BLW Vs. LDP: Comparing Low Duration CEFs
(This article was co-produced with Hoya Capital Real Estate)
This article was triggered by a comment in my article FPF: One Of The Better Performers In The Limited-Duration Space about this low-duration closed-end fund. The following chart shows why investors should consider these funds.
BBB-rated corporate debt has seen its yield climb to levels last seen just before the COVID-19 scare of early 2020. Supply chain issues and now with employment contracts again including covenants COLA, inflation seems to be with us for an extended period. With more companies issuing debt securities to lock in recent historically low rates, investors will demand higher coupons to take on all of these sources of interest rate risk. Solution? Low duration fund. While unleveraged ETFs in this space should be safer, the extra yield provided by CEFs should offset that.
In this article, I have chosen to compare the CEF mentioned by the commentator, the BlackRock Limited Time Income Trust (BLW) against the one I’ve owned for years, the Cohen&Steers Limited Duration Preferred&Income Fund (PLD). After exploring both in detail, the final section will compare the key features of both and include the First Trust Intermediate Duration Preferred & Income Fund (FPF), since I recently gave FPF a bullish rating.
Despite its nearly 5% premium and despite most of the factors favoring BLW, I like LDP. For those who don’t hold any of the three, FPF is definitely worth looking into. For investors looking for a CEF suitable for the period when interest rates are rising, I am bullish on all three picks.
What is duration?
Duration is a measure of the price sensitivity of a bind Or other debt instrument to a change of interest rate. The duration of an obligation is easily confused with its duration or the time of maturity because some types of duration metrics are also calculated in years.
Although the chart is from late 2018 and the longer duration did better in 2005-06 and 2016-18, on average the annualized cumulative return since 1976 on the Barclays 1–3 Year Govt/Credit Index was 4 .69% and 3.4% for the Barclays 1–3 Year Govt/Credit index. Barclays Long Govt/Credit Index. The correlation with interest rates was higher for short duration bonds at 87% compared to 24% for long duration bonds.
Explore the BlackRock Limited Time Income Trust
Seeking Alpha describes this CEC as
BlackRock Limited Duration Income Trust is a closed-end, fixed-income mutual fund launched by BlackRock, Inc. It is managed by BlackRock Advisors, LLC. The fund invests in US fixed income securities. It invests in securities of companies operating in diversified sectors. The fund invests primarily in high quality corporate bonds, mortgage-related securities, asset-backed securities, US government and agency securities, and floating rate senior secured loans. Its average portfolio duration is less than five years. BLW was launched in 2003.
Source: seekalpha.com BLW
Blackrock states that the investment objective of BLW is to provide current income and capital appreciation. The Fund seeks to achieve its investment objective by investing primarily in three distinct asset classes:
- mid-grade corporate bonds, investment-grade corporate bonds, mortgage-backed securities, asset-backed securities, and US government and agency securities;
- senior secured floating rate loans to corporations and other commercial entities;
- US dollar-denominated securities of US and non-US issuers rated below investment grade.
BLW has $571 million in assets under management and is currently yielding 7.3%. Blackrock charges 139 basis points in fees, 48 basis points tied to its 35% leverage ratio.
Approximately 20% of the portfolio is held in higher quality debt securities, with the remainder being higher yielding junk bonds. While 17% of assets are foreign, only 2% are denominated in currencies other than the US dollar.
With over 2,000 different assets, BLW holds most of the three CEFs reviewed here and should therefore have the lowest overall default risk.
Dividends are $0.0981 since the end of 2019. With term loans being the second largest asset class (32.67%), there is room to move to higher coupon assets over the next three years if rates actually go up.
Explore the Cohen&Steers Limited Duration Preferred&Income Fund
Seeking Alpha describes this CEF as
The fund is managed by Cohen & Steers Capital Management, Inc. It invests in bond markets around the world. The fund uses derivatives such as interest rate swaps to make its investments. It seeks to invest in companies operating in all financial sectors, including banking, diversified financial services, real estate and insurance. The fund invests primarily in floating rate and fixed-floating rate preferred securities, preferred securities, traditional preferred securities, hybrid preferred securities, debt securities and convertible securities. It uses fundamental analysis, with an emphasis on issuer creditworthiness and prevailing market factors to create its portfolio. LDP was launched in 2012.
Source: researchalpha.com LDP
The Cohen & Steers website lists LDP’s two investment objectives:
- Principal: To seek high current income by investing in preferred securities and other income securities.
- Secondary: Capital appreciation.
LDP has accumulated $752 million in assets and is currently yielding 6.2%. Cohen & Steers charges 178 basis points in fees, of which 60 basis points cover leverage costs (30%).
It’s interesting to see what different managers decide to share with investors. Here, the sector is industry-based, unlike BLW which was issue-based. Other sources show that the main type of assets in this CEF are also corporate bonds, followed by convertibles, then preferred stocks. I haven’t seen a currency exposure listing.
Currently, LDP’s only investment-grade debt is in all three BBB ratings, with the lowest still considered IG. Most of the rest is in the next letter, BB.
LDP distributions in 2022 have been reduced to $0.135 from $0.143, which is a reduction from pre-COVID distributions.
Comparison of the three short-lived CEFs
Readers should read my article on FPF for an in-depth review. The article also explains durations and why it is important to know the duration of a bond fund. The FPF sets out the same two investment objectives: income and appreciation. Here is an up-to-date price table.
If the goal is the shortest duration, BLW is the clear winner. It also offers the highest yield, lowest fees, highest discount, and lowest average bond price. And it does all of this even with the highest quality portfolio of assets, based on credit rating.
Let’s see if they match in terms of performance.
Apparently all of these wonderful points on BLW come at the cost of performance, as it trails the other two by a wide margin. Since this was primarily a time when longer duration funds should do better, I looked to see if the last 3 months, when rate fears rose, showed a different outcome.
BLW looks even worse, especially more recently.
While different investors will come to their own conclusion, despite its nearly 5% premium and despite most of the factors favoring BLW, I will stick with LDP. For those who don’t hold any of the three, FPF is definitely worth looking into.
With rates set to climb and a possible increase in FIVE FIVE rates before 2024, keeping durations short is a strategy to protect the fixed income assets an investor wants to hold. Another would be to use futures assets and build yourself a bond ladder. I’ve also covered this strategy: Build a “CD” ladder using Baby Bonds.
There are also equity strategies where an investor uses ETFs/CEFs designed to generate more returns than a typical S&P 500 fund. Here are some examples :
Here are Vanguard’s 10-year return projections, released 12/12/21:
If these prove to be accurate (and most of the 2010s were overly pessimistic), hitting a CAGR of 5% would make an investor’s portfolio a “winner”!