Fewer Distribution Cuts For January

In the January announcements, we saw few material cuts to distributions with only one increase (greater than 3%).  That compares to the 27 cuts we saw in December and the 7 distribution increases.  The big winners this month were the municipal funds which look like they've turned a corner.  For one, interest rates seem to have made an interim peak and are now down materially from the October highs at 2.57%.  

According to CEFA, the average levered national muni fund trades at a discount of 11.4%.  This is the largest at anytime of the last ten years and even surpasses the wide discounts of late 2015.  

Overall, discounts have bounced off very wide levels reached during the Christmas week when the bottom seemed to fall out of all funds.  We think a combination of tax loss harvesting and the spike in the VIX created a perfect storm for CEFs selling off.  These securities have lower liquidity so it doesn't take much in the way of sell orders to wipe out the limit book and see the floor drop.  

(Source: Closed-end Fund Advisors)

You can clearly see the bounce back in the above chart with the anomaly being the second and third week of December.  Discounts are still very wide compared to recent history.  Getting back to munis, just 16 months ago, the average muni closed-end fund traded at a premium to NAV.  Today, as we noted above, the average fund trades at an 11% discount.  

Distribution Increase (greater than 3%)

Invesco Senior Income (VVR):  Monthly distribution increased 7.7% to $0.021 from $0.0195.

Distribution Decreases (greater than 3%)

Lazard Global Total Return (LGI):  Monthly distribution decreased by 23.2% to $0.089 from $0.116.

Lazard World Div & Inc (LOR):  Monthly distribution decreased by 21.7% to $0.058 from $0.074

Delaware Enhanced Global Div & Inc (DEX):  Monthly distribution decreased by 4% to $0.091 from $0.0945.

Delaware Dividend and Income (DDF):  Monthly distribution decreased by 4% to $0.091 from $0.095. 

MFS Special Value (MFV):  Monthly distribution decreased by 3.6% to $0.0436 from $0.0452.

Last month, we highlighted the DoubleLine Opportunistic Credit (DBL) fund which cut their distribution by 34%.  The share price reacted as expected with the fund dropping from a small premium to a 7.7% discount over the subsequent 3 weeks.  The distribution yield dropped from 10.36% to the current 6.86%.  That cut in income sent some investors to the exits.  

However, as we noted last month, the cut was not a reduction in the income payout but a cessation of the fund paying out ROC.  In other words, all they did was stop returning your own capital.  If you wanted to maintain the same 10.36% distribution, you could effectively sell a few shares each month and 'pay it to yourself'.  

This month, the large distribution cutter was the two global equity income funds from Lazard.  LGI and LOR cut their distributions by a significant 23% and 21%, respectively.  This may be due to 1) the creation of the targeted 7% of NAV distribution policy and 2) the pending shareholder approval of the merger of LOR into LGI.  

In the press release, they cited the 7% of NAV policy:

NEW YORK, December 14, 2018 – The Board of Directors of Lazard Global Total Return and Income Fund, Inc. (the “Fund”) (NYSE:LGI) has authorized the Fund to declare today, pursuant to a level distribution policy, a monthly distribution equal to, on an annualized basis, 7.0% of the Fund’s net asset value per share as of the close of markets on December 31, 2018 on the Fund’s outstanding common stock. The distribution is payable on January 23, 2019 to shareholders of record on January 11, 2019. The ex-dividend date is January 10, 2019

In other words, in months when the NAV of the funds declines, the distribution is likely to decline as well.  The NAV has been on a steady long-term decline as the stronger dollar and weak equity prices have weighed on the fund's value.  Unless that decline arrests, it is likely that another cut will be in store for next month.  

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Despite what CEFConnect.com says about the distributions, the 19a shows it being 100% return of capital.  There was a blurb on the 19a stating that the fund estimates that it has "distributed more than its net investment income and net realized capital gains."

Despite the large size of the cuts, the share price didn't react likely because of the already wide discounts, the new distribution policy, and the pending merger.  The new distribution policy should help prevent the NAV from falling as sharply since that payment comes directly out of the net asset value.  

In general, investors shouldn't be concerned with the distribution cuts since they were just returning your own capital to you anyway.  The change was clearly a move to prevent the NAV from declining further.  

Concluding Thoughts

The opportunities in the closed-end fund market today are tremendous and despite the market being down significantly.  The lack of distribution cuts for January, traditionally a month when we see a large amount of changes in the distribution, bodes well for the space.  Still, investors need to be aware of distribution announcements, most of which are released on the first few days of the month.  

The big cuts to distributions were relegated to the equity side with the Lazard funds.  The discount on the funds are wide given the weakness in European equities specifically.  For those holding the shares, you may want think about swapping at least some of the position to Swiss Helvetia Fund (SWZ) which has a lot of overlap in terms of exposure.  However, we do think SWZ will eventually liquidate.  New financials will be out in the next month or so which should shed some light on the probability of that outcome.  At a 13%+ discount, that would be a compelling risk-reward.  

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