IVH CEF: moving from the sell price to the conservation price


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Thesis

Ivy High Income Opportunities Fund (NYSE: IVH) is a closed-end fund focused on US high-yield bonds and leveraged loans. The fund takes on significant credit risk, as the entire portfolio is rated B or CCC. We wrote a article at the end of last year by awarding the fund a To sell rating based on the upcoming monetary tightening cycle and low absolute levels of credit spreads. The fund is down more than -15% since our rating with the duration matched to 3-year Treasury yields having risen more than 150 basis points (1.5%) since the start of the year. Credit spreads also widened slightly due to the Ukraine conflict and duration avoidance by market participants. We believe that most of the rate movement is now behind us. So we go from To sell for Hold on IVH, from the perspective of a pure short seller where the trade is now more likely to give up gains already made.

Performance

The fund is down more than -15% in progress since our rating:

IVH fund rating

Note (Looking for Alpha)

If we take into account the fund’s dividend yield, the total return since our rating rises slightly to -12.21%, a still very disappointing performance which represents almost two years of dividends. It is still extremely important, even when dealing with buy and hold instruments, to trade the macro environment – i.e. lighten positioning during monetary tightening environments and, conversely, to overlap exposure during a recession.

Year-to-date, the fund has underperformed the unleveraged junk bond ETF JNK:

YTD performance of the IVH fund

Cumulative performance since the beginning of the year (in search of alpha)

The underperformance is due to the leverage built into the CEF which works to amplify returns both upside and downside. Although the fund has a low duration of around 3.3 years, 3-year Treasury yields have risen more than 150 basis points since the start of the year, contributing to a strongly negative performance for IVH .

Interest rate environment

The 3-year point of the yield curve is now very close to 3%:

U.S. Treasuries 3-Year Yield

3-year yields (the Fed)

We can see from the above chart of 3-year CMT rates that we are approaching the highs seen in 2018 and some of the highest levels in over a decade for this point on the curve. The movement was brutal and violent – if we look at the graph and the slope of the upward curve, we realize the violence of the revaluation of rates in the market. Nobody wants to be caught behind the bond move, so the market has been very aggressive in pricing the next steps for the Fed to take.

Some banks are even now posting Fed Funds rates close to 4%:

nomura rate prediction

Nomura Rate Prediction (Nomura)

While the OIS curve only implies a rate a little north of 3% for Fed Funds, Nomura has now published a research paper where they see rates approaching 4%. We think this is far-fetched and more about getting attention by being the outlier bank with the most aggressive rate call. We reiterate our position that we see rates returning to 2018 highs with a very busy schedule, but we don’t think we’ll go much further than that. We see an aggressive Fed this summer followed by a very slow tightening schedule and a “wait and see” attitude from the Fed in terms of the real economic impact derived from higher rate levels.

Assets

The fund has a below-average credit distribution, with most of the underlying credit names falling into the B and CCC tranches:

IVH credit quality

Distribution of credit (IVY)

The fund invests mainly in bonds. The fund is not a pure bond vehicle, however, with a 34% allocation to leveraged loans:

IVH fund portfolio

Wallet (IVY)

The fund doesn’t disclose much else in terms of industry concentration, seniority, and privileges for the leveraged loan portfolio, so it gets a minus from me for this extreme opacity. It shows a very high annual turnover of assets:

IVH fund portfolio

Portfolio Features (IVY)

The fund therefore has a high-risk credit composition, with most names in the riskier high-yield categories and leverage leading the way.

Conclusion

IVH is a closed-end fund focused on high yield bonds and leveraged loans. Although the fund has a short duration of 3.3 years, it was nevertheless significantly affected by the violent rise in rates this year against the backdrop of the hawkish Fed. With 3-year Treasury yields up more than 150 basis points in 2022, the fund posted a negative return of more than -15%. We think most of the rate movement is now over, with the start of the curve approaching highs not seen since 2018. So we are moving from To sell for Hold on the fund.

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