XAI Octagon Floating Rate & Alternative Income Term Trust (NYSE:XFLT) Q3 2023 Earnings Conference Call November 30, 2023 10:30 AM ET
Kimberly Flynn – Managing Director, XA Investments
Steven Perry – Vice President, XA Investments
Lauren Law – Portfolio Manager
Gretchen Lam – Senior Portfolio Manager, Octagon
[Call Starts Abruptly] XFLT quarterly webinar. We’re really pleased to be in front of you. It’s been a good quarter. I’m going to cover off a few disclosures and then we’ll welcome our speakers.
Today, we’re going to talk about a number of forward-looking matters. And in the materials presented, there are forward-looking statements. Investors should not place undue reliance upon those forward-looking statements and actual results can differ materially. The presentation is intended to be educational in nature. And any of the investments or opportunities discussed here today may or may not be suitable for the audience. Neither XAI or Octagon is acting as an advisor to audience members and investors should consult with their own investment advisors or tax advisors prior to making any investment decisions.
Just a note about performance. We do quote past performance and past performance does not assure future results. As you know, current performance may be lower or higher than any of the historical performance presented here.
With that, let’s talk about some of the housekeeping matters. We would love your questions and there’s a Q&A box at the bottom of the screen and you can enter questions throughout the webinar. We’ll blend those and have our speakers address them at the right moment. If you have any other questions you’d appreciate to take offline, you can contact me, Kimberly Flynn. You can contact my colleague, Steven Perry of XA Investments. We’re always happy to help. There’s also additional information, financials and fund information at xainvestments.com. So please, send us your questions and look forward to addressing those on today’s webinar.
We’re really pleased to have a new speaker, another member of the Octagon Investment Committee, Lauren Law is joining us today. Lauren and Gretchen have worked closely together on the Octagon Investment Committee for a number of years. So we’re going to hear Lauren’s perspective on the loan market and the CLO market in a little bit. My colleague, Steven Perry, who runs product management for XFLT, some of you have probably chatted with Steven. He’s going to talk about the state of the fund and some of the fund management topics that we usually cover, things appreciate leverage and whatnot. So we’ll get into that.
Octagon, as you probably know, is one of the seasoned time-tested team, the team has a 25-year track record. XFLT is the only way for investors in a registered fund format to be able to access Octagon strategy. And Octagon is focused entirely on below investment grade credit which is where XFLT invests. So we’re obviously happy to have them on the webinar today and they’ll share their insights on the credit markets with us.
We do have another important matter that I wanted to cover with current investors. You may have received proxy proposal materials, either electronically or in the mail. We would ask you to look for those materials and please vote your shares. Your vote is very important. I’d appreciate to briefly just cover what the proxy is all about and we’ll let you all make your own decisions with respect to the votes.
Basically in October of this year, the Board met and they unanimously approved two different proposals: The first being the approval of a new sub advisory agreement with Octagon, who has been the fund’s sub advisors since inception, Octagon’s parent company has a new parent and that does demand a vote of shareholders. And so we would ask you to consider proposal number 1. The second proposal is an amendment to the declaration of the fund’s trust to eliminate a termination date. The fund, when it was brought to market, appreciate many other listed close end funds, had a term. The term date is December 31, 2029 and management has proposed and the Board has approved an amendment to the declaration of trust to eliminate that term and allow the fund to continue on as a perpetual fund.
So those are the matters in front of shareholders. And we would once again ask you to consider voting your shares. Your vote counts and it matters and we’d appreciate you doing that.
We’ve got a number of planned questions and topics for Gretchen and Lauren and Steven. We’re going to get right into it. recall that you can enter your own questions in the Q&A function and we’ll make sure we get to those questions, so keep them coming.
I’ll start out first with a discussion with respect to the financials for the quarter. So Steven, if you could take it away.
Absolutely. Great to be here. Thanks for having us and thanks for joining the webinar. I’ll go over a couple of brief financial highlights for XFLT for the fiscal year ended September 30th. As always, you can find the annual report on our website or at sec.gov. Any questions, please don’t hesitate to contact us.
So for the fiscal year-end September 30th, net investment income was $0.92 per share and realized and unrealized gain was $0.30 per weighted average common share. Total income was $1.22. The ratio of net investment income to average net assets was 14.3%.
Additionally, the fund was able to grow and scale. The XFLT issued 3.2 million common shares at the at-the-market program for approximately $22 million in net proceeds. Additionally, you may recall back in May, the fund increased its distribution rate to $0.085 per share. Throughout the quarter, those free distributions maintained that level, $0.085.
We also celebrated a $500 million mark in total managed assets on September 19th. You may recall if you’re a long-term investor in the fund, the fund started out around $100 million back in 2017.
Lastly, the weighted average current yields for the different assets in the portfolio, CLO equity is 23.5%, CLO debt 13%, loans above 10.25%, and the bonds almost 7%.
A – Kimberly Flynn
Steven, could you talk about Board governance? I know the Board has been really active, I think there have been 9 Board meetings in the last 12 months. So give us an update with respect to governance and let us know what shareholders should be thinking about here?
Yes. So every year the Board has 4 regularly scheduled meetings. The Board has also met for shareholder meeting and a couple other special Board meetings. Those meetings include the 4 independent trustees. And they’ll talk on matters, special meetings or special matters, distribution matters, reelection. I do want to highlight the last 12 months, the transaction overview. I briefly touched on the at-the-market program, but there are a couple other matters that the Board is very involved in and that’s the 6% series 2029 convertible preferred and a new 6.95 series 2029 convertible preferred that closed on November 6th.
So that’s a new update for the fund this past — it was subsequent to quarter end, but that’s also a new update for the fund. So the Board continues to be very active. Management continues to have discussions with members of the Board and we’re very pleased with the relationship with them and how things are going.
Steven, could you just tell us where we sit today in terms of the fund, sort of summary characteristics and where the fund has been trading in the secondary market?
Yes, I’ll go through a few basics, and feel free to jump in, add to, or interrupt and ask questions. But here we have this typical slide that you’re used to seeing. We have 507 million in total managed assets across 44.6 million shares. You’ll note the current distribution rate of $0.085 of note. You’ll note in the footnote there that 100% of the fiscal year ended 2023, distribution characteristics were 100% net income and 0% return of capital. That’s something that we focus on a lot and we try and set the distribution rates appropriate for the level of income coming into the fund.
Additionally, as is typical, you’ll note the top 10 holdings are CLO equity positions. Those are typically chunkier buys for the portfolio than individual loans.
Going over the portfolio composition, over time, you’ll note it’s relatively consistent. Of note, you’ll see that CLO debt is a higher percentage of the portfolio than in times past. But we can talk about how Octagon has seen opportunities with CLO debt versus CLO equity and how those dynamics play out in the marketplace later on in the webinar.
From a net return perspective, a total return perspective, the fund has performed well, beating the benchmark on quarter-to-date 1 year 3.5 and inception to date. It’s been a very good year for the fund. It’s been a very good, 3-year and the quarter was also very positive. What we saw this quarter is we saw price is rebound. And so not only was there interest and fees coming into the fund, but there was also an appreciation of the market price of loans and CLO debt and equity.
Let’s see here, what else do we have? I’ll advance to premium discount history. XFLT has had the benefit of trading at average premium since inception in the secondary market. Inception to date average was 3.3%. And when we updated the deck as of last Friday, the current premium was 2.74%.
Here we just appreciate to overlay how the price and NAV perform in relation to each other. And we overlay that with a broader picture, the orange line is the S&P 500 Index. Last Friday, price closed at 6.75, NAV at 6.57. And S&P has had a little bit of a good run the last week or so.
What you’ll note here is the daily trading volume for XFLT. Of note, the last 90 days have seen a large uptick in volume. It’s consistently higher than prior quarters and prior years. We view this as a very positive thing. We know that there are more shares issued, so obviously volume is going to enhance, but this allows for very good shareholder liquidity.
So Kim with that, I’ll kick it back to you. I know we have some other topics to cover and some questions to cover.
Sure. Steven, I’d love to talk about the growth of XFLT over time. You mentioned the at-the-market program. But can you talk about the different methods that the fund has used to grow the common share base? I think that’d be great.
Yes. So here is a picture of total managed assets in the fund. We break it up into net assets, credit facility and preferreds. So just a good graphic for you here.
In terms of growing the fund, we mentioned that XFLT trades at a premium to its net value. That allows the trust to issue shares via the at-the-market program. Those shares are issued at a price that is above net asset value. So it’s accretive to the fund. That program is pretty consistent ongoing throughout the year, as long as the funds has positive trading dynamics. Additionally, we have in the past been able to do follow on equity offerings in the form of overnight offerings. We have not seen any of those recently or done any of those recently. But what we have seen is the convertible preferreds. Those have converted to common shares pretty consistently over time. I don’t know that there were no conversions in the most recent quarter. But we appreciate this form of leverage for a variety of reasons that we can get into. But those conversions in conjunction with the at-the-market program helped the fund scale and furnish some scale efficiencies to fixed costs for the fund.
Steven, we do have a question that’s come in with respect to the fund’s use of leverage. So if you could just talk about — we’ve been in a rising rate environment and so obviously the fund’s cost of leverage have moved up, but the fund is a floating rate asset — the assets in the fund are floating rate also. So we’re benefiting from those higher interest rates. Can you just talk about what the rate increases have done to the cost of leverage, but also how the fund’s portfolio has responded? I think that’d be helpful to cover now.
Yes, absolutely. So here on the screen now we overlay various rates. We have the 3-month LIBOR, Fed Funds rate and SOFR. And as you can see, and as you’re aware, the fed has been raising interest rates pretty consistently since the start of 2022. Now what that means for the fund is that means borrowers in the fund, typically, it’s tied to — their interest payments are tied to a base rate and a spread. So as base rates rise, the level of interest paid to the fund and paid by borrowers, increases. There are a lot of various dynamics that I’ll let the Octagon team get into if it comes up, that affects the amount of interest that’s coming into the fund. But overall as rates rise, we do see more interest income coming into the fund.
Now, what it means from a leverage perspective, and let me get to that slide here, is interesting. Because we have the credit facility and we have the fixed rate preferred, the retail preferreds at 6.50 and the convertible preferreds at 6. Now what you won’t see on here is the 6.95 preferreds. None of those are drawn at this time. So it does not affect the leverage sources as of September 30th.
For the bank borrower, the credit facility. That is tied to the base rate of SOFR plus a spread of 1.45. And so as we’ve seen interest rates rise, we’ve seen that cost of leverage rise. What the fund has been able to do is toggle between bank borrowings and fixed rate preferred. That allows the trust to be more dynamic in its use of leverage, keeping costs of leverage down. But as you’ll see, the main portion of that is still floating rate leverage. And you’ll be able to contrast the cost of leverage in Q2 to the cost — the weighted average cost in Q3. It’s up about 18 basis points to 6.52%.
We appreciate the retail preferreds. We have a large institution ownership in those. The convertible preferreds are privately placed. And on the left of that you can see how the retail preferreds have traded in the secondary market. They’ve traded down from par a little bit. However, we’ve seen them consistently trade around par. Any other points Kim, you’d appreciate to hit on in terms of rates and leverage that I missed?
No, I think you’ve covered. I mean, the fund has assets and liabilities, which with bolder floating rate. So the fund is behaving as you would expect with income levels being higher, as cost of leverage does advance higher, but you have that they advance in lockstep. So, I think the fund is built and designed to handle a rising rate environment and benefit from that. Maybe Gretchen, if you’d appreciate to comment just in terms of the impact of rising rates at the portfolio level that might bring additional color to the conversation?
Sure, Kim, happy to. The way that we think about it as portfolio managers is if we look at all of the assets held in XFLT, about two-thirds of the assets are truly floating, directly floating rate And that is comprised of both the CLO tranche debt and the floating rate loans that the trust holds. XFLT CLO equity allocation, which represents the lion’s share of the other 1/3 of the trust assets and what I would describe as hedged floating rate, meaning both the assets and the liabilities of the CLO itself are predominantly floating rate, and so CLO equity is relatively indifferent to movements in base rates, very modestly exposed to rates, but predominantly indifferent.
And, if you look at the quantum of the assets that are again considered floating rate, that totals as of 9/30 about 330 million in notional value. And these are the assets that have really greatly benefited from rates rising over the last 2 years. Base rates back in January of 2021 were 25 basis points, and today they’re just shy of 5.5.
As Steven mentioned, we do have the revolver, which of course is floating rate. As of 9/30, the balance on the revolver was 150 million. And so, while clearly there is some incremental cost in leverage cost, as rates rise, net-net, the trust is still a strong beneficiary of rates moving up, given the fact that the value of the assets that are floating rate in the fund is far greater than the revolver balance.
And in addition, and importantly, I just note that we do have the ability as rates advance to adjust, of course, the revolver balance, and adjust the proportion of revolver debt versus the fixed rate preferreds, based on our views of both expectations of movements in rates, as well as market for credit risk on a go forward basis.
Next question. Lauren, I’d love to have you speak to the loan market. So how has the financial performance of loan borrowers trended this quarter? And then, what does that mean for CLO performance?
Sure, Kim. 2023 has been a very interesting year for the loan market. The fundamental performance of borrowers have by and large exceeded what the market was expecting at the outset of the year. And this is evident in the total return performance of the loan market.
During the third quarter, both revenue and EBITDA grew across loan market borrowers. We are seeing a deceleration in that rate of revenue growth. But we’re seeing margin expansion and EBITDA actually outpacing what we’re seeing in terms of revenue.
On average, we’re seeing strong growth and profitability driven by this low-single-digit revenue growth, and the margin expansion I mentioned. I think it’s important to note though, that focusing only on averages can mask some underlying issues. We continue to see similar to previous quarters, a fair amount of dispersion of performance across loan market borrowers. And while the average statistics look quite good, there are still some sectors, some subsectors and just some borrowers that have experienced underperformance. And in some instances, this underperformance has occurred to a meaningful degree.
In this interest rate environment, highly levered borrowers simply have less margin for error, and missed performance expectations can quickly turn into an issue. So what does this mean for CLO performance? For the better part of the last year and a half, CLOs have outperformed by minimizing credit losses. And I think this continues to be the winning strategy in 2024, just as it has been in 2023. And the managers who have outperformed have done so by selectively taking risks, avoiding major losses, and capitalizing on the increased spread available in the market today.
We’re looking for managers that actively handle the riskiest loans in their CLOs. We want them to be nimble in identifying deteriorating credit performance. We want them to be early in doing this and also opportunistic when it comes to identifying opportunities for some outsized returns on the other side.
In short, we want our managers to take risk in a disciplined way. I think one important thing to note here is that it is very difficult for managers to do what we want them to do to be nimble, once the reinvestment period of the CLO comes to its conclusion. So post reinvestment period, CLOs are simply prohibited from engaging in the type of active trading we think is necessary in the current environment. And so for this reason, in XFLT, we have been reducing exposure to post reinvestment period deals, and we’ll continue to do this. We think the longer equity is simply going to outperform. And as we buy additional assets we’re looking for deals with runway to the end of the reinvestment period so that managers have the time to handle the credit risk in the portfolio, capture the higher spreads available on new issue loans and repair some of the inevitable losses associated with those idiosyncratic credit issues that continue to pop up from time to time.
So, Lauren, could you speak to specific industries within the loan market? Are you seeing certain parts of the market outperform or underperform? Are you avoiding anything today? And what are Octagon’s expectations for loan defaults going forward? We’re starting to — I mean, loan defaults have been so low, historically low. So what does Octagon expect in 2024?
Sure. What’s really interesting about the loan market, this year and even last here is that it hasn’t been one particular sector that has been under assault. So in previous default cycles, we’ve seen 80% or so of the defaults actually be associated one sector. We saw this in oil and gas, we saw this in retail. And it’s really been different this cycle, where weak performance, as I noted earlier, appears to be more idiosyncratic in nature. That being said, we are seeing weakness more prevalent in some sectors versus others.
Healthcare is an example of a sector that has been struggling really since COVID with higher labor costs as well as the lower availability of labor. In many cases, healthcare borrowers have limited pricing power, so this dramatic cost enhance has led to pretty significant margin contraction. Given that healthcare historically has been viewed as a defensive sector, not tied to a typical economic cycle and really prone to growth due to the demographics that drive their revenue performance, these healthcare borrowers have tended to be very highly levered. So the combination of this margin contraction, pressure on the cost side with highly levered capital structures have led to some stress within this sector.
We are starting to see the labor challenges abate somewhat, but it is still a highly levered sector that is running at operating margins that are nowhere near their normalized levels and cash flows remain constrained. So that’s a sector where we have been very selective.
Real estate is another sector which I think will come as a surprise to no one that has been under a bit of pressure, specifically commercial real estate related borrowers are seeing weakness, particularly those exposed to the office sector. I think, it is noteworthy, however, that this is a relatively small sector within the loan market.
Another good example of an area where we’re seeing weakness is the telecom sector. This weakness is both as a function of top line underperformance as well as the burden of high CapEx needs and relatively full debt loads, as rates have risen.
On the output of our side, we continue to be pretty constructive on a lot of our software exposure, as well as some of the business service providers. Both of these end markets really benefit from oftentimes recurring subscription levels, the ability to raise price, and better than average growth versus some of the other names in the loan market.
As we look forward into 2024, on the default side, our expectation for defaults remains relatively unchanged with what we have communicated in past quarters. On an LTM basis, the LSTA is calculating a 1.34% loan default rate, so that’s much better than what the market had been anticipating at the beginning of 2023.
And while this rate does understate the level of credit stress in the market, as this rate generally excludes distressed exchanges, it still represents dramatic outperformance versus expectation. Most strategists predicted a 3% to 4% default rate at the beginning of the year, And with some outliers actually predicting default rates into the double-digits. We would expect defaults to remain elevated in 2024, as some loan borrowers contend with performance headwinds, such as those maybe in the healthcare telecom sectors I’ve mentioned early. Others deal with challenging refinancing needs or simply unable to continue to service their significantly higher interest burden, in light of the current interest rate regime.
So we had some good news in this quarter, I think with some of the recession fears easing as inflation came off of its peak and GDP seems resilient. The equity market has reacted positively, how have the loan and the CLO markets reacted? And where are loans and CLO debt, CLO equity trading today?
Yes. During the third quarter performance in both markets, certainly reflected the easing of both inflationary and recessionary fears. We spoke last quarter about how as the macro view has improved throughout the year and loan borrower performance exceeded expectations, risk assets have outperformed in the loan market. So this trend continued into the third quarter with CCC rated loans outperforming both the B and BB components of the market. This outperformance has been rather meaningful with CCCs on a year-to-date basis rallying roughly 5 points. In contrast, BB loans have been only a point, so it’s significant.
Turning to CLO tranches, mezzanine and equity tranches have also exhibited strong performance in 2023, both rallying significantly through the second and third quarters. CLO BBs are actually one of the best returning asset classes in all of fixed income, posting a 16% total return on a year-to-date basis through 9/30, so very compelling return this year. At 9/30, the CLOIE BB index is trading to yield in excess of 13%, and at an $88.92 price.
And lastly, turning to equity, while there is no CLO equity index that we can reference specifically, CLO equity has also experienced robust performance in 2023 and is currently trading to yields in the mid to high-teens context.
All of this is to say that despite strong performance year-to-date, the loan market as well as the CLO, mezzanine and equity markets are still trading at very compelling levels, both in terms of future price upside as well as current yields.
Gretchen, so new CLO issuance was lower in 2023, I think in part due to challenging CLO ARB for new deals. How has that evolved over the course of the year? And what is Octagon’s outlook for primary CLO issuance and CLO arbitrage in 2024?
So maybe just to take a step back, the U.S. CLO market is plus or minus a $1 trillion market today in total size. And the size of the market has grown dramatically in the last a decade or so, and it continues to grow today. Now the pace of new CLO issuance, the pace of growth is indeed lower in 2023. And you can see that, here on Slide 22. We’ll probably end the year at about 90 billion in new issuance for U.S. broadly syndicated CLOs. And many of our research friends expect approximately 100 billion in issuance for 2024.
Now, as we look forward to 2024, we are perhaps a bit more hopeful than that in terms of the issuance outlook. It’s certainly true that the arbitrage or said differently that the net interest margin inherent in a newly issued CLO is low relative to history. This is not because the coupons on the loans are low, quite the opposite. They’re historically high right now. It’s because the spreads on the CLO liabilities are historically high. And in particular, the spreads on CLO AAAs, which comprise almost two thirds of the CLO capitalization. And it is the CLO liabilities, the cost of financing, not the loan assets that is causing the arbitrage to really be challenged in the current environment.
And now as an aside, this dynamic makes existing CLOs, CLOs that were issued years before, which likely have relatively cheaper financing in place, very attractive for CLO equity investors. And this is why within XFLT we have not purchased a CLO equity position in the primary market, in almost 2 years. All of our purchases, over the course of the last couple of years have been in the secondary market because of that fact.
So what do we expect for 2024 then? There are a number of reasons why AAA spreads have remained persistently high, driven in large part by both regulatory and currency related challenges among the largest buyers of the AAA tranche. And we are starting to see some early signs that some of these challenges may be evading, still early days, but if this continues to play out, we believe that AAA spreads may start to revert back down to their long-term levels which should help preserve higher CLO issuance in the future. So we do think there is, again, risk to the upside perhaps with that $100 billion number for 2024 issuance.
Lauren, could you speak to just the outlook for the CLO market, cover sort of CLO debt, CLO equity as an investor. I know, Steven mentioned that Octagon has liked CLO debt, and has increased slightly the allocation of CLO debt. What is your expectation for CLO markets in the year to come?
We feel pretty constructive about the CLO market in the year to come. I think there are some things you need to consider. While the economy continues to be resilient, challenges for leveraged credit do persist. Octagon continues to sit in the higher for longer camp, and this is certainly helping our CLO mezz exposure. But I think you have to consider that while it is, great to be an owner of floating rate assets in a rising rate environment, this dynamic may present challenges for companies that borrows loading.
So we expect that we will continue to see some challenges at the bottom end of the credit spectrum in the loan market, so low rated borrowers with capital structures that were conceived in a near zero interest rate environment may confront challenges in the event of fundamental unperformance. Said differently, highly levered borrowers are operating with a thin margin for error, and some low error.
And I think it’s important to highlight that that risk in the market, but I definitely don’t want to leave investors with a dire view of the outlook for levered credit. I think it’s important to note that most loans and most CLOs and CLOs to an even greater degree are well positioned to weather this higher interest rate environment. CLO over collateralization cushions are well positioned to withstand credit losses from both defaults and trading losses as well as the headwind of increased CCC downgrades which is something that CLOs have been contending with. This means equity distributions will continue, and likely at robust levels.
Another thing I think to consider is that the current yields on both loans and CLO debts at almost 10% and 13% respectively are very high versus levels we have experienced historically.
From a technical standpoint, technicals are very supportive in both the loan and CLO tranche markets with modest CLO issuance supporting historically low net loan issuance. And as we look forward, we are focused both on avoiding credit losses in the loan book, and positioning the CLO tranche exposure within XFLT with the managers that are skilled at doing that in their portfolios as well.
Thank you, Lauren. Gretchen, anything to add there?
Awesome. Well, we do have time for audience questions. So, look to the bottom of the screen, there’s a Q&A function, type your question in there. We do have 1 or 2 that have come in, so we’ll get to those, shortly. Just a quick reminder on, how to vote your XFLT proxy. You can vote in a number of ways by Internet, by phone, by mail or in person at the special meeting. Votes need to be in before that, meeting date, which is December 19th. Please let us know if you have any questions or if for some reason you haven’t received your proxy card.
Great. So let’s advance now. Steven, this is going to be a question I think for the two of us to tackle, which is more on the fund management. We’ve got two related questions actually, from some of our regular webinar participants. So thank you so much for those questions. And this is with respect to the fund distribution rate, distribution policy. And I know you talked about, the funds 2023 distribution, was 100% net investment income and there was no return of capital. And so one of the things that I think the question is getting at is, is it the fund board’s goal, to set a dividend rate that can be covered by net investment income going forward?
Yes, absolutely. That is the goal. That is the philosophy that the XFLT fund Board has had since inception. The fund Board is very disciplined with respect to distribution settings. The board requires, in frequent, not only reports from Steven and from the team, but also, dialogue in between board meetings with respect to dividend coverage.
So we’ve always had an income based distribution policy and we expect to have going forward the same income based distribution policy. And that’s really important.
One of the questions was with respect to, do you just focus on distribution coverage by net investment income alone, or do you also factor in expected capital gains?
And I think, this is sort of a nuanced question, but I’ll try to address it. So we have the forecast that we do for net investment income and estimates that we make and we adjust throughout the year. Now capital gains are a little bit harder to forecast a little bit harder to assess. And from time to time, the Octagon team will produce short-term capital gains, sometimes from trading activity, from repositioning the portfolio. And so, we do factor those in, not ahead of at time. But, we will adjust our estimates real time reflecting any of the gains that do come in, because obviously that can be, those gains can be distributed as part of net investment income. And so I would say that the philosophy, the approach is more, the former than the latter. We’re focused on, estimates of net investment income as opposed to trying to forecast or assess what capital gains are going to be, and when and if the portfolio managers might sell those.
So that doesn’t really factor in those capital gains in advance. It is something that we do think about real time and adjust as we go. But Steven, maybe if you could cover the distribution history and add any other color in from the discussions that you have regularly with our fund Board. I think that’d be helpful.
Great explanation and as you see here, we see the enhance from $0.073 to $0.085 earlier this year. There are a couple factors that we talk about internally and with the board on distribution and those go into GAAP accounting and tax accounting. And so right now we’ve talked about the GAAP accounting and the income into the fund. But there is also a tax consideration with an asset class appreciate CLO equity. We don’t need to get deep into that. But what the management tries to do is to thread that needle between any differences between GAAP income and taxable income. And we endeavor to have that income based distribution policy, still, appreciate you said, Kim.
Yes. And I think that XFLT is uniquely positioned to be able to steer potential GAAP and tax differences because of its composition, the fact that the fund invests in loans and CLO debt as well as CLO equity. CLO equity, because of the tax reporting that’s done, that’s lagged, can create some, frankly, problems for fund sponsors who invest heavily in CLO equity. For XFLT, CLO equity has always been less than 50%. And so that allows us to set distributions on a GAAP basis using that method income and it allows us to make the required tax payments. And so you don’t see from XFLT a history, therefore, of making special distributions to confront our tax requirements. We’re better able to handle the differences, the small differences that can from time to time appear between GAAP and tax.
Now some of the CLO equity focused competitor funds, which are heavily allocated to CLO equity, I will just confess that they have a harder time with that and to confront some of their tax obligations, sometimes you’ll see those CLO equity focused funds make special distributions at year-end to confront those tax obligations. So hopefully that’s helpful in explaining the XFLT distribution history and explaining the philosophy that the fund Board uses in terms of guiding the approach to declaring our monthly distributions.
Steven, do you see any more questions from the audience? I think we’ve addressed the ones that have come in. If you — we appreciate the shareholders who’ve already taken the time to vote. It’s very quick and easy. So please recall to do so. Your vote is important to us. And then if you have any other questions, you can contact Steven, you can contact me directly. We’re always happy to take your calls or e-mails. It was a pleasure. Thanks so much to Lauren for joining us on today’s webinar and thanks to Gretchen as well.