Monday, September 17, 2012

Income expert eyes Nuveen Floating Rate

Nuveen Floating Rate Income Fund (JFR), a closed-end fund, invests nearly 90% of its $700 million portfolio in adjustable-rate senior, secured loans to mostly private companies.

JFR holds some 220 positions. The bulk of these loans are sub-investment grade, with 31% rated BB and nearly 51% rated B, for an average credit rating of B+.

About a third of the portfolio value is leveraged to juice returns. The fund makes money by borrowing at low short-term rates and using the borrowed money to invest in higher-yielding, floating-rate loans.

These loans reset every 60 to 90 days and are pegged a couple of percentage points above a short-term benchmark.

The Fed's announcement in January that it was prepared to keep its short-term target interest rate at "exceptionally" low levels until late 2014 would be expected to adversely affect profit margins on the fund's floating rate investments.

However, the fund's borrowing costs for the 13 weeks ending January 31, 2012 averaged 0.06%. Meanwhile, the loan portfolio carries an average coupon rate of 4.0%, according to Morningstar data.
Distributions are made entirely from investment income and not supplemented by return of capital or capital gains. The current rate equates to $0.82 annually, for a forward yield of around 7%.

Management fees, interest and other expenses of 1.21% of the annualized net asset value take a thin slice off total returns. Distributions are taxable at your marginal income tax rate, so this fund is best held in a tax-sheltered account.

With a portfolio of sub-investment grade loans, the fund's returns can be volatile. In the credit crisis of 2008, when risk-averse investors lost interest in subprime corporate lenders, the portfolio value plunged. The fund lost 42.1%, versus a loss of 37.0% for the S&P 500.

But the rebound was sharper, as the fund gained 84.0% in 2009, more than threefold the benchmark index's 26.5%.

A strong rebound in the speculative debt market -- as the economy has improved and default rates declined -- has led to JFR's robust returns of better than 12% over the past three months.

Looking ahead, management is forecasting that the default rate for its loans over the next year will stay below the long-term average of 3.78%.

Currently trading at a discount of 2.1% to its net asset value, near its 52-week average discount of 2.5%, the fund is attractively priced for new money.

Action to Take --> JFR has continued to raise its distribution, and the recovering U.S. economy provides a favorable outlook for its speculative loan portfolio.

If you can withstand the volatility, Nuveen Floating Rate Income Fund offers a nice monthly 7% yield, even if no distribution increases were to take place this year.

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