XFLT: A Powerful Engine For Yield Income – XAI Octagon Floating Rate & Alternative Income Term Trust (NYSE:XFLT)

The XAI Octagon Floating Rate & Alternative Income Term Trust (XFLT) could use some rebranding. With a lengthy name like that and an even more complicated business model and investment structure, no wonder it is relatively under-appreciated in the marketplace.

Investment Strategy

For those unfamiliar with leveraged loans, this is perhaps not the best investment. However, for those willing to stomach the volatility or feel that the yield is too attractive to pass up, read on.

XFLT’s portfolio, as of the end of July 2019, was comprised of 41% senior secured first lien loans, 33% CLO equity, 14% CLO debt, 7% secured second lien loans, just under 1% high yield investments, and 4% cash and equivalents. There are 164 holdings in the fund with an average price of 89.35% of par value and an effective maturity of just under 8 years.

Share Price And Dividend Yield

Interestingly, XFLT has traded at times at a premium to NAV, and at times at a discount to NAV (see below figure). Amidst the late December market selloff, XFLT could have been picked up at quite attractive prices in the $7 / share range.

Even at today’s levels in the $9 / share range, the distributions paid on a monthly basis represent a nearly 10% payment for investors. Investors may also be attracted to the fact that XFLT has increased its monthly distribution since inception and that more increases are possible along the way.

Investors considering exposure to XFLT should certainly review the company’s quarterly webinar materials. The webinar presentation offers some more context on how XFLT is a unique vehicle, offering public markets’ investors exposure to CLOs in a broadly diversified portfolio:

Other Ways To Get Exposure To Loans

Other vehicles exist where investors can gain exposure to different types of loans in the public markets. However, it is important to note that the below vehicles offer investors exposure to senior loans (bank loans) and that the leveraged loan exposure offered by XFLT represents a credit class with a potentially riskier profile (hence the higher yield).

• Invesco Senior Loan ETF (BKLN) has $4.4 billion in total assets and yields 4.9%
• SPDR Blackstone/GSO Senior Loan ETF (SRLN) has $2.0 billion in total assets and yields 5.4%
• First Trust Senior Loan Exchange-Traded Fund (FTSL) has $1.6 billion in total assets and yields 4.5%
• Highland iBoxx Senior Load ETF (NASDAQ:SNLN) has $230 million in total assets and yields 5.1%

There are not too many ways to play this theme in the public markets, hence XFLT’s status as a unique investment vehicle for public markets’ investors.

Risks

A significant chunk – nearly 75% as of June 30, 2019 – of XFLT’s portfolio is not easy to diligence. As per a recent public filing with the SEC, approximately 74.99% of XFLT’s net assets as of June 30, 2019 – $59,005,928 in estimated value – are securities exempt from registration with the SEC under Rule 144A of the Securities Act of 1933. There is a risk that these securities are marked higher than their true long-term value on XFLT’s books.

There is also a risk that in a macroeconomic downturn, leveraged loans and CLOs in XFLT’s portfolio do not perform up to the standards to which the investment managers at XFLT have underwritten them. In this event, which some believe is on the horizon after a long bull market, XFLT could pose a significant and permanent loss of capital for investors, so this investment is certainly not without its risks. There is no free lunch for a 10% yield!

Finally, investors should note that a significant chunk of their capital is being eaten away by fees – the annual expense as a percentage of the assets XFLT manages is just under 3.5%, while the annual expense as a percentage of net assets attributable to common shares is just under 5.2%. This is not insignificant and, while investors may consider it justifiable given the attractive dividend yield, should be aware that they are compensating XFLT management quite handsomely. (The full breakdown of this fee can be found on the XFLT website linked above).

Conclusion

XFLT represents a unique investment opportunity for retail investors and other parties to gain exposure to the CLO market as a part of their broader asset allocation strategy. Yield-oriented investors might consider XFLT to be part of their portfolios, but should be aware of the risks outlined above. Good luck.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.