abrdn Income Credit Strategies Fund (ACP-PA)

abrdn Income Credit Strategies Fund is a closed-end mutual fund that invests in bonds — specifically, corporate debt across different credit qualities and maturities. The fund’s strategy is to build a portfolio of bonds that pay interest coupons, then use leverage (borrowing money) to amplify the returns. By borrowing at short-term rates and investing the proceeds in longer-term bonds that pay more interest, the fund can generate a higher dividend than the bonds would naturally yield. That works well when credit spreads are wide and short-term rates stay low, but it becomes a problem when the credit cycle turns, when short-term rates spike, or when bond spreads tighten. The fund is managed by abrdn, a large Edinburgh-based asset management firm, and it serves income-focused investors willing to accept the risks that come with leverage and credit exposure.

The fund structure and investment approach

A closed-end fund in bonds operates on the same principle as a closed-end real estate fund: a fixed pool of capital is invested into a portfolio of assets and locked down, with no daily redemption mechanism. When you buy shares, you are buying a claim on the income and capital appreciation of the underlying bond portfolio. Unlike an open-end bond fund, where every shareholder owns a pro-rata piece of the fund’s assets, a closed-end bond fund shares a fixed amount of assets. If the fund declines in value, that loss is borne entirely by current shareholders; there is no mechanism to protect early buyers from future losses.

The fund’s strategy is straightforward in principle: invest in corporate bonds from investment-grade issuers (those with strong credit quality) and high-yield issuers (those with more credit risk and higher yields to compensate). The fund then borrows money in the short-term credit markets — commercial paper and short-term bank loans — to buy additional bonds. This is called leverage. If the fund borrows at 4 percent and invests the proceeds in bonds yielding 6 percent, the net gain of 2 percent increases returns to shareholders. The fund pays out most or all of that gain as a dividend.

This strategy makes sense in certain market environments. When short-term rates are low relative to longer-term bond yields, leverage amplifies returns without creating undue risk. The fund can generate a high current yield — perhaps 8 to 10 percent or more — that appeals to income-focused investors. When credit spreads (the extra interest high-yield bonds pay over safe bonds) are wide, there is also a margin of safety built in: if an economy turns and some bonds default, the fund has already been paid enough extra yield to absorb some losses. But that margin of safety can evaporate if spreads compress (tighten) or if the credit cycle turns sharply downward.

How the leverage works and where the risk lives

Understanding leverage is central to understanding abrdn’s strategy and its risks. The fund’s net asset value is the total value of bonds it holds, minus the value of the debt it has borrowed. As long as the bonds are generating more interest than the borrowing costs, shareholders benefit from leverage. But there are several failure modes.

First, if the bonds the fund holds decline in value, the fund’s leverage magnifies that loss. If the fund borrows a dollar to buy a bond and the bond falls 10 percent in value, the fund’s equity has fallen 20 percent (or more, depending on the leverage ratio). A sharp credit market shock — a recession, a financial crisis, a sudden spike in default rates — can trigger rapid mark-to-market losses and force a painful choice: sell bonds at terrible prices to deleverage, or hold and accept that the fund’s share price will fall sharply.

Second, if the cost of short-term borrowing (the interest rate on commercial paper or bank loans) rises sharply, the fund’s net income gets compressed. If short-term rates go from 2 percent to 5 percent while bond yields stay flat, the leverage that was generating extra return now destroys it. The fund has to cut its dividend, which causes the share price to fall as investors re-evaluate how much they are willing to pay for a lower yield.

Third, in a liquidity crisis — a moment when credit markets seize up and borrowing becomes difficult or impossible — a leveraged fund can be forced to sell bonds at any price just to meet its borrowing obligations. This happened dramatically during the 2008-09 financial crisis, when many closed-end bond funds suffered huge losses and had to dramatically cut dividends as leverage became unsustainable.

The current environment and what has changed

abrdn’s fund thrived in the period from roughly 2009 through 2021, when interest rates were low and credit spreads were generous. The Federal Reserve kept short-term rates near zero, bond yields were relatively high, and corporate credit was strong. The fund could leverage at nearly free rates and invest in bonds earning 5, 6, or 7 percent, generating attractive dividends for shareholders without taking extraordinary risks.

That environment has changed. Short-term rates have risen to levels not seen since before 2008. Longer-term bond yields have also risen, but not by the same magnitude, which has compressed the advantage of leverage. The spread between short-term borrowing costs and long-term bond yields — the crucial margin that leverage exploits — has narrowed significantly. Additionally, there is real concern about credit in parts of the market: certain industries have heavily levered balance sheets, and economic growth uncertainty creates risk that some bonds will default.

In this environment, the fund’s dividend is under pressure. It has to choose between maintaining a high dividend by accepting higher leverage ratios (and thus more risk), or reducing the dividend to a more sustainable level. Additionally, if short-term rates remain high for years, the leverage strategy becomes structurally unprofitable: the borrowing cost will exceed the bond yield forever, and the fund will be in slow, terminal decline.

The management team and the strategy’s evolution

abrdn is a major global asset manager with deep expertise in fixed income investing. The firm manages tens of billions of dollars in bond and credit portfolios. The Income Credit Strategies Fund benefits from that expertise: the team that selects bonds, manages credit risk, and timing calls on when to adjust leverage has real experience. That said, the fund is ultimately constrained by market conditions: even a skilled bond manager cannot make leverage profitable when short-term rates are very high.

The fund has been adapted and rebalanced multiple times as market conditions have shifted. The manager has reduced leverage ratios at various points when the cost of borrowing became prohibitive, bought different types of bonds to optimize the risk-return mix, and adjusted the strategy based on economic outlook. But these adjustments are marginal changes within a broadly fixed structure. The fund cannot permanently solve the problem of leverage being uneconomical without redesigning itself.

Like all closed-end funds, abrdn’s shares trade at a price that may diverge significantly from the net asset value — the actual value of the bonds held divided by the number of shares outstanding. When investors are confident in the income stream and confident in credit, they might pay a premium: they are willing to pay more than net asset value for a stream of regular dividends. When fear is high or rates are rising sharply, the fund might trade at a steep discount: investors are skeptical and want a bargain price before committing capital to a leveraged bond fund.

The fund has experienced large swings between premium and discount valuations. During periods of extreme discount, a long-term investor holding the fund has suffered large share-price losses even if the underlying bonds were performing reasonably well. That is the cost of owning a leveraged closed-end fund: you are betting not just on the bonds, but on investor sentiment toward leverage and credit.

How to research this fund

Anyone considering this fund should read the prospectus and understand the leverage strategy, the current leverage ratio, and the distribution policy. The annual and semi-annual reports will show the current portfolio composition, the expense ratio, the fee structure, and how distributions are calculated. Watch whether the fund is maintaining its dividend at a stable rate or whether it is being forced to cut it. Watch the leverage ratio: if it is increasing, the fund is taking more risk; if it is decreasing, the fund is being more conservative.

Compare the current yield on the shares to what you could earn in a simple bond fund or in individual bonds, and think carefully about whether the extra yield is adequate compensation for the leverage risk. In times of credit stress or rising rates, leveraged funds tend to underperform their non-leveraged peers significantly. The dividend might be high, but if the share price falls 20 or 30 percent, the total return is poor. This is not a buy-and-forget vehicle; it requires active monitoring and a clear understanding of when the leverage is working in your favor and when it is working against you.