XFLT: A Steady 14.6% Yield Amid Rising Rates, But Beware Credit Cycles

The XAI Octagon Floating Rate & Alternative Income Trust (XFLT) offers investors a compelling income opportunity in an environment where traditional fixed-income yields remain muted. With an annualized distribution yield of 14.5% as of June 2025, XFLT stands out among closed-end funds (CEFs), particularly as it positions itself to navigate rising interest rates and credit market volatility. However, its robust performance hinges on a nuanced mix of strategic asset allocation, disciplined risk management, and the proven expertise of its sub-advisor, Octagon Credit Investors. Let's dissect its strengths, risks, and suitability for income-focused portfolios.

The Case for XFLT: Yield, Leverage, and Liquidity

XFLT's 14.5% yield (based on its market price) is underpinned by its 80% allocation to floating-rate credit instruments, including senior secured loans and collateralized loan obligations (CLOs). These assets are inherently less sensitive to rising rates, as their interest payments reset periodically. This structural advantage is critical in a Fed tightening cycle, where traditional bonds face valuation headwinds.

The fund's low leverage of 38.3% (as of January 2025, the most recent data) further distinguishes it from many leveraged CEFs. This conservative use of borrowed capital reduces the risk of forced sales during liquidity crunches and limits the volatility of its net asset value (NAV).

Credit Fundamentals: A Defensive Edge

XFLT's portfolio leans into below-investment-grade credit, but its focus on senior secured loans—which sit higher in corporate capital structures—buffers against defaults. Octagon's rigorous credit analysis and proprietary ratings system aim to identify issuers with improving fundamentals, even in weaker economic conditions.

The inclusion of CLO equity, which offers equity-like upside in rising rate environments, adds another layer of defensive positioning. While CLOs carry liquidity risks during market stress, their floating-rate nature aligns with XFLT's overarching strategy.

Octagon's Track Record: A Key Differentiator

The fund benefits from the $32 billion credit expertise of Octagon Credit Investors, a firm with over 25 years of experience managing stressed and opportunistic credit portfolios. Its four-step investment process—continuous opportunity assessment, rigorous analysis, committee-driven approvals, and active monitoring—has delivered consistent returns over cycles. Key managers like Lauren Law and Gretchen Lam bring decades of collaboration, which is rare in an industry often plagued by turnover.

Distribution Consistency Amid Challenges

Despite a 9.1% cut in June's distribution (to $0.070 per share from $0.077), XFLT has maintained a 100% net income payout for distributions in recent years, avoiding return-of-capital dilution. The reduction reflects yield compression in loan and CLO markets, a headwind that may persist if spreads narrow further. However, the 14.5% yield remains compelling compared to alternatives, and the fund's history of monthly distributions since its 2016 inception signals operational stability.

Risks to Consider

• Credit Cycle Volatility: Exposure to below-investment-grade credit means defaults could rise if economic growth slows.
• Liquidity Constraints: CLOs and private loans may face reduced trading volumes during market stress.
• Rate Spread Compression: Narrowing spreads between high-yield and Treasury yields could limit future yield upside.
• Discount to NAV: XFLT's shares often trade at a discount to its NAV, which could widen in a risk-off environment.

Is XFLT Right for Your Portfolio?

For income-focused investors willing to accept credit risk, XFLT offers a high-yielding, rate-resistant alternative to traditional bonds. Its floating-rate exposure and low leverage make it a viable hedge against rising rates, while Octagon's credit discipline reduces downside risks.

However, investors should avoid overconcentration: Allocate no more than 5-10% of a portfolio to such high-yield CEFs, and pair them with safer fixed-income holdings. Additionally, monitor the fund's discount to NAV (currently around 5-8%) and distribution sustainability, as any further cuts could pressure its market price.

Final Take

XFLT is a selective buy for portfolios needing income resilience in 2025. Its yield, rate sensitivity, and Octagon's track record justify its place in conservative growth strategies—provided investors acknowledge and manage its credit and liquidity risks. As always, diversification and a long-term horizon are critical to navigating the inevitable cycles ahead.

Investment Grade: B+ (High Yield, Moderate Risk)
Hold for: 1-3 years