Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally posted to members of the CEF/ETF Income Laboratory on March 24th, 2022.
PGIM Global High Yield Fund (NYSE:GHY) first comes up as quite an attractive fund looking at the basic metrics. A deep double-digit discount with a distribution yield clocking in at 9.60%. However, where the fund falls short is the distribution coverage. I suspect there could be a distribution trim as the coverage continues to slip. We would also have to consider the credit risk in the high yield space at this time.
Higher interest rates have been pushing this fund down as well. It comes in with a leverage-adjusted duration of 5.2 years. One of the biggest impacts on the duration of a portfolio is the maturity of the underlying portfolio. GHY’s portfolio has a maturity averaging 6.6 years.
This isn’t the worst duration we’ve seen as investment-grade bond funds, and muni funds would carry a higher duration. This translates to that for every 1% increase in rates, GHY’s underlying portfolio should fall around 5.2%. If the Fed pushes rates up to 2%, GHY’s underlying investments could decline by over 10%.
On a YTD basis, it would appear the NAV has already been declining by a sizable portion. The share price has fallen even faster. Of course, that is what has opened up the deeper discount in the fund.
I believe that if a distribution cut is announced, the discount could widen a bit further from here. Since the fund’s discount is already quite deep and the fund has been experiencing such declines already, it might not create a sharp drop. I would suggest that some of the distribution trim at this point is priced in.
1-Year Z-score: -2.33
Distribution Yield: 9.60%
Expense Ratio: 1.23%
Managed Assets: $739 million
GHY seeks “to provide a high level of current income by investing primarily in below-investment-grade fixed income instruments of issuers located around the world, including emerging markets.”
This is a fairly straightforward high yield bond fund with greater flexibility to invest more internationally. Investing outside the U.S. can help provide greater diversification for investors, getting away from “home country bias.” In our previous article on GHY, I had noted how high the correlation was with its U.S. peer, PGIM High Yield Bond Fund (ISD). So despite its global focus, these two had historically shown a high correlation.
The fund’s expense ratio comes to 1.23%; it comes up to 1.56% when including leverage. With higher interest rates coming, their borrowing expenses will increase as well. In 2019, when rates were higher, the fund reported an expense ratio of 2.56%. Given the inflation expectations, rates are expected to be even higher in this round. It can’t be said for sure until it really happens, but that could suggest we see expense ratios on funds climb past those previous 2019 highs. For GHY, they pay interest of 1-month USD LIBOR plus 0.75%.
The fund’s leverage amount being employed is rather modest, relatively speaking. The size of the fund is also coming in at a fair size of nearly $740 million in total managed assets.
Performance – Attractive Discount
If we again compare GHY and ISD, we can see that the more recent YTD returns show ISD pulling away in performance. It isn’t by a significant amount, but I believe it highlights the geopolitical risks at the moment. Both being high yield bond funds means they are susceptible to credit risks.
The exposure to Russia and Ukraine for GHY is minimal, but it seems those aren’t the only countries that investors are worried about.
In this case, what is looking better for GHY is the fund’s current discount. If we look at the longer-term chart, the fund has been at deeper discounts. Pushing around the 15% discount market on several occasions, but bouncing off of those levels fairly quickly. Over the last 1 year, the average discount comes in at 6.99%, providing a 1-year z-score of -2.33.
That’s fairly substantial and has been something we’ve seen happening so far in 2022. Discounts have been widening out considerably from where we were at the end of 2021. Throughout most of 2021, discounts were at historically narrow ranges for the closed-end fund space.
Below is over the last ~10 years, showing that GHY is currently even deeper than its average slightly. They launched at the end of 2012, so it isn’t quite an entire 10 year period we are looking at. That being said, this is why it could represent a fairly attractive time to enter a position at this time. However, higher rates could continue to play a role in keeping the share price and NAV under pressure as well.
Distribution – Trim Could Be Possible
GHY has held its distribution rather steady over the last few years now. They had a series of distribution cuts and then a couple of bumps back up throughout their history. However, the lack of coverage is a concern here.
The last time we touched on the fund, they were showing distribution coverage of 81.3% for the previous 3 month period and a fiscal YTD coverage of 81% with higher leverage. They have deleveraged their portfolio, it would seem, so that could be driving some of the coverage declines. Leverage came in at 26% previously. The latest report at the end of February 2022 shows us a 77.7% coverage ratio and a fiscal YTD coverage ratio of 78.2%.
From their latest Semi-Annual Report, we see a similar lack of coverage in the fund. NII coverage, in that case, was around 88%, which is better. Still, we would like to see NII at over 100% coverage for a bond fund. This would be for the previous six months ending January 31st, 2022.
For tax purposes, there has been some return of capital in their distribution for fiscal 2021.
For the year ended July 31, 2021, the tax character of dividends paid by the Fund were $45,046,004 of ordinary income and $6,518,084 of tax return of capital. For the year ended July 31, 2020, the tax character of dividends paid by the Fund was $51,359,468 of ordinary income. Annual Report
The ROC is expected considering that NII and capital gains weren’t enough in terms of earnings. Being a high yield bond fund, the majority classified as ordinary income would also be expected here. This would make the fund a better fit for a tax-sheltered account.
GHY’s managers can be rather active in managing the fund represented by a higher turnover in some years. Over the last six months, it was reported at 23%. In fiscal 2020, the fund’s turnover rate came to 49%. In fiscal 2019, it was quite elevated at a turnover rate of 96%.
That being said, they have hundreds of positions in their portfolio. At the end of February, they listed 336 positions. This is typical of high-yield bond funds. These are riskier holdings; some of the holdings are in companies that are classified as in default or default imminent with little prospect of recovery. That’s why spreading the portfolio across hundreds of positions can be important. The idea is that hopefully, a minority of the debt holdings you are holding defaults or goes bankrupt while others pay back par as expected.
The trade-off here is that the yields are higher for junk-rated companies. That helps compensate for the fact that there will be defaults in the portfolio. This all brings up another important risk at this time of credit risk. If the economy is expected to slow down due to the Fed raising rates, it could make it harder for these below-investment-grade companies to operate with tighter financial conditions. I would say that it has certainly been weighing on a fund such as GHY on top of the geopolitical risk with its international exposure.
The geographic breakdown of the fund has the largest exposure to the U.S. That is common for most CEFs, even those with a global tilt.
If we look at their last Semi-Annual Report, they listed Russia as a weighting of 0.6% and Ukraine as 0.3% of their portfolio.
Since we last touched on the fund, the U.S. exposure has come down from the 47% allocation. There doesn’t seem to be a specific shift they choose to go with when reducing their U.S. exposure. Most of the countries listed all had a small boost to their allocation, as well as the “other” category.
Taking a look at the top ten, the total exposure comes in at 15.1%. Considering there are 336 positions, these top ten still represent a fairly large weighting relative to the rest of the portfolio. However, we can see how diverse the exposure is by the representation of different sectors and countries.
Ford (F) had previously been the largest position for the fund, but this has now fallen down the list a bit. Petroleos Mexicanos has taken over as the number one position, and Chesapeake Energy (CHK) has also climbed higher. Both were previously positions as well.
High-yield bonds and funds aren’t necessarily the best place to be positioned in the short term if you are an active trader. They have taken a beating with higher interest rates, geopolitical risks and credit risks due to an economy that is expected to slow down. The lack of distribution coverage for GHY could also be playing a role in the current valuation. On the other hand, the deep discount could be providing an opportunity for a longer-term investor, with the understanding that it could continue to be a bumpy ride for the short term. Overall, I would take a pass for now, but it could be a firm hold. I could also see an argument for wanting to take a position now, just in case things rebound from here.