GOF: An 11.6% Yielder Trading At A 'Cheap' 12.5% Premium Is A Decent Deal
GOF: An 11.6% Yielder Trading At A 'Cheap' 12.5% Premium Is A Decent Deal
Public
Summary
This is a fund that I've written about previously, more so in a bearish manner as the valuation and under-earned distribution always concerned me.
The fund recently merged with two other Guggenheim funds, GPM and GGM, which sent the valuation lower by 13%.
A new Guggenheim fund is coming out in the next few weeks, GUG, which may be sapping some demand from GOF as investors go from a 13% premium to NAV.
However, GUG's new yield will be much lower than GOF's, which could reverse that flow.
I like GOF here for a medium term hold given the lack of opportunities in the CEF space. This is a relative value true.
This report was issued to members of Yield Hunting on Nov 22nd. All data herein is from that date or sooner. Most figures have not changed all that much since then. FYI, we are reducing our public articles so only a fraction of these will be visible on the main part of the site.
Guggenheim Strategic Opp (NYSE:GOF)
GOF is an interesting high yield, cross-asset fund that we think looks relatively attractive today at its current valuation. The fund is mostly invested in bank loans and high yield corporates. I compare the fund to the PIMCO CEF suite in terms of positioning, risk, and yield.
The fund recently gobbled up two other Guggenheim funds, GPM and GGM, and is now a fairly large fund with over $2B in total assets. We will discuss why we think the shares can be bought at these levels despite the premium and some other risks it faces.
What?
This fund is at a 12.5% premium. And wait, is that distribution yield earned? Nope.
So what gives….?
Let’s go through it.
What Does This Fund Do?
This is a traditional multisector bond fund. These are cross-asset portfolios that can move into whichever piece of the bond market they deem most desirable. They also own some equities and have a covered call option strategy on top. This is true go-anywhere type of fund.
The one thing I like about it is that they really use leverage how it is supposed to be used. For example, going into the Covid Crisis back in February 2020, the fund employed no leverage. The semi-annual report from then stated how they saw valuations as too rich across all assets. They trimmed down their risk exposure in response to what they saw.
Shortly after the Covid Crisis hit, they then began levering up the fund. By the end of May they were at 9% and by November had hit 27%. By the end of May this year, they were still at 30%. However, between May 31, 2021 and today, leverage has been reduced significantly since assets have appreciated materially and have arguably become overvalued again.
For those that want a slightly more risky “bond fund” that pays you handsomely, this is a fund to take a look at today.
Fund Characteristics
· Inception: 7/26/2007
· Total assets: $2,065mm
· Leverage: 15%
· Expense Ratio: 1.83%
· Avg Discount (3yr): 13.3%
· Market Yield: 11.6%
· Current Distribution: $0.182 per share per month
· Daily Volume 593K shares
· Daily Volume $8.15mm
A Quick Look At The Portfolio
It is helpful to look at what they own so you get a better sense of the strategy but it does change fairly often. Here the managers are more active than most other ‘active’ managers. They actually earn their bacon by constantly looking at what is of value and what they can monetize out of the portfolio.
Nearly 50% of the portfolio are bank loans. This is something I like and have been stressing in our Morning Notes and Weekly Commentaries. Another 30% in high yield corporate bonds plus about 14% in ABS.
(Source: Guggenheim)
The fund also invests in equities and preferred stocks that account for about 16% of the total assets. You can also see they have private placements which are pre-IPO venture capital.
The investment strategy is basically go-anywhere. The prospectus states that the investment objective as follows:
The Fund seeks to combine a credit-managed fixed-income portfolio with access to a diversified pool of alternative investments and equity strategies. The Fund seeks to achieve its investment objective by investing in a wide range of fixed-income and other debt and senior-equity securities (“Income Securities”) selected from a variety of credit qualities and sectors, including, but not limited to, corporate bonds, loans and loan participations, structured finance investments, U.S. government and agency securities, mezzanine and preferred securities and convertible securities, and in common stocks, limited liability company interests, trust certificates, and other equity investments (“Common Equity Securities”), exposure to which is obtained primarily by investing in exchange-traded funds (“ETFs”) that Guggenheim believes offer attractive yield and/or capital appreciation potential, including employing a strategy of writing (selling) covered call and put options on such equities. Guggenheim believes the volatility of the Fund can be reduced by diversifying across a large number of sectors and securities, some of which historically have not been highly correlated to one another.
The fund has no limitation in to how much they can invest in fixed income securities that are rated "junk." They can also invest up to 20% of assets into non-US dollar denominated fixed income securities from outside of the US. And up to 10% of total assets in fixed income in emerging markets.
Interesting and uniquely, they can invest up to 50% of the total assets in common equity securities as well. This includes common stocks but more often they invest in ETFs and other investment funds (including CEFs).
Lastly, they can invest up to 30% of total assets in investment funds that are '40 Act funds. These include those CEFs mentioned but also mutual funds, ETFs and other listed investment vehicles.
Recent Corporate Action Lends To Thesis
On April 20, 2021, Guggenheim announced that the board of trustees of three of the funds from the sponsor, approved a merger of GPM and GGM, into GOF. The Guggenheim Credit Allocation Fund (NYSE:GGM) and the Guggenheim Enhanced Equity Income (NYSE:GPM) have different strategies and mandates than GOF. But GOF was arguably the better and more successful product given the track record.
The three funds had very little overlap in investment mandates. It is unclear why they wanted to end GPM and GGM's but GOF consistently traded at a higher valuation and a much stronger total return NAV over the last 5 years.
Perhaps they thought they could grow GOF to be much larger given their at-the-market offering ("ATM") if the other funds were merged into it. An ATM in the CEF world is a fund that slowly trickles out new shares to the market when the price is above the NAV, slowly growing the total assets of the fund- and of course the fee revenue.
The other two funds had these but used them far less since the price was at a discount much of the time.
The premium for GOF fell from ~23% to about ~13% once the merger was announced. It is currently trading around an 11% premium.
But in reality, the fund is not any different, just larger. Sometimes greater size can mean it is harder to implement the strategy. In this case, that is highly unlikely. The markets that GOF operates are liquid and the amount of assets being deployed is relatively small.
I could see if the GOF strategy was being diluted by the addition of GGM and GPM but that isn't what is happening. What I mean is if GOF was $1B in assets, GGM was $400mm and GPM was $600mm, then the new fund ("New GOF") would be 50% GOF's strategy, 20% GGM's, and 30% GPM's. In those cases, blending the valuations of the funds would make sense.
However, since they are liquidating the other funds and merging it into GOF, the new fund is still 100% GOF. In my estimation, the valuation of GOF should have remained the same.
GOF 2.0 Coming To Market Soon
Guggenheim announced its intention to IPO a new fund, Guggenheim Active Allocation Fund (NYSE:GUG). The new fund made some buzz over the summer as it could hold crypto-assets as part of its portfolio. In the N-2 filing, they noted that:
The Fund may seek investment exposure to cryptocurrency (notably, Bitcoin), often referred to as “virtual currency” or “digital currency,” through cash settled derivatives instruments, such as cash settled exchange traded futures, or through investment vehicles that offer exposure to Bitcoin or other cryptocurrencies through direct investments or indirect exposure such as derivatives contracts.
This fund has the objective of seeking to "maximize total return through a combination of current income and capital appreciation."
Literally word for word of GOF's investment objective. However, the way they get there is a bit different. The brochure notes:
The Fund will pursue both a tactical asset allocation strategy, dynamically allocating across asset classes, and a relative value-based investment strategy, utilizing quantitative and qualitative analysis to seek to identify securities with attractive relative value and risk/reward characteristics. The Fund’s sub-adviser, Guggenheim Partners Investment Management, LLC (the “Sub-Adviser”), seeks to combine a credit-managed fixed-income portfolio with a diversified pool of alternative investments2 and equity strategies. The Fund is a new offering that will seek to dynamically allocate across fixed income, equity and alternative strategies2 to maximize total return. The flexibility to allocate across asset classes and express Guggenheim’s macroeconomic views, while also giving investors access to non-traditional fixed income, offers the potential to deliver alpha by exploiting market inefficiencies. There can be no assurance that the Fund’s investment objective will be achieved.
In a lot of ways it is similar to GOF but in others it's slightly different. This fund will focus on an active/dynamic asset allocation that is much more tactical while GOF focuses more on buying individual securities that are undervalued.
But this is not about GUG. Why I discuss GUG is because it is currently being shopped around and gaining a lot of interest. I know a lot of wirehouses that are selling their GOF to buy GUG. The thinking is that you go from a 13% premium to NAV "saving" that 13%.
The Distribution
GOF's distribution looks juicy on the outside. However, the 11.72% yield is not covered ("earned") by the net investment income from the underlying portfolio. In other words, the interest from the bonds and other holdings do not actually produce the $0.1872 per share distribution payment.
Last year, the distribution was only about 34% earned with most of the rest being classified as a return of capital. Those three words, 'return of capital' has a large negative connotation but in some cases, it is fine - even a positive.
(Source: Guggenheim)
In the case of GOF, the excess distribution is simply the capital appreciation from the underlying securities. In other words, they are paying their investors the underlying income production PLUS the appreciation. While capital appreciation can be inconsistent Guggenheim has had success in maintaining a stable NAV. [I understand a lot of the holdings may be illiquid and not marked to market.]
The NAV stability is likely the key to the distribution being kept the same. The ATM offering also helps bring in new capital that can be used to fund the distribution. This, however, is not a positive thing since if the price goes below the NAV, the ability to bring in that new capital would end and they would then have a choice to make regarding the distribution payment.
I do think some advisors are moving to the pre-IPO GUG in to save on the valuation. However, the new GUG yield is rumored to be in the 6.75% - 7.25% area. That is obviously much lower than GOF's yield (again, which is not covered).
Once that is declared about 45-60 days post IPO (and pricing looks to be next week), it could cause some to sell out of GUG and move back to GOF. On the other hand, with the crypto news, it may cause some buying based on that "hot" allocation.
Concluding Thoughts
GOF is a great fund but it has always traded expensive, much like PIMCO Dynamic Income (NYSE:PDI). You can see the long-term performance of these funds since 2017. PDI outperformed early on because of the allocation to non-agency and the much higher leverage. Since the Covid Crisis, the two funds have performed similarly.
I do think the merger and upcoming new Guggenheim fund is depressing the valuation. This is a relative play for me meaning that I do think the downside risk here is lower than the upside potential in a CEF market that is characterized by high valuations. I also like the underlying portfolio of mostly loans and asset-backed securities.
But this is not a long-term hold for me as of now and that may change. My concerns over the structure of the fund in terms of using the ATM to fund the distributions and the need for the shares to stay at a premium concern me to this day (I wrote about this fund many years ago).
Given the dearth of opportunities in the CEF space, I took a decent-sized position in this one as my confidence level is relatively high.
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