There was a time when investors who needed income could play it safe by purchasing bonds with attractive yields that were rated investment-grade for credit quality. They didn’t care about stock market gains. The idea was to preserve capital and live off the income.
But that style of income investing hasn’t worked for some time — bond yields are too low. This chart shows how yields-to-maturity have changed for U.S. corporate bonds, high-yield (or junk) bonds and 10-year U.S. Treasury notes
over the past 20 years:
Even the Bloomberg U.S. High Yield Corporate Index is yielding only 4.87% — the spread above the investment-grade ICE BofA U.S. Corporate Bond Index is a mere 252 basis points for all the extra credit risk investors are taking.
Meanwhile, even junk-bond yields won’t help you stay ahead of inflation, with the consumer-price index increasing 6.2% for one year through October.
A whole generation of income-seeking investors hasn’t experienced inflation this high since the 1980s. But irrespective of inflation, the long decline of interest rates and bond yields (aside from the spikes on the chart) has forced many income-seekers to branch out into other securities types, including preferred stocks, most of which have yields well below 5% these days, common stocks, real estate investment trusts, energy partnerships, business development companies and even equity funds that follow covered call option strategies to produce monthly income.
There are more complex investment vehicles through which institutional investors and sophisticated high-net-worth individuals have been able to enjoy higher yields for decades. Some of these vehicles are now being opened up to just about any investor.
One type of income investment you may not have considered or heard about is an interval fund. Examples of interval funds include the Pimco Flexible Credit Income Fund and the Nuveen Enhanced High Yield Municipal Bond Fund.
Today we will focus on the First Eagle Credit Opportunities Fund. The fund is managed by First Eagle Alternative Credit, a unit of First Eagle Investment Management. First Eagle Alternative Credit has about $20 billion in assets under management, including about $180 million in the First Eagle Credit Opportunities Fund, which was established in September 2020. The parent company, First Eagle Investment Management, is based in New York, with about $109 billion in assets under management.
During an interview, Andrew Park, First Eagle’s senior alternative strategies director, and J. Christian Champ, the firm’s managing director of tradable credit, described its structure and investment style.
An interval fund is a closed-end mutual fund that buys back shares only during specific intervals. Shares of the First Eagle Credit Opportunities Fund aren’t traded on public exchanges, and purchases or sales take place at the close of business, at the net asset value (NAV).
A fund’s NAV is simply the sum of its assets divided by the number of shares. A traditional open-ended mutual fund isn’t publicly traded either, and investors can buy or sell at NAV at the market close every business day. This means the manager of an open-ended fund has limited investment choices because a relatively high level of liquidity is needed to handle daily redemptions.
An interval fund sets intervals (time periods) during which shares can be sold back to the fund manager and the number of shares it is willing to redeem during any interval. This makes it possible for the manager to go for higher yields by participating in less liquid markets.
The First Eagle Credit Opportunities Fund has a 21-day repurchase window each quarter, when it will buy back up to 5% of shares outstanding, assuming shareholders request that level of redemptions. If the shareholders as a group request to redeem more than 5% of shares outstanding, their requests will be pro-rated.
So this is a less-liquid type of income investment than most noninstitutional investors are used to. In return for giving up daily liquidity, the investors get a monthly stream of income. The fund’s annualized distribution yield as of Sept. 30 was 7.11%.
Many interval funds are available only to “accredited investors,” as defined here by the Securities and Exchange Commission. But the First Eagle Credit Opportunities Fund is available to all investors, with account minimums depending on the share class. Shares can be purchased through registered investment advisers who clear through Charles Schwab, TD Ameritrade, Fidelity Investments or Pershing, and also directly by individuals at TD Ameritrade and Fidelity Investments.
Park said: “We believe this is a core alternative income solution as investors seek non-traditional income-oriented investments.”
How the high yield is achieved
The First Eagle Credit Opportunities Fund has two “credit sleeves,” according to Park — a more liquid sleeve that includes publicly traded securities and cash equivalents, to be ready for redemptions, and the illiquid or private sleeve. And that’s where the opportunity lies for investors who otherwise wouldn’t be able to participate in a lucrative area of lending.
The fund lends to private-equity firms to finance acquisitions. The loans typically have seven-year maturities. However, they are usually paid off early, according to Champ. He said that in the new regulatory environment following the 2008 credit crisis, alternative lenders have stepped in to fill a void left by banks. He described “a true partnership” between First Eagle Alternative Credit and the private-equity borrowers that allows for quick execution of new credit arrangements.
“With a bank, it may be a six- to nine-month process,” he said. There are repeat credit arrangements with the same borrowers, “so we have already underwritten the businesses,” he added.
The speed of execution enables First Eagle Alternative Credit to set relatively high interest rates for the loans.
Champ also said the fund managers avoid overconcentration in any one industry. “When credit funds underperform, they have usually been over-focused on a segment,” he said, naming the energy and media industries as examples.
He also said the First Alternative Credit team focuses on industries or products that “need to exist” and have long-term pricing power. Examples include health care and business services, such as plumbing and HVAC.
The current high-inflation environment may lead to much higher interest rates over the next few years. Champ explained that if interest rates rise, the fund’s yield will adjust accordingly because of “rate floors” to the indexes upon which its loans’ interest rates are based.
Aiming for the best of two worlds
Park said the First Eagle Credit Opportunities Fund can appeal to investors who need more income than what is provided through the most liquid channels, such as bond funds and preferred stocks, but who haven’t considered making the jump to riskier vehicles with very high yields, such as business development companies, which can be highly volatile and can take high risks with junior-lien positions when making loans.
Champ said most of the First Eagle Credit Opportunities Fund’s credit positions are first-lien.
Investors who are willing to give up daily liquidity and make a multiyear commitment in return for a high level of monthly income should consider interval funds, including the First Eagle Credit Opportunities Fund.