Be Right Now?
2014 was unkind to Babson Capital Global Short Duration High Yield Fund. It appears to be getting back on its feet. While high yield is risky overall, staying short is a safer way to play the space. Babson Capital Global Short Duration High Yield Fund’s (NYSE: BGH ) net asset value, or NAV, fell nearly 13% last year. However, its started to stabilize this year. Which shows the risks of high yield, but doesn’t tarnish the potential benefit of staying short term. If you are looking for a high yield fund, but are worried about low interest rates, you might consider taking a look here. What’s in a high yield? I recently took a look at a couple of high yield closed-end funds , or CEFs, with broad investment mandates. Essentially, the two finds I compared, BlackRock Corporate High Yield Fund (NYSE: HYT ) and Dreyfus High Yield Strategies Fund (NYSE: DHF ), both have notable leeway when it comes to their portfolio selections. That’s not the case at BGH . Sure, it can invest around the world, but its average duration has to come in at three years or less. Why is that relevant? Because shorter duration bonds tend to be less impacted by changes in interest rates. So with interest rates near historic lows, if you are concerned about the impact of a rising yield environment, you’d want to stay toward the shorter end of the duration spectrum. HYT’s “model” duration was around five years at the end of the first quarter. DHF’s average duration was a touch over three years. BGH’s was a little under two years. Looking at this from a big picture perspective , this means that if interest rates were to increase by one percentage point, BGH’s value would be expected to decline by around 2%. DHF would fall by around 3% and HYD 5%. If rates fell, the opposite would happen, with BGH gaining less than the others. So, if you are concerned about interest rates going up but are still looking for a high yield fund, a short-term option like BGH might be worth a quick review. Short history That said, I looked at BGH because a reader requested it. The fund’s IPO was in late 2012, so it’s fairly young and doesn’t have much of a track record to go off of (less than three years). That doesn’t tarnish the value of its short duration focus, but it does mean the fund hasn’t been tested by time. So that’s a grain of salt you’ll need to take if you decide to invest here. However, it’s worth noting that last year was a tough one on the fund largely because of its exposure to oil companies ( recently around 20% of assets). With oil prices declining some 50% in the back half of 2014, it’s not surprising that BGH saw its NAV decline nearly 13% last year. That drop spoiled what was looking like a solid history. The fund IPOed with an NAV of roughly $23.80 per share. That had increased to nearly $25.25 by the start of 2014 only to drop to $22 by the end of the year. It remains around that level today, after having dropped even further at the start of 2015. There’s two takeaways here. First, this is a high yield fund, so even a short duration can’t offset the risk of investing in the debt of financially weak companies. (Note that HYD saw a similar NAV drop.) Two, the downdraft, at this point, appears to be over. So watch the NAV to see if management can get it to start moving higher again. This is, literally, the first time BGH has dealt with notable adversity. What else is worth knowing? Like many competing high yield CEFs, BGH makes use of leverage to enhance returns. Right now leverage stands at nearly 25% of assets. That helps boost yield, since BGH’s borrowing costs are lower than the interest it receives on its investments. And leverage can enhance returns if bond prices go up-but can also augment losses if bond prices decline. So leverage cuts both ways. Keep this in mind as it increases volatility even for a fund with a short duration. Leverage, however, also increases costs since the fund has to pay interest expenses. In fact, BGH is not a cheap fund to own, with an expense ratio of more than 2%. That may be fine with yield-hungry investors, however, since the fund’s yield is around 10%. But if you are looking for a cheap fund to own, this isn’t it. Without a longer history, it’s too soon to tell if 2014’s poor showing was an aberration. But certainly such a high yield gets increasingly hard to justify when the NAV is falling. However, return of capital doesn’t appear to be an issue yet since the fund avoided that type of distribution in 2013 and 2014. So, so far, BGH should probably get the benefit of the doubt here. Just keep in mind that a fund with a 10% yield is likely to be giving you all of your return in the form of distributions. That, in turn, makes it harder to grow NAV. While bonds are all about the income, a long-term trend of a declining NAV will most likely lead to distribution cuts at some point. So it is really important to watch BGH to see what happens on the NAV side of things from here. That remains true even though the fund is trading hands at a 10% discount to NAV. Indeed, that’s only a bargain if net asset value can recover from downdrafts like the one experienced in 2014. Too early for most At this point, I’d say BGH is a little too young for my tastes. I see value in its short duration peg, which might interest investors who want high yield exposure but want to limit interest rate risk. However, without a lot of history to go on (and one good year followed by one bad year in its short life), it’s hard to get a read on the value this fund would have in a portfolio. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
