Co-authored by Treading Softly
I’ve never been known as one who is extremely popular. It may be, but I’m not the most outgoing or the most verbose person you’ll ever meet. When I was young, I didn’t have a massive group of friends – I had maybe three or four friends that I considered to be extremely close with.
To my credit, however, I do believe that these experiences led me to understand that just because something is popular does not mean that it’s effective for your goals and that just because something is misunderstood does not mean that it should be avoided or ignored.
Back in 2021, investors were piling into debt investments. We saw many bonds that were trading with yields-to-maturity below 3%. Some even had negative YTMs, meaning that an investor who held until maturity was guaranteed to have a loss! Even in the “high yield” ballpark, where I frequently seek income opportunities, prices were high and yields were relatively low. Everyone wanted to own debt. Floating-rate, fixed-rate, high yield, low yield, it was all being bid up in the market.
Now that interest rates have climbed to sky-high levels and investors are leaving in droves from the fixed-income sector, debt investments have become more attractive to me and those who are willing to buy against the popular cycle. You can find investment grade bonds with what used to be considered high yields simply because Treasury notes are currently trading hands at 4% to 5% yields, something that many investors never thought they’d see in their lifetime again. If you take more risk than a Treasury note, you can lock in much higher yields for the long haul and be rewarded with strong capital gains when those bonds mature at par.
Today, I want to look at a fund that is buying actively while others are selling. Senior secured loans to corporations that are just a notch or two below investment grade are trading at 10%+ yields. The CLO (collateralized loan obligation) vehicle offers a way to invest in this sector of the market and receive an extremely high yield.
I’m happy to be long this fund and enjoying the massive income that comes from it, because of their willingness to do exactly what I would be doing – buying the dip.
Let’s dive in!
Keep Buying As It Keeps Growing
Oxford Lane Capital (NASDAQ:OXLC), yielding 19.5%, has been a very active buyer of CLO equity positions since COVID. This quarter was no different, with a net investment activity of $160 million. Source
$104.8 million of the capital for this came from issuing shares at a premium to NAV, the rest came from cash.
OXLC’s equity portfolio has grown from $1.6 billion to over $1.9 billion over the past year at the original cost. This is more than double what OXLC had in September 2019: Source
OXLC has funded this growth without having to take out debt or new preferred equity. As a result, OXLC’s balance sheet has become stronger over the past year. Last year, preferred plus debt was 0.62x equity, today it is 0.49x.
OXLC owns more assets, is carrying less leverage, and is earning an outstanding yield on its holdings.
When looking at the yields that OXLC is earning on its positions, we would put the most weight on the “effective yield”. Effective yield includes assumptions that some borrowers will default, while the “cash distribution yield” is the yield based on actual cash received during the quarter.
The cash coming into OXLC is immense relative to their cost basis, which is why OXLC has been able to pay such an enormous dividend and still retain cash for reinvestment.
Many have worried about NAV for OXLC, as it has been falling all year. Yet in a single quarter, OXLC saw its NAV jump over 10% and it is now up year to date.
Meanwhile, the underlying loans in OXLC’s CLO positions are still trading at a hefty discount to par value.
As loans repay at par, this creates substantial capital upside potential for OXLC’s CLO positions. OXLC has been backing up the truck and buying more CLO equity while prices have been low. This is going to be a great benefit to shareholders as interest rates stabilize and the prices of all debt start to recover.
Many authors on seeking alpha love to hate OXLC, simply because they misunderstand its overarching purpose. OXLC does not exist to best the SP500 (SPY). It doesn’t exist to be a non-volatile price-wise investment. It exists to leverage the credit markets that exist underlying the entire U.S. economy and provides massive levels of income in doing so.
The best ETF to compare something like OXLC to would be a senior loan fund – like Invesco Senior Loan ETF (BKLN). The reason is that OXLC and the CLOs that it holds are leveraged bets on senior loans. When we make that comparison, we can see that the volatility within OXLC vastly exceeds the volatility seen in an ETF of this nature, yet its returns also vastly exceed that as well.
The yields that we are currently seeing on senior loans are exceptional and highly attractive. Yet partially, they are generated this high because investors have left the sector, selling them off at a discount to their par value. OXLC is a rapidly growing fund because they are issuing shares to be able to buy more of this debt at a deeply discounted price. In doing so, they are able to provide me with massive amounts of income pouring into my account. It does not take a large holding in OXLC to see a massive boost in your income.
When it comes to retirement, you don’t need to be popular to have a successful retirement. You can be misunderstood and live the best life possible. I want you to have a retirement that you enjoy because it meets you where you are. I’m not looking for you to have a cookie-cutter retirement that looks like everyone else’s. What I want you to have is the income flowing into your account from the market that allows you to enjoy a retirement that meets you where you are and allows you to enjoy your retirement your way. That’s true financial freedom.
That’s the beauty of my Income Method. That’s the beauty of income investing.
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