XAI Floating Rate & Alternative Income Trust (XFLT) Earnings Call Transcript & Summary

Welcome to the XAI Octagon Floating Rate & Alternative Income Term Trust quarterly webinar. My name is Robert Chenoweth, Product Specialist at XA Investments, and I will be your moderator. In today's webinar, we will provide a third quarter update for XFLT and take questions from the audience. But before we begin, there are a few disclosures I'd like to make you aware of. The information discussed today does not constitute investment tax, legal, regulatory or accounting advice. This information should not be considered as an offer to sell or buy any security. Investors are advised to make an independent review before purchasing or selling. Investments can carry a risk of loss and past performance does not guarantee future results. All right. Very good. So a little bit before we begin. Registrants will receive a link to the replay following the webinar. I'll send that to the e-mail you provided when you registered. You can also resource additional information on our website at xainvestments.com under the Knowledge Bank tab. During this webinar, you'll be able to submit questions through the Q&A tab, we've changed over to Zoom. So it's a little different this time. You'll see it at the bottom of your webinar screen. So that's the Q&A tab. We may not be able to answer all the questions, but please feel free to reach out to us after the webinar. We'll share our contact info towards the end. So -- all right. So we are joined today by Gretchen Lam from Octagon Credit Investors. Gretchen joined Octagon in 1999 and is a member of the Octagon Investment Committee and serves as a senior portfolio manager across CLOs and oversees the firm's structured credit investment strategies. We're also joined today by Kimberly Flynn. Kim is a founding partner and Managing Director at XA Investments, responsible for all product and business development activities. Before this, Kim was Head of Product Development at Nuveen, leading their global Structured Products group. So we have prepared questions and topics today to discuss on the webinar. These are all relevant to XFLT and the bank loan and CLO market. These topics will correspond with the slides we use today. There'll be a replay as well as availability for the presentation for you to download soon after the webinar, and I'll include all of that in my e-mail. All right. So before we begin, just a quick intro into Octagon. Octagon has focused on below investment-grade credits since 1994 with assets under management of $33.2 billion. Their investment process is rooted in fundamental credit and relative value analysis. They are an experienced team with a track record exceeding 25 years, and they are a leading institutional credit investor. So with that, I will go ahead and hand it over to Kim for the next part of the webinar. Kim?

Thanks, Robert. One thing that we're doing different this quarter based on requests that we've had from investors and research analysts is to spend a little bit more time covering the financial highlights. We're going to get into this in today's webinar, and we've got a detailed question in the Q&A. So if you'll give us a moment to cover some of the basic fund overview and set the stage, we'll circle back to financial highlights. So let's start with the overview and the top 10 holdings. If you have been part of our webinars in the past, you'll see that the top 10 holdings remain invested in CLO equity. The asset allocation of the fund remains in a similar asset mix since the inception of the fund, while there are opportunities to move around when Octagon sees opportunity, largely the strategic mix stays the same. The fund ended the quarter of 9/30 with total managed assets of about $389 million. Average daily trading volume was $172,000. We did see the funds average daily volume decline in the summer months and into the fall. I think just with the risk off stance, investors moving to the sidelines that ultimately affected some of the trading volume in the closed-end fund market, and in particular, in our fund. The regulatory leverage stands at 41.82%. Average cost of leverage is slightly higher this quarter. Recall that the fund's assets and liabilities are both floating rate. That's important for the positioning of the fund. And so while leverage costs are higher, the fund's yields have moved higher as we've seen changes in LIBOR and SOFR this period. We have seen NAV declines in the quarter. We're going to talk about that. We always remind investors, when investing in CLO equity, the biggest risk is the mark-to-market volatility associated with owning these shares. You want to be a long-term investor in CLO equity because you want to be able to navigate various periods of volatility in the market, just like we've experienced since the Fed started raising rates earlier this year. We've seen a lot of that volatility and that has created a lot of downward pressure from the NAV of the fund. We're going to talk a little bit more about what that means for investors, but I just want to remind you all that the fund is earning its distributions. We pay a distribution rate on NAV of 13.71%, which we have an income-based distribution policy. And so it's important to bear in mind that the income generation potential of the fund is going to differ from the stated total returns and that's because of those mark-to-market valuation declines associated with the CLO -- equity and CLO debt positions, in particular, in the fund. And we'll talk about more why that is important to understand. So moving on, as I mentioned, composition has really remained fairly steady. You see here over the last 4 quarters, we haven't seen a big shift in terms of the loan. Generally speaking, the fund has about 50% in loans and about 50% in CLO equity and debt, and we would expect that strategic mix to stay the same into next year. Let's talk a little bit about net returns. So this is, as I was mentioning, previewing the NAV returns here. When we show total returns, we include NAV and any distributions that have been paid to shareholders. And NAV declines as we've observed in the CLO debt and equity market this year are going to impact total return in a negative way. These are largely unrealized losses associated with price changes. One benefit of transparency that XFLT provides to investors is that we do have a daily NAV. It does introduce additional volatility, but we think that the transparency is important. And so while you're going to see market moves show up in the daily NAV of the fund, you also -- that's a good thing. We want to know where the market is moving. But as we talked about with CLO debt and equity, investors buy CLO debt and equity because they're cash flow producing investments. And you want to hold CLO debt and equity over a cycle because you are going to have periods of time where the valuation done by third parties, in this case, market with an eye does third-party valuation of the fund's investments, is going to mark down the assets. And a lot of that reflects the current state of the capital markets concerns about inflation, concerns about -- recessionary concerns. And so that's why we've seen the NAV decline in XFLT. We ended the quarter at $6.39. And this time last year, the NAV of the fund was at $8.19. So you can see that's a big move down from $8.19 to $6.39 as I mentioned, largely reflecting these pricing changes, which are unrealized losses. Now we can't predict what the future will hold, but we have seen this pattern before in funds like ours that invest in CLO debt and equity. And as you see strength return to the economy, the pricing tends to improve. And so that's why it's important to underscore the nature of these NAV changes that are attributable to pricing and unrealized losses. Let's move on now and talk a little bit about price performance. In the secondary market, the fund has continued to trade well. In the quarter, we did see the fund move to a slight discount which is atypical for XFLT. It's been a couple of years since we really saw a discount. The fund has moved back to a premium of about 3% in line with the inception to date average premium. But I think that does just reflect the concerns in the overall market. And frankly, people moving to cash, liquidating positions that are liquid, XFLT being traded on the NYSE and having a daily NAV just like many other liquid investments, we did see some selling in the period, which pushed the fund to a slight discount. But we've seen that buyers come back into the fund and have moved the fund to a slight premium. Just a little bit about the price and NAV history. We plot price and NAV next to S&P 500, just to show in terms of when we do start to see like as we observed in the last quarter, some recovery in the S&P 500, you do see the price follow generally that line. Now the NAV does somewhat a little less so. We haven't seen a lot of movement up in the NAV. So the expectation is that NAV recovery is ahead of us, not behind us, and you see that in the green line. And so I won't predict the future, but this gives you a sense of where we've been in terms of the high low. I mentioned this time last year, the NAV was $8.19, and the price was $8.58. So an altogether different sort of economic environment in terms of the way people felt about the markets and that does then get reflected in terms of the secondary market in terms of price for the fund. We've seen a lot of action in terms of the Fed this year. The Fed has raised rates by 375 basis points. A lot of that happened in the period here that we're reporting on. Most recently, the Fed raise rates again on November 2. Now I think there is some news and potentially, we may see some less aggressive Fed movements in the future, which the market responded to in a very positive way yesterday in the trading day. But 1 thing I want to point out in the lower right-hand corner is just the radical shift from last year at this time. I guess we're just showing 3/31 relative to November 25, but you can see how much 1-month and 3-month LIBOR have moved up. 1 month LIBOR now stands at 4.73% and 3-months is it at 4.05%. So very different place that we find ourselves in terms of where the risk-free rate is. Let's move on now a little bit. I mentioned earlier the volume kind of in the last 4, 5 months has been lower than we had seen in the sort of healthy markets of 2021. Nothing else to observe here. In terms of scale efficiencies, XFLT, we've been really on a mission to grow the fund, improve fee economies, and frankly, the trading volume has been a sign of overall health and wellness. We want buyers and sellers to have an active secondary market by which to trade if they so desire. So this has been something that we're really proud of in terms of scaling the fund over the last 5 years. We did just celebrate the fund's fifth anniversary. We plan to continue driving those fee economies and scale efficiencies into the future. And this will be potential opportunity for us to continue growing the fund in an accretive way for shareholders. Everything that we've done on our -- at the market and our overnight have been accretive. And that's the plan for the future as well. Leverage sources. This has been kind of the topic -- hot topic of the last few months is a lot of closed-end funds which have fixed rates have been suffering as leverage costs have increased. Now as I mentioned, assets and liabilities here, both floating rate. And so the fund is well positioned in a rising rate environment. We did observe the average cost of leverage in the third quarter increased. You'll see that on the top line, bank borrowings went up from 1.91% in Q2 to 3.41% this quarter. We do have the benefit of our preferreds that are fixed rate, and the benefit is that it gives us a lot of flexibility. Given the longer life of CLO equity, having this mix of leverage really sets XFLT up. It also is a source of differentiation for our fund relative to our competitors that invest in CLO equity because the fund has a diversified mix of loans and CLOs. The loans are what allow us to achieve bank borrowings at such an attractive rate of borrowing, and that brings the overall fund level of leverage to about 4.37% for the quarter end. Now I'll end on a high note, which is distributions, and then I'll turn it over to Robert and Gretchen to get more into the CLO market and the loan market. But we're really proud that the fund has continued to pay steady distributions every month. This is 25-level distributions. And we are paying net investment income. We have an income-based distribution. From period to period, you may see a small return of capital, but that all shakes out, if you look at the funds, distributions over the course of the year. And that's -- our aim is to deliver those steady distributions. And right now, as of November 25, the most recent distribution rate was 13.23% based on the market price of $6.62. I will note that these levels, this 13% level is elevated relative to the history of our fund, but part of that is because of these depressed prices in NAVs that we're observing in XFLT relative to its own price in NAV history. So I'll turn it back to you, Robert, and we'll go from there.

Great. Thank you so much, Kim. Great job. Gretchen, you are up. So we'll start with some of our prepared questions here, the first 1. Loan market volatility has continued on the heels of slowing economic growth, rising rates and recession concerns. Can you give us some insight into what you were seeing in the loan market?

Sure. Thanks, Robert, and thanks for those of you on the phone today. Loan prices were down about 0.25 point in the third quarter to just under $0.92 on the $1. But the market still generated a 1.4% return in the quarter due to coupon income. Year-to-date through yesterday, the loan market is down only 1%, which compares very favorably to other below investment grade and even IG credit asset classes. Beyond those averages though, and I think this is where it gets a little bit more interesting. Over the last 9 months or so, we have seen in the loan market, really a repricing of fundamental credit risk. And we've also seen kind of a general preference among market participants to move up in quality. This has led to a wide and widening dispersion between the trading prices of higher quality or BB rated loans and loans with higher credit risk that are often rated CCC by the rating agencies. And in fact, if you look at the subbed index prices today, there is a 21-point trading price differential on average between loans rated BB and loans rated CCC+ or lower. Back in January of this year, that price differential was less than 8 points. So we've really seen a widening and most of that movement is actually a movement down in price in -- among CCC-rated loans than the higher-quality loans kind of moving in price. They've moved much more modestly than the lowest rated loans.

Great. Very interesting to hear that. So as far as CLOs, we'll move into CLOs real quick. Can you give us an update on their performance in Q3? And where are CLOs trading now?

Yes. Historically, the CLO market rises and falls with the loan market over the medium to long term. But in the third quarter, we saw that junior CLO tranches. Those rated A and BBB and BB actually generated negative returns in the quarter despite the fact that the loan market was up modestly. Looking at the BB tranches in particular, and that's the tranche of debt that XFLT is most focused on, the returns in the quarter for BB tranches were down a little over 2.5%. And while year-to-date CLO BB tranches are down over 9.5%, they continue to handily outperform higher duration credit assets like high yields, which is down over 14% year-to-date and even investment-grade corporates, which is down over 18%. It's worth underscoring, it is really an attractive time to put capital to work in the CLO market. CLO debt and BB debt in particular, is yielding double digits on a current basis with further upside potential from convexity and pull to par. And CLO equity in the secondary market, we're modeling out returns in the mid- to high teens and, in some cases, even higher. So this is quite a unique period of time for both, CLO debt and CLO equity and, in our view, very compelling to put capital to work.

Well, that's good to hear. Thank you for that. I've got a 2-part question next for you. So the Fed has raised interest rates 6x this year. So part one, how has this aggressive action impacted the loan and CLO markets? And part 2, how are the rising rates affecting issuers when it comes to interest coverage?

Yes. We've spent a lot of 2022 talking about rising rates. And it's certainly a theme that I believe we'll continue into 2023. Look, on the one hand, rising rates are good for investors in loans and CLO tranches, right? 3-month LIBOR, which is still the reference rate on the majority of loans. And CLO debt tranches has increased from 21 basis points in January of this year to over 470 basis points today. So that means, of course, that investors are earning all things equal, an incremental 4.5 percentage points more to own those assets than they were in the beginning of the year. And that, of course, is a good thing. On the other hand, we have to look at not just what rising rates do for loan investors, but what they do to corporate borrowers. We expect, in some cases, companies will end up paying twice as much in interest expense in 2023 than they did in 2021. And that will certainly strain corporate cash flow next year. But it's not all bad news for corporate borrowers. And here's why. First, many companies do have interest rate hedges in place, or they've issued bonds or other fixed coupon debt, which, of course, is fixed and doesn't float up with rates. Second, interest coverage which will certainly fall in 2023 on average is starting from a very high level, historically. And you can see that on the bottom left chart on Page 19 where we've tracked that publicly reporting loan issuers recovering their interest expense over 5.5x in the second quarter of 2022. We don't have third quarter numbers just yet. And lastly, what covers your interest is, of course, EBITDA and ultimately unlevered free cash flow. And EBITDA, really since the beginning of 2021, has continued growing on average among publicly reporting loan issuers. Now to be sure, continued EBITDA growth will be challenged for many issuers in 2023. But it is worth noting that, as you can see on the bottom right here, thus far in 2022, issuers have continued to grow cash profits. And that will provide for many issuers, an important offset to rising rates and rising interest expense in 2023.

That's good info. Thank you. And just to remind everybody, these slides will be available for download after the webinar if you'd like to come back and take a look at some of these visuals, very helpful for me at least. So next question, so we just talked a little bit about rates rising. How does that infect issuers? So as far as investors, loan spreads have widened, and rates are rising. So should investors expect income from floating rate loans to increase? And second part, how do rising rates affect CLO equity distributions?

Yes, absolutely. We spoke about the impact of rising base rates and the effect that, that has had on the coupons of loans again, over 400 -- up over 450 basis points just year-to-date. On top of that, we've seen the credit risk premium for new loans increase. And so if you look at, for example, the underlying loan portfolios in most CLOs, they have been able to increase their spread of the underlying portfolios, in many cases, without taking on incremental risk on top of the fact that the reference rate, either LIBOR or SOFR for those loans has also increased. So the current yield for loans today is, it's approaching 10%. It's in the very high single digits. And if you were to apply if you were to amortize the discount that most loans are trading at today, again, mark it at plus or minus $0.92 on the dollar. The all-in yields projected yields are well into the double digits. So very attractive profile from the standpoint of the current income that investors, in loans and CLO tranches for that matter, are earning. And I think what's unique again is that we're in an environment where the current income prospects are very high. And if you believe the forward SOFR and LIBOR curves likely moving higher into 2023, but where loans and CLO debt also providing convexity pull to par upside, which really augments your current income and allows us to project total returns that are even in excess of the very robust levels of current income that we're earning real time. Now for CLO equity, the result of the rate movement that we've seen in 2023 is more mixed. And I'll say that mathematically, structurally, all things equal, and that's an important caveat. CLO equity does benefit from rising rates, meaning that as rates rise, the net interest margin, the net arbitrage, if you will, embedded in the CLO structure will improve as rates rise. So why didn't that happen in 2022? What happened was when rates, both LIBOR and SOFR rose, they didn't rise in -- equally. And what I mean by that is all things were not equal, in other words. First, you had a reference rate floor on many loan assets and still do. Earlier in the year, those floors were a huge benefit to the equity distributions. They were a huge benefit in 2021. They were a huge benefit in early 2022. And the reason for that is the floors were set well in excess of where LIBOR was at that time. And so the income coming off of the loan portfolio was enhanced by those floors. As rates rose in the first quarter and really starting in March of this year, LIBOR rose above the level of most floors on loans. The benefit of those floors went away. Second, you have a dynamic which has always existed, where CLO debt, meaning the liabilities that finance CLOs always reference 3-month LIBOR or 3-month SOFR. But the loan assets have the option of the borrower to reference 1-month or 3-month LIBOR or 1-month or 3-month SOFR. Now normally, the basis between 1 month and 3 month is very small. But -- so it doesn't sort of move the dial in a meaningful way in terms of the equity distributions. But this year, with the market strong expectation of rates rising in the future, that base has really increased. And today, it's about 65 basis points between 1-month and 3-month LIBOR. And that might not sound like a lot, but when you amplify that basis by the structural leverage in the CLO, it has been a headwind for CLO equity distributions this year on a sequential and a year-over-year basis. To be clear, though, the most important things driving CLO equity distributions and how robust they are, it's really 2 things. One, what is the spread on the loan -- the underlying loan collateral and that has increased in 2022. So that's a positive for CLO equity. And the second thing, of course, is what are the cushions to overcollateralization tests, what's the history of realized losses and impairments in the CLO such that the CLOs are permitted to distribute the net interest margin, the equity distributions to equity investors? And while we are certainly seeing headwinds as we look out into 2023 in terms of rising defaults, so far in 2022, those cushions to the overcollateralization covenant have actually increased modestly. So I do believe that CLOs overall, there may be some modest headwinds that we've seen in 2022, looking at the pace of cash distributions. CLO structures are still in very, very good shape and well positioned to withstand any economic headwinds in 2023.

Great. Thank you. Great job, Gretchen. So we're going to give you a little break here and move over to Kim. Kim had prepared everyone for this new addition to our webinar a little earlier. We're going to discuss the XFLT financial highlights for the quarter. So Kim, you are up here, can you give us a little info please?

Sure. Happy to do it. We, every quarter, will report our financials and have included those in the presentation, but we wanted to call a little bit more attention to it. So XFLT, as you may know, has a fiscal year that ended September 30. We report -- the annual report just was filed with the SEC and published, and it's available for you to take a look. We'll be doing our semiannual, come the end of March. For the third quarter, we'll give you an update on the growth of the fund. We did issue about 595,000 shares of common stock through our accretive at-the-market program. UBS runs that program for us. Given the limited trading volume that I mentioned, the ATM has not been quite as productive as in quarters past, but the fund did raise proceeds of about $4.2 million. And as Gretchen mentioned, she was able to deploy those new proceeds into very attractive market opportunities this quarter. Monthly distributions paid, we pay $0.073 per share, and we make regular payments here in the period July 1 to August 1 -- September 1. There is a good question in our Q&A, just about distribution. So we'll cover that in a moment. Keep those questions coming, and we'll get to them. For fiscal year ended September 30, net investment income was $0.82, and there were, as we talked about, unrealized losses for the fiscal year period, the year period of $1.91 per weighted average common share. The total loss from investment operations was $1.09. This is -- as we were talking about, this is the largest impact to total return that we're publishing is the unrealized losses associated with valuation declines and CLO debt and CLO equity. For fiscal year ended September 30, the ratio of net investment income to average net assets was about 10.81%. We did celebrate the fifth anniversary, September 27. Some of you may have seen our LinkedIn post just commemorating the growth of the fund. The fund started out with an IPO of $82 million. As you may recall, the fund was capacity constrained, Octagon can only deploy so much capital, and so the fund was smaller by design. We've been able to grow through accretive ATM issuance and accretive overnight offerings. The fund has traded at significant premiums in its history, and that's what's allowed us to continue growing and achieving some of those scale economies that we talked about. Now this is an interesting point. This is a data point, the weighted average current yields. Here, these are not IRRs. They don't reflect anticipated losses that might come from investing in below investment-grade credit. But we do get questions from time to time about just what's the current yield in the marketplace for CLO equity, what's the current yield for loans. As Gretchen mentioned earlier, you're seeing opportunistic loans north of 10%. So very, very attractive. CLO debt at 10.76%. CLO equity at 28.92%. So this is also -- the current pricing in the market is reflective of the environment that we've been in. And I think there's -- obviously, at these attractive yields, any new proceeds that the fund is able to generate and deploy will be very beneficial for shareholders. So back to you, Robert.

Great. Thank you, Kim. And just to let everyone know, we have posted more information on XFLT on the XFLT sites such as annual reports and things like that. So feel free to check that out. Next question for you, Kim, is how have loans and CLOs performed in this rising rate and inflationary environment versus more traditional fixed income investments.

Sure. I think Gretchen did a nice job covering this. What all I'll add is if you look at the graph on the right-hand side, you see the relative outperformance of loans to high yield and CLOs to other risky assets like equities, the S&P 500 being down so much this year. There's a lot being discussed, I think, among investment advisers, financial advisers about the 60-40 mix. Now I don't think that the 60-40 model is dead. But I -- the thing I would say is we've always positioned XFLT as an income-producing investment, and investors are now looking at alternative sources of income to replace some more traditional exposures. With investment-grade corporates with more traditional investments being down this year, I think it does have advisers reevaluating investment allocation decisions. But there's always going to be a place in the portfolio for an income-focused strategy. And one like XFLT, which is floating rate, I think it's going to be benefiting from some of the anxieties that people have around municipal bonds and high yield in the current market just given the potential for additional rate hikes. So yes, the relative performance year-to-date has been terrific. Now you don't see a positive number on this page. So there's nothing to brag about here. We've obviously seen significant price and NAV declines in our portfolio. But as we talked about, those are pricing changes, they're unrealized. A lot of investors sadly in this year have realized significant losses to the extent that they've traded out of equity positions and the like. So we encourage investors who invest in CLOs to be focused on their long-term investment horizon and to be reflective of the period that we've been through and have a sort of a great appreciation for -- and frankly, understanding of why you see those NAV declines. And in some ways, we would tell people to expect it when we have this kind of market volatility. But to the extent that you expect it, I think it makes people focused on the original intent and goal of buying something that is going to produce income over multiple cycles, and that's what we endeavor to do.

Great. Thank you. So maybe we'll move over to XFLT performance. So Kim, this is a 2-part question. How is XFLT performed relative to its fund peer group? And part two, XFLT has traded at an average 3.59% premium since inception. You had mentioned it recently traded at a discount. But what do you attribute XFLT's superior trading performance to in the secondary?

Sure. Happy to do it. So we -- XFLT is unique in the secondary market in the portfolio allocation, the 50-50 mix of loan and CLOs. We have a number of very strong competitors that have largely CLO focused closed-end funds. And so we don't typically get compared to the senior loan funds, which are pure or focused largely, 90% to 100% in senior loans. And so when we talk about the advantages that XFLT has, the first being the blend of our investments allows us to borrow with a bank facility through SocGen. It allows us to reduce the overall cost of leverage relative to some of our competitors, which are not able to use a bank facility, they're using largely preferred fixed leverage. Now 1 of the other points I made about transparency is that we are doing a daily NAV. And we -- I think many investors in this space buy more than just 1 fund. And so we know we've heard from some of our friends at investors who invest with Eagle, who invest with Oxford Lane and they like to look at the NAV of XFLT just to kind of see where things are headed directionally. We also will use third-party valuation. We're not striking NAVs internally. This also aids with increased transparency. XFLT, just as a reminder, does not charge any form of performance fee. There's no income incentive fee. It's just a flat fee. And as you can see, our distribution rate is not nearly as high as some of the competitor funds, and that goes back to the mix of loans and CLOs. This is an institutional strategy that Octagon has been running for a number of years, and the investment objective is to enhance risk-adjusted returns. And so therefore, it's this blended mix. And if the fund were -- had a higher allocation in line with the competitors, you would see a much higher distribution rate. But we think that the current distribution rate and the risk-adjusted return profile is quite attractive. Particularly for investors, we found that are newer to the CLO marketplace XFLT is, I think, a good option in terms of getting people comfortable. And I think that's the genesis of the institutional strategy that Octagon has run is that they like the mix. They like being able to trade between loans, CLO debt, CLO equity when there's an opportunity to do so. And the fund for the last 12 months has traded at an average premium of 7.91%. I think a lot of the premium discount, our fund does trade a little bit differently. But part of it is due to the frequency of the NAV. What you'll see with some of our competitors like Eagle and Oxford, they can actually generate very large premiums relative to when their NAV is struck. So I think you should just bear that in mind. And there's always risk when you're buying something in the marketplace at a significant premium. But I think what this is reflecting in my mind is the demand. There's not just demand for CLO access that Octagon provides, that our competitors provide, there's also a demand for high levels of floating rate income. And over time, these funds have been able to meet that objective. And there's only a handful of funds. The rest of the closed-end fund marketplace doesn't typically generate these levels of distributions. And the rest of the closed-end fund marketplace doesn't typically trade as well as this competitive set of funds, Robert.

Great. Thank you, Ken. I'm going to add an audience question in quickly. We're running a little low on time. So Gretchen, I'm going to ask this question to you from the audience. Since LIBOR has risen so meaningfully this year, and only a portion of XFLT's debt is floating, wouldn't it stand to reason that all else equal as the lagged impact of rising rates takes effect and XFLT's portfolio, XFLT's net investment income and ultimately dividend should increase?

Sure. We talked a little bit about some of the headwinds that CLO equity has faced in 2022 from a cash distribution standpoint and that's certainly playing into the cash flows in 2022. Of course, the other assets which are between the loans and CLO debt, the majority of assets in the fund, they, of course, have risen as we've discussed, with rates moving up. I will say, we feel very confident about the income generated off of the fund. And as we look forward, we should see those equity distributions and the basis between 1- and 3-months LIBOR and SOFR have normalized. And as we look forward, again, looking at the forward LIBOR curve, that suggests that, that will start to kind of normalize in the first quarter of next year. But look, I think the fund is very well positioned from a dividend perspective. And we will continue to evaluate and take into consideration the shifting kind of macroeconomic factors. But as we look out today, we feel very confident with the income generation in the fund today and looking forward.

Great. Thank you, Gretchen. I'm going to continue with you and go to the default topic. So I know the last 12-month loan default rate is 0.90%, expected to rise. I know the historical average is around 2.6%. Do you think we are headed back to that long-term historical average?

Sure. Over the long term, all things revert to the mean. And based on a number of risk factors in the market that we track on a day-to-day basis, the percentage of low-priced loans, the percentage of CCC exposure in the market, the pace of downgrades by the rating agencies in the market. It does appear that loan defaults are moving up. And we've seen that over the last few months. I would know even at an LTM 90 basis points, they're still historically quite low. But we know that defaults are a lagging indicator. And I've said before, if you're looking at the default rate, you're looking at the night sky. You're not seeing what's happening today, you're seeing what's happened some time ago. So we are not -- we certainly track defaults, and our expectation is that they will increase. Our expectation is that they will likely increase in the context of the historical average, but we're also looking very closely at those indicators that do not lag as much. We're looking at market prices, we're looking at ratings, et cetera. And those are, I would say, more so driving our day-to-day decisions than what a last 12-month default number may indicate. Given all of those things, how do we think about CLOs and loans given the increased risk of default in the market? It means to us that the manager matters. Both Octagon and sub-advisor of XFLT, the collateral manager of the CLOs whose tranches we're investing in, really matters. The manager's ability to avoid investments in underperforming credits matters. And it's really -- we're in an environment where it is the tail risk in these loan portfolios. It's the exposure to the riskiest component, the riskiest part of the loan portfolios and it was really going to drive performance, certainly at the CLO level and also as it relates to the direct investments in loans that we have in XFLT. And as we invest in those loans directly and in CLO tranches, we're very much focused on that. But I would say, certainly, these headwinds are an opportunity as well. They are an opportunity for nimble managers to put capital to work at historically, very attractive levels.

Great. Thank you. This is going to be the last question. Thank you for everyone who hung on to the webnar. Gretchen, last 1 for you. What type of headwinds do you expect loan investors to face near term? And what is your outlook for the loan and CLO markets going forward?

Sure. We've spoken about many of them over the course of the last hour. But look, there's no denying the fact that the macro environment is challenging. Inflation is high, interest rates are high and going higher, economic growth is slowing, defaults are ticking up. But it is worth underscoring, I think, that CLOs and CLO structures have seen environments like this before, and they have exhibited resiliency through those environments. Volatility can be very accretive to CLO equity over the long term, even in the face of higher defaults. Just as a reminder, loans are prepayable at any time at par. The historical rate of annual prepayments market-wide has varied from 10% to 40%. On an LTM basis, it's been approximately 17%. And those prepayments importantly come in at $1.00 on the dollar, and they allow managers to recycle those proceeds, those prepayments at discounts to par. And that is very accretive. It allows building a par NAV over time. And to put some numbers around that for a fund that receives 17% prepayments, just the market level of prepayments over a year and is able to reinvest those proceeds at a $0.05 discount would be -- which would be a price over the current trading price of the market. That manager can create additional principal NAV that allows cushion, should that fund experience defaults. And the level of cushion that would be created by 17% prepayments at a 5% discount is equal to over 2 points of default losses. So as we look out over the future, we say, CLOs are likely to experience higher default losses in the next 12 months than they have in the previous 12 months. But they also have an extraordinary ability to buy assets, buy loan assets at a discount to par and offset those default impairments and those realized losses in a way that we think is particularly effective in this environment. So we are excited about where the market is trading. We think it's an incredible opportunity to put capital to work. We are certainly very much focused on the macro credit and also focused on the fact that, that creates opportunities.

Great. Thank you so much, Gretchen. That's going to do it today. Gretchen thank you very much for all of your insight. Kim, thank you for yours. It's always great to hear about the fund and the markets. I especially want to thank everyone who attended today. As I mentioned, I will follow up with replay information and the presentation. Feel free to follow us on LinkedIn for more updates at XA Investments and our knowledge bank on our website, which you can find a lot of educational information as well. So enjoy your holidays, and we appreciate the time you spent with us today. Thank you.