A good hunting ground for double-digit yields is the world of closed end funds (CEFs), as my colleague Tim Melvin often points out.
For those of you who are unfamiliar, CEFs are a type of fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created and no new money will flow into the fund.
That means the shares can trade at a premium or discount to the net asset value – meaning you can buy a fund that owns great stocks for less money than the shares you get to control are worth.
Let me show you a great opportunity in this space…
A very popular CEF is the Liberty All-Star Equity Fund (USA). Its investment objective is to seek total investment return, consisting of long-term capital appreciation and current income. Since its inception in 1986, USA has delivered a 2,440% total return.
What I like most about this fund is that it uses a multi-manager strategy—without the use of any leverage.
USA allocates its portfolio assets on an approximately equal basis among several independent investment managers (currently five of them), all with different investment styles, recommended and monitored by USA’s investment advisor, ALPS Advisors, Inc.
There are three value managers—Aristotle Capital Management, Fiduciary Management, and Pzena Investment Management—along with two growth managers, Sustainable Growth Advisors and TCW Investment Management.
So, you have access to five portfolio managers using different styles in one package. USA’s 0.93% total expense ratio is not only reasonable within the CEF universe, it’s fantastic for a fund of funds.
The fund’s portfolio clearly reflects the various investing styles coming together under a single umbrella and is quite diversified. The value part is quite evident in the 21.2% allocation to financials, and the growth part shows up in the 21.4% allocation to the technology sector.
Here are the other sector allocation percentages:
- Healthcare: 14.2%
- Consumer discretionary: 13%
- Industrials: 8%
- Communication services: 5.9%
- Materials: 5.8%
- Consumer staples: 4.6%
- Energy: 2.6%
- Real estate: 1.9%
- Utilities: 1.4%
Not surprisingly, the top four stocks are members of the Magnificent Seven: Microsoft (3.4%), Nvidia (2.5%), Amazon (2.5%), and Alphabet (2.3%).
A Closer Look
Historically, the fund has had some big fluctuations in its trading price relative to its underlying net asset value. In the last 10 years, USA has traded at more than a 20% discount and more than a 15% premium, so investors should brace themselves for some potentially wild short-term volatility. It currently trades at nearly a 3% discount,
Liberty All-Star Equity Fund’s payout policy is to pay distributions on its shares totaling approximately 10% of its net asset value per year, payable in four quarterly installments of 2.5% of the fund’s net asset value at the close of trading on the Friday prior to each quarterly declaration date.
These fixed distributions are not related to the amount of the USA’s net investment income or net realized capital gains or losses, and may be taxed as ordinary income up to the amount of the fund’s current and accumulated earnings and profits. If the total distributions made under the distribution policy exceed its net investment income and net realized capital gains, the excess will generally be treated as a non-taxable return of capital, reducing the shareholder’s adjusted basis in his or her shares.
Distributions that involve paying out a percentage of assets regularly have predictability as a key advantage. Shareholders should never be surprised by a distribution increase or decrease because of its payout policy.
As the share price rises, so does the distribution, and vice-versa. A look at USA’s distribution history shows that the quarterly distribution took a big hit during the 2008-09 global financial crisis, but it’s been rising mostly ever since, even during the pandemic recession. However, the distribution did fall during the 2022 bear market for both stocks and bonds.
Currently, USA has a yield of 10.27%. The fund’s price is up 6.26% over the past year and 2.41% year-to-date.
While there have been ups and downs, as there are with any fund that’s been around for 37 years, the fund’s long-term track record has been pretty good. The diversified approach and balance between value and growth strategies are unlikely to ever produce market-leading returns, but it should help to smooth out volatility in the pursuit of building wealth over the long-term.
USA is a buy under $6 per share.
For more CEF opportunities at a discount, check you Tim Melvin’s CEF newsletter below.