XFLT: The High-Yield Mirage – Why Risk-Adjusted Returns and Sustainability Signal Caution

The XAI Octagon Floating Rate & Alternative Income Term Trust (XFLT) has long lured income-seeking investors with its eye-popping 16.85% yield. However, a closer look at its risk-adjusted returns and financial sustainability reveals a troubling narrative: XFLT's high yield is increasingly at odds with its deteriorating performance and structural vulnerabilities. For investors, this raises a critical question: Is XFLT a compelling income play, or a cautionary tale of unsustainable payouts?

Risk-Adjusted Returns: A Sharpening Decline

XFLT's performance metrics tell a story of diminishing returns. Over the five years ending 2025, the fund's Sharpe ratio stood at 0.53, suggesting it generated modest risk-adjusted returns. But this masks a sharp reversal in the past 12 months, where the Sharpe ratio plummeted to -1.23-far worse than the S&P 500's 0.76. This stark underperformance reflects not just volatility but a failure to reward investors for the risks taken.

The Calmar ratio, which measures returns relative to drawdowns, compounds the concern. At -0.40 for 2025, XFLT's ratio underscores its inability to avoid significant losses during market stress, according to a Seeking Alpha article. These metrics align with broader trends reported by Seeking Alpha: XFLT's 3-year annualized return of -7.47% and a year-to-date drop of -14.46% highlight its struggle to navigate rising interest rates and sector-specific strains.

Dividend Sustainability: A House of Cards?

XFLT's 16.85% yield, while alluring, is built on precarious foundations. The fund's payout ratio-105.75% as of September 2025-means it distributes more in dividends than it earns, a red flag for long-term viability. This imbalance has already forced cuts: In May 2025, XFLT reduced its monthly dividend by 9.09%, from $0.077 to $0.070 per share. Such reductions are likely to continue, given its Dividend Sustainability Score of 4.59% and a Dividend Growth Potential Score of 55.16%, both pointing to eroding confidence in its payout model.

Compounding these issues is XFLT's exposure to private credit and leveraged loans. While these assets aim to generate income across credit cycles, they also amplify risks during downturns. With the fund trading at a 7.96% discount to net asset value (NAV) as of August 2025, the market appears to price in concerns about asset quality and valuation compression. Analysts warn that defaults in its portfolio could further suppress returns, exacerbating the fund's challenges.

The Bigger Picture: A Misaligned Strategy

XFLT's struggles reflect a broader tension in the alternative income space. Its focus on floating rate instruments and structured credit investments, while theoretically adaptive to rate cycles, has proven vulnerable to macroeconomic headwinds. Elevated interest rates have compressed yields in loan and CLO markets, directly impacting XFLT's ability to cover payouts. Meanwhile, its high leverage and concentrated portfolio amplify downside risks, making it a poor fit for risk-averse investors.

For those chasing income, XFLT's trajectory offers a sobering lesson: high yields often come with hidden costs. The fund's negative returns, unsustainable payout ratios, and deteriorating risk metrics suggest that its current yield is a mirage-one that may vanish as market conditions evolve.

Conclusion: Proceed with Caution

While XFLT's 16.85% yield is tempting, the data paints a clear picture: its long-term value is under siege. Poor risk-adjusted returns, a structurally unsound payout model, and macroeconomic headwinds collectively argue against treating XFLT as a reliable income source. Investors would be wise to approach this fund with caution, prioritizing sustainability over yield alone. In a market where risks are increasingly mispriced, XFLT serves as a reminder that what glitters may not always endure.