BLW: A Reasonable Choice For Today’s Bond Market, But Watch Its NAV (NYSE:BLW)

The BlackRock Limited Duration Income (NYSE:BLW) is a closed-end fund that income-focused investors can employ as a method of achieving their goals. As is the case with most fixed-income funds, this one has a reasonable 9.53% yield at the current price. This yield is reasonable, but unfortunately, it does not compare very well with other funds that invest in similar assets. We can see that here:

Fund Name	Morningstar Classification	Current Yield
BlackRock Limited Duration Income Trust	Fixed Income-Taxable-Limited Duration	9.53%
Allspring Multi-Sector Income Fund (ERC)	Fixed Income-Taxable-Limited Duration	8.78%
Eaton Vance Limited Duration Income Fund (EVV)	Fixed Income-Taxable-Limited Duration	10.07%
Eaton Vance Short Duration Diversified Income Fund (EVG)	Fixed Income-Taxable-Limited Duration	9.04%
Franklin Limited Duration Income Trust (FTF)	Fixed Income-Taxable-Limited Duration	11.90%
PCM Fund (PCM)	Fixed Income-Taxable-Limited Duration	11.35%

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As we can see, there are quite a few peer funds that boast low double-digit yields. The BlackRock Limited Duration Income Trust’s yield certainly appears to be quite meager by comparison. This is despite the fact that a 9.53% yield is very attractive to any fixed-income investor who remembers the nearly non-existent yields that dominated most developed market economies in the decade following the 2009 recession. The simple fact that the fund’s yield is not the highest available in the peer group is not necessarily the end of the world, however. After all, a very high yield can sometimes be a sign that the market expects that a fund will need to slash its payout in the near future and has already priced the fund for the expected distribution cut. The fact that this fund has a lower yield than its peers could therefore suggest that the market is confident about its ability to maintain the payout going forward. That is something that is obviously very important to any investor who is seeking a safe and secure income to use to pay their bills or finance their lifestyles.

As regular readers can no doubt remember, we previously discussed the BlackRock Limited Duration Income Trust in early January 2024. The market at that time was very different than what we have seen today. In particular, back in early January of this year, many market participants were expecting that the Federal Reserve would cut interest rates by 125 to 150 basis points over the course of this year. That would naturally have caused bond prices to rise and yields to fall, which they did in November and December of the previous year in anticipation of this event. However, since that time, a number of inflation and economic reports have been released that have made the case for rate cuts much weaker. In fact, the first three inflation reports of this year have shown that the inflation rate is actually getting worse:

As we can see, the month-over-month change in January, February, and March shows that the rate of price growth is accelerating. This is exactly the opposite of what the Federal Reserve wants to see to support interest rate cuts. The market has realized this as well, and it has reduced its expectations for 2024 rate cuts. As of right now, the market is expecting either two or three rate cuts this year. As this is fewer than was expected at the start of the year, the bond market has sold off to reflect the new expectations that interest rates will remain higher for longer. The BlackRock Limited Duration Income Trust primarily invests in bonds, so we might have expected it to have sold off as well. This is certainly the case, as shares of the fund are down 2.86% since the last article on this fund was published:

We can see that the BlackRock Limited Duration Income Trust has managed to beat the Bloomberg U.S. Aggregate Bond Index (AGG) over the period, albeit barely. This is pretty much what we would expect from this fund, as short-duration bonds should theoretically be less sensitive to interest rate movements than the bond market as a whole. Therefore, the expected performance of this fund is that it will beat the index during periods of rising rates and underperform during periods of falling rates. Unfortunately, this thesis has not played out as it should over all periods, such as in 2022:

As we can see, the fund’s shares significantly underperformed the Bloomberg U.S. Aggregate Bond Index over the full-year 2022 period. The fund’s net asset value performed better than the shares did, but its net asset value still underperformed the broader market index. This is probably because of the leverage that this fund uses, which we will discuss later in this article.

However, as I pointed out in the previous article on this fund, the share price performance does not accurately reflect how investors in this fund actually did during a given period. To quote myself:

A cursory look at the fund’s share price performance does not really provide an accurate picture of what investors in the fund actually received. This is because bonds deliver a significant portion of their investment return in the form of direct payments to their holders. The BlackRock Limited Duration Income Trust, as with all closed-end funds, pays out all of its investment profits to the shareholders and aims to keep its portfolio value relatively stable over the long term. As such, we need to include the distribution into our analysis to determine the return that investors actually received.

When we include the distributions that the fund paid out over the period since the previous article on this fund, we see that investors received a 0.21% total return. This is quite a bit better than the 2.11% total loss that investors in the Bloomberg U.S. Aggregate Bond Index suffered over the same period:

This return will undoubtedly prove to be a turn-off to potential investors, especially since there were several other things in the markets that delivered respectable gains over the same period. At least this fund did manage to hand investors a profit as opposed to the loss that the broader bond market suffered.

As a few months have passed since the previous article on this fund was published, a few things have changed. Perhaps the biggest of these changes is that the fund released its full-year 2023 financial report so we will make sure to pay special attention to that as part of our analysis. Let us proceed and see if this fund makes any sense to purchase for a portfolio today.

About The Fund

According to the fund’s website, the BlackRock Limited Duration Income Trust has the primary objective of providing its investors with a very high level of current income and capital appreciation. The provision of current income makes a lot of sense given the strategy that this fund is using to achieve this objective. The website explains the strategy:

BlackRock Limited Duration Income Trust’s investment objective is to provide current income and capital appreciation. The Fund seeks to achieve its investment objective by investing primarily in three distinct asset classes:

• Intermediate duration, investment grade corporate bonds, mortgage-related securities, asset-backed securities and US Government and agency securities;
• Senior, secured floating rate loans made to corporate and other business entities; and
• U.S. dollar-denominated securities of US and non-US issuers rated below investment grade.

The Fund’s portfolio normally has an average portfolio duration of less than five years (including the effect of anticipated leverage), although it may be longer from time to time depending on market conditions. The Fund may invest directly in such securities or synthetically through the use of derivatives. No assurance can be given that the Trust’s investment objective will be achieved.

Thus, the BlackRock Limited Duration Income Trust is a bond fund that can invest in both investment-grade and below-investment-grade debt. The latter of these securities are colloquially known as “junk bonds” and typically have a much higher default rate than the typical investment-grade bonds that we are all very familiar with. Bonds and other fixed-income investments deliver an outsized percentage of their total returns via the coupon payments that they make to their investors, which in this case is the fund. These coupon payments serve as a source of income, so the fund’s objective of providing current income works pretty well with its strategy.

However, as I pointed out in the previous article, it is very difficult to justify a capital appreciation objective with a bond strategy:

The fact that the BlackRock Limited Duration Income Trust only invests in debt securities is what makes the fund’s objective of capital appreciation very difficult to achieve on any sort of long-term basis. This is because debt securities do not deliver net capital gains over their lifetimes. An investor purchases a bond at face value and receives the face value back at maturity. Thus, there are no net capital gains because there is no connection to the growth and prosperity of the issuing company. While bonds do change price when interest rates change and it is possible to profit from these changes by trading bonds, these are not really the same thing as common stocks deliver. After all, interest rates cannot go below zero so there is a limit to how high bond prices can actually go. Thus, all the fund can really deliver to the investors is income from the bonds’ coupons and possibly some trading profits.

Over most of the forty-year period from the 1980s until the pandemic, we were in a bull market for bonds as the effective federal funds rate fell from the double-digit levels that were prevalent in the late 1970s until today:

The fund might have been able to deliver long-term capital appreciation over this period as interest rates fell. However, it is arguable whether or not this period could be permanently over. There are various Federal Reserve officials who have mentioned the central bank’s desire to find a “neutral interest rate,” which specifically refers to some rate that provides a small positive real rate of return. As I have suggested in past articles, such as this one, it might not be possible for the nation to return to a very low inflation environment without substantial improvements to the Federal government’s budgetary outlook. The Congressional Budget Office points out that this is going to be impossible without some sort of Social Security and Medicare reform, which will naturally be very unpopular with the American citizenry. As such, it seems highly unlikely that it will be possible to achieve a “neutral” rate that allows for the gains that bond investors experienced over the past forty years. The overwhelming majority of returns from these assets will almost certainly come from coupon payments. As such, it will be difficult for the fund to achieve its stated objective of providing its investors with capital appreciation. It should not have trouble achieving current income, however.

In my previous article on this fund, we saw that the BlackRock Limited Duration Income Trust was heavily invested in floating-rate senior secured loans (“leveraged loans”) as opposed to traditional bonds. That is still the case today:

The fund’s current 45.40% leveraged loan allocation represents a slight increase over the 44.58% that we saw the last time that we discussed the fund. This is not entirely surprising given the year-to-date movements in the bond market. As we can see here, both investment-grade bonds and high-yield junk bonds are down year-to-date:

This is due to the weakened expectations of 2024 interest rate cuts that I alluded to in the introduction to this article. The market has been selling off bonds as part of the repricing for higher interest rates going forward. This has almost certainly caused the price of both the high-yield bonds and the investment-grade bonds that are held by the BlackRock Limited Duration Income Trust to fall over the same period. However, senior secured loans and most collateralized loan obligations do not decline when interest rates rise. Rather, these securities tend to stay remarkably stable in any interest rate environment. Thus, if the fund had conducted no trading activity at all, it should have seen the weighting of these assets increase as a percentage of the total portfolio. We do see this, as the fund’s term loan and collateralized loan obligations are both up since the time of our previous discussion.

Asset Type	Weighting Today	Previous Weighting
Term Loans	45.40%	44.58%
CLO	5.36%	4.87%

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We also see that the junk bond allocation has increased slightly, going from 42.49% to 43.31% over the intervening period. This also makes sense considering that junk bonds have been outperforming conventional investment-grade bonds (which actually saw their weightings decrease over the period).

With that said, it seems very unlikely that the fund’s managers are not actively changing the composition and holdings of the fund. The BlackRock Limited Duration Income Trust had an annual portfolio turnover of 106.00% for the full-year 2023 period, so obviously management is doing a great deal of trading. This fund is, in fact, much more active at changing its positions than some of its peers:

Fund Name	Annual Turnover
BlackRock Limited Duration Income Trust	106.00%
Allspring Multi-Sector Income Fund	42.00%
Eaton Vance Limited Duration Income Fund	201.00%
Eaton Vance Short Duration Diversified Income Fund	231.00%
Franklin Limited Duration Income Trust	104.86%
PCM Fund	20.00%

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(all figures are from each fund’s most recent annual report)

As we can see, the BlackRock Limited Duration Income Trust has a substantially lower annual turnover than either of the Eaton Vance funds, but it engages in more trading activity than any of the other funds that are considered peers of this fund. This is something that could be important to investors due to the simple fact that it costs money to trade bonds or other assets, and these costs are billed directly to the fund’s shareholders. This naturally increases a fund’s expenses and represents a headwind to the fund’s performance.

The BlackRock Limited Duration Income Trust currently has an expense ratio of 3.64%. Here is how that compares to its peers:

Fund Name	Expense Ratio
BlackRock Limited Duration Income Trust	3.64%
Allspring Multi-Sector Income Fund	3.40%
Eaton Vance Limited Duration Income Fund	2.72%
Eaton Vance Short Duration Diversified Income Fund	2.68%
Franklin Limited Duration Income Trust	4.06%
PCM Fund	5.68%

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(all figures are from each fund’s most recent annual report)

The BlackRock Limited Duration Income Trust is quite expensive compared to BlackRock’s own iShares family of exchange-traded funds, but we can see that it is not out of line with its peers.

However, a fund’s expense ratio itself is not nearly as important as its performance after paying the fees. After all, most investors will gladly pay a lot of money in expenses if the fund still manages to deliver higher returns than its peers at the end of the day. In the case of this fund, the cost of owning it seems to be justified. As we can see here, the BlackRock Limited Duration Income Trust has substantially outperformed all of its peers over the past five years:

Indeed, the differences in total return over the period are not even close. The BlackRock Limited Duration Income Trust thus appears to earn its expenses. We should be able to overlook the fact that it is a bit more expensive than some of its peers.

Leverage

As is the case with most closed-end funds, the BlackRock Limited Duration Income Trust employs leverage as a method of boosting the effective yield that it receives from the assets in its portfolio. I explained how this works in my previous article on this fund:

In short, the fund borrows money and then uses that borrowed money to purchase floating-rate loans, high-yield bonds, and other income-producing debt securities. As long as the yield that the fund receives from the purchased assets is higher than the interest rate that it needs to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, which will usually be the case. It is important to note that the use of leverage is less effective today than it was a few years ago when interest rates were essentially negative.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. This is one reason why the fund’s share price and net asset value seem to be somewhat more volatile than we would expect given the nature of its assets. As such, we want to ensure that the fund is not using too much leverage because that would expose us to an excessive amount of risk. I generally prefer a fund’s leverage to be under a third as a percentage of its assets for this reason.

As of the time of writing, the BlackRock Limited Duration Income Trust has leveraged assets comprising 36.98% of its portfolio. This is quite a bit more than the 32.37% leverage that the fund had the last time that we discussed it. This is not surprising considering that the fund’s net asset value has declined 1.14% since the date of our previous discussion:

The decline in net asset value means that the fund’s portfolio is smaller today than it was on January 8, 2024, when we last discussed it. As such, if the fund’s outstanding borrowings remained stable, then they would represent a larger proportion of a smaller portfolio than they did a few months ago. However, the fact that the fund’s leverage increased by more than 400 basis points over the past three months seems a bit high given the 1.14% decline in net asset value. Thus, the fund probably increased its borrowings somewhat over the period.

As mentioned in the quote above, I generally prefer a closed-end fund’s leverage to be under a third as a percentage of its assets. This is simply because the risk of a fund increases with its leverage. However, debt funds such as the BlackRock Limited Duration Income Trust can usually carry somewhat higher leverage than equity funds due to the lower volatility of their assets. Here is how this fund’s leverage compares to its peers:

Fund Name	Leverage Ratio
BlackRock Limited Duration Income Trust	36.98%
Allspring Multi-Sector Income Fund	29.71%
Eaton Vance Limited Duration Income Fund	31.62%
Eaton Vance Short Duration Diversified Income Fund	32.02%
Franklin Limited Duration Income Trust	31.74%
PCM Fund	40.74%

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(all figures from CEF Data)

It appears that the BlackRock Limited Duration Income Trust is a bit more leveraged than its peers. Indeed, only the PCM Fund is currently employing a higher level of leverage. This could be a sign that the fund is using more leverage than it really should be. However, it is not substantially above the one-third level that we would ordinarily prefer, so it is probably okay.

It does not appear that investors really need to worry about the fund’s leverage right now, but we should certainly keep an eye on it, as we do not want the fund’s leverage to increase from the current level.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the BlackRock Limited Duration Income Trust is to provide its investors with a very high level of current income and capital appreciation. It is likely that the overwhelming majority of the fund’s returns will be in the form of current income, however. In pursuit of that objective, the fund invests in a portfolio that consists primarily of leveraged loans and junk bonds, but it can include other income-producing debt-linked securities as its management deems appropriate. These securities deliver a significant proportion of their total return via the regular coupon payments that they make to the fund, which collects these payments on behalf of its own investors. The fund combines these coupon payments with any capital gains that it manages to realize by selling bonds that go up in price. This fund even borrows money to allow it to receive payments from more bonds than it could control solely with its own equity capital. Finally, it pays out all of the money that it collects from these sources to its own shareholders, net of its expenses. When we consider the yields that are currently available on most below-investment-grade loans and bonds combined with the beneficial effects of leverage, we can assume that this business model would result in the fund’s shares having a very high yield.

This is indeed the case, as the BlackRock Limited Duration Income Trust pays a monthly distribution of $0.1079 per share ($1.2948 per share annually). This gives the fund a 9.53% yield at the current price. As we saw in the introduction, this yield is decent but still well below that of some similar funds. This fund has also not been especially consistent with respect to its distribution over the years. As we can see here, the fund has both reduced and raised it several times:

The fact that the fund’s distribution has exhibited such considerable volatility over time could be something of a turn-off for those investors who are seeking to earn a safe and stable income from the assets in their portfolios. However, the recent trend has been positive, as the fund increased its distribution back in October 2023 following an increase in October 2019. The fund did not reduce its distribution in response to the pandemic or the severe sell-off in bonds that occurred back in 2022. Thus, over the past three years or so this fund’s distribution history has been better than that of many other bond funds. This is probably because of the floating-rate securities that are held by this fund, as these actually benefited when the Federal Reserve raised interest rates back in 2022.

As I have pointed out in the past, the fund’s distribution history is not necessarily the most important thing for any investor who is considering taking a position in the fund today. This is because today’s buyer will receive the current distribution at the current yield. This individual will not be affected by any actions that have occurred in the past. Thus, the most important thing for our purposes today is how well the fund can sustain its current distribution.

Fortunately, we have a very recent document that we can consult for the purposes of our analysis. As of the time of writing, the most recent financial report for the BlackRock Limited Duration Income Trust is the annual report that corresponds to the full-year period that ended on December 31, 2023. This is a newer report than the one that we had the last time that we discussed this fund, which is nice because it should give us a good idea of how well the fund did in the volatile market that dominated 2023. As we can all remember, the first half of the year generally saw rising bond prices and falling yields as various market participants attempted to position for the pivot that they were expecting during the second half of the year. As the year progressed into the summer months, it became very obvious that there would be no 2023 pivot, and bonds sold off. While the first half of the year could have given this fund the potential to realize some capital gains, the rising yields of the summer almost certainly resulted in it taking some losses. Eventually, the fund may have had the opportunity to offset these losses during the final two months of the year, when bond prices shot up on expectations of a series of interest rate cuts in 2024. This report will give us a good idea of how well the fund managed to do during all three of these periods and, most importantly, how well it covered its distributions.

For the full-year 2023 period, the BlackRock Limited Duration Income Trust received $1,042,876 in dividends and $55,878,128 in interest from the assets in its portfolio. When we combine this with a small amount of income from other sources, we get a total investment income of $57,291,524 for the full-year period. The fund paid its expenses out of this amount, which left it with $39,521,697 available for the shareholders. This was, unfortunately, not enough to cover the distributions that the fund paid out during the period. Over the course of the year, the BlackRock Limited Duration Income Trust paid out $43,089,203 to its investors. At first glance, this is likely to be concerning, as we would ordinarily prefer that a fixed-income fund fully cover its distributions out of its net investment income. This fund obviously failed to accomplish that task.

However, the fund does have other means through which it can obtain the money that it requires to cover the distributions. For example, it might be able to exploit the fact that bond prices rise when interest rates fall to earn some capital gains profits. Realized capital gains are not considered to be income for tax or accounting purposes, but they obviously do result in money coming into a fund that can be paid out to the investors.

The fund actually did manage to have some success at earning money via these alternative sources over the period. For the full-year 2023 period, the BlackRock Limited Duration Income Trust reported net realized losses of $24,227,242, but these were more than offset by $48,977,568 net unrealized gains. Overall, the fund’s assets increased by $21,182,820 after accounting for all inflows and outflows during the period. Thus, the fund technically did manage to cover all of the distributions that it paid out during the full-year period. This is encouraging.

However, it is important to keep in mind that the fund only managed to cover its distributions due to unrealized capital gains. As we are all well aware, unrealized capital gains can be erased by any market correction. If this could happen, it will naturally change the fund’s prospects.

Unfortunately, the fund has not managed to cover the distributions that it has paid out this year. This chart shows the fund’s net asset value since December 31, 2023:

As we can see, the fund’s net asset value per share has declined by 1.35% year-to-date. This tells us that the fund has paid out more this year than it has managed to earn from its investment portfolio. We should therefore keep an eye on this fund’s net asset value going forward. The market is still expecting 50 to 75 basis of interest rate cuts this year, and there is a very real risk that continued high inflation will prevent those cuts from materializing. That would undoubtedly cause bonds to decline further and put further pressure on this fund’s net asset value. Thus, there could be a risk that it will not be able to sustain its recently increased distribution.

Valuation

As of April 23, 2024 (the most recent date for which data is currently available), the BlackRock Limited Duration Income Trust has a net asset value of $13.87 per share, but the shares currently trade at $13.46 each. This gives the fund a 2.96% discount at the current price. This is substantially higher than the 0.43% discount that the fund’s shares have had on average over the past month. Thus, the current price appears to be reasonable for anyone who wishes to add this fund to their portfolio today.

Conclusion

In conclusion, the BlackRock Limited Duration Income Trust is an interesting fund that should theoretically be able to hold up better than most bond funds in the event that interest rates remain high for longer than the market expects. This is a very real risk right now, as some Federal Reserve officials have stated that interest rate hikes could be possible. The fund is mostly invested in floating-rate assets such as leveraged loans and collateralized loan obligations that should hold their value just fine in such an event. Indeed, the biggest concern here is that the fund has failed to cover its distributions year-to-date.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.