NFJ: Poor Performance, But The Portfolio Is Not That Bad For Today's Market

seekingalpha03-26

The Virtus Dividend, Interest & Premium Strategy Fund uses a combination of convertible securities and dividend-paying common stock to generate income.The fund has a higher current yield than its ...

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There is no reason to expect that it cannot sustain the new higher level.The fund is currently trading at a very attractive valuation, but I see no reason to expect that it will outperform its peers.   Kameleon007 The Virtus Dividend, Interest & Premium Strategy Fund (NYSE:NFJ) is a closed-end fund that income-focused investors can employ as a method of achieving their goals. This fund uses a somewhat unusual strategy to achieve this goal, but it will probably not be surprising to those regular readers who are familiar with some of Virtus’s other closed-end funds. After all, this one uses a combination of convertible securities and dividend-paying common stock as its primary source of income. It then throws in a covered call strategy for additional income, much like some of Eaton Vance’s equity income funds. This all allows the fund to boast an 8.92% yield, which is certainly reasonable for a closed-end fund that does not require investors to sacrifice all of the potential upside that comes with an equity investment. Morningstar classifies the Virtus Dividend, Interest & Premium Strategy Fund as an “Equity–Covered Call Fund,” so we can use that to establish a peer group for this fund. Here is how its yield compares against said peers:   Fund Name Morningstar Classification Current Yield   Virtus Dividend, Interest & Premium Strategy Fund Equity – Covered Call Fund 8.92%   BlackRock Enhanced Equity Dividend Trust (BDJ) Equity – Covered Call Fund 8.15%   Eaton Vance Enhanced Equity Income Fund (EOI) Equity – Covered Call Fund 7.08%   Columbia Seligman Premium Technology Growth Fund (STK) Equity – Covered Call Fund 5.75%   First Trust Enhanced Equity Income Fund (FFA) Equity – Covered Call Fund 6.57%   Madison Covered Call & Equity Strategy Fund (MCN) Equity – Covered Call Fund 9.86%   Voya Global Advantage & Premium Opportunity Fund (IGA) Equity – Covered Call Fund 8.89%   Click to enlarge As we can see, the Virtus Dividend, Interest & Premium Strategy Fund has a higher current yield than many of its peers. This is something that might attract income-focused investors, but it is not necessarily a good thing. After all, an outsized yield relative to its peers might suggest that investors have to sacrifice something in exchange for yield. In the case of the Madison Covered Call & Equity Strategy Fund, it is upside potential as that fund has a much higher percentage of its portfolio overwritten than the other funds listed here. In the case of the Virtus Dividend, Interest & Premium Strategy Fund, it may be performance as we are about to see. As is the case with many of Virtus’s closed-end funds, the Virtus Dividend, Interest & Premium Strategy Fund has delivered a rather disappointing performance over the past three years. As we can see here, shares of the fund have declined by 7.95% over the period. For comparison purposes, the S&P 500 Index (SP500) is up 32.83% over the same period:   Seeking Alpha While income-focused investors might be willing to accept a certain amount of underperformance in exchange for a higher distribution yield, the idea of losing money over a three-year period is likely to be anathema to them. This is especially true when we consider that investors in this fund have been watching everything else go up in price while their positions in this fund stagnate. However, this alone does not tell the whole story. As I have pointed out in various previous articles, closed-end funds typically pay out most or all of their investment profits to their shareholders in the form of distributions. The basic goal is to keep the underlying portfolio relatively stable while giving the investors all of the capital gains and other profits. This is one of the reasons why funds such as this one have very high yields relative to the rest of the market. It also means that shareholders do much better than the share price performance alone would suggest. As such, we need to take the fund’s distributions into consideration as part of any performance analysis. When we do that, we see that investors in this fund have realized a 15.74% total return over the trailing three-year period. This is still worse than the S&P 500 Index, but it is much better than the loss that is indicated by the share price performance alone:   Seeking Alpha The iShares Convertible Bond ETF (ICVT) is down 11.57% over the same period after we take the distributions paid by the index fund into account, so this fund has obviously beaten that possible benchmark. This fund’s fact sheet does not actually provide a performance benchmark for it, so it is uncertain which of these indices (if either) the fund is using to evaluate its performance. Unfortunately, this fund has underperformed all of its peers over the trailing three-year period by a considerable margin:   Seeking Alpha In table form:   Fund Name Trailing Three-Year Total Return   Virtus Dividend, Interest & Premium Strategy Fund 15.74%   BlackRock Enhanced Equity Dividend Trust (BDJ) 20.36%   Eaton Vance Enhanced Equity Income Fund (EOI) 37.29%   Columbia Seligman Premium Technology Growth Fund (STK) 36.59%   First Trust Enhanced Equity Income Fund (FFA) 24.06%   Madison Covered Call & Equity Strategy Fund (MCN) 28.42%   Voya Global Advantage & Premium Opportunity Fund (IGA) 22.80%   Click to enlarge Admittedly, this is not likely to make anyone favor this fund over one of its peers, especially when comparing it to the Eaton Vance Enhanced Equity Income Fund or the Columbia Seligman Premium Technology Growth Fund. However, both of those funds have significantly lower yields than the Virtus Dividend, Interest & Premium Strategy Fund. In addition, it is always important to keep in mind that past performance is no guarantee of future results so we should still analyze this fund as it stands today in order to determine if it makes sense as an investment. We will endeavor to accomplish this task in this article. About The Fund According to the fund’s website, the Virtus Dividend, Interest & Premium Strategy Fund has the primary objective of providing its investors with a high level of current income and current gains. This makes a certain amount of sense given the strategy that this fund is employing to achieve this objective. As the website explains:  The Fund seeks current income and gains, with long-term capital appreciation as a secondary objective. Under normal circumstances, the Fund will invest at least 80% of its net assets (plus any borrowings for investment purposes) in securities and other instruments that provide dividends, interest or option premiums. The Fund will employ an option strategy of writing (selling) covered call options on equity securities held in the Fund. The equity portion of the Fund generally invests in U.S. equities and American depositary receipts with attractive quality characteristics, shareholder yield, and consistent financial output. The convertible portion of the Fund generally invests in income-producing convertible securities, including synthetic convertible securities, and may include convertible securities that are of below-investment grade quality. The option portion of the Fund is designed to generate gains from option premiums in an attempt to enhance amounts available for distributions payable to the Fund’s shareholders.  I will admit that this description is not quite as clear as I would have liked. Basically, the fund invests in a portfolio of dividend-paying equity securities and then writes covered call options against them. This is very similar to the strategy employed by the BlackRock Enhanced Equity Dividend Trust, which we have discussed various times in the past (most recently here). The basic goal of this strategy is to generate income in the form of both dividends paid by the stocks and option premiums from the covered call options, while still retaining some ability to earn capital gains through the stocks gaining in price. In addition to this strategy, the fund also invests some of its assets in convertible bonds, much like Virtus’s other funds. Convertible bonds deliver their investment returns via direct coupon payments to the fund (just like ordinary bonds) along with potentially some capital gains following the conversion to common stocks. As such, the fund’s objective makes a great deal of sense. Unfortunately, this strategy has not exactly worked out very well for the fund over the past few years. One reason for this is that the bubble in convertible securities popped in late 2021 once the market realized that interest rate hikes were on the horizon. The market proved to be correct about this, which sparked a sell-off in convertible securities that they have not yet recovered from:   Seeking Alpha This makes sense to a certain extent. As we can all likely remember, the market was rather crazy in 2021 as the combination of an enormous amount of newly printed money entering the economy from all of the pandemic-era support programs and low interest rates caused people to purchase anything that even offered the remote possibility of earning a return sometime in the future. An obvious example of this was Ford (F) issuing 0% coupon convertible notes in March of 2021. Needless to say, any multi-year bond with a 0% coupon is not going to be very competitive in today’s 5% to 6% interest-rate world. The incredibly low yields offered by convertible securities were not sufficient to offset the price decline that accompanied the series of interest rate increases, which has obviously resulted in these things being dead (or worse) money for the past few years. The Virtus Dividend, Interest & Premium Strategy Fund is the only one of its peers that actually invested in convertible notes, so the incredibly poor performance of these securities has weighed on it when compared to its peers. Fortunately, the Virtus Dividend, Interest & Premium Strategy Fund does not have a particularly high allocation to convertible securities right now. As we can see here, only 19.40% of the fund is invested in such securities:   Virtus The overwhelming majority of this fund is invested in common equities, which is good as common equities have substantially outperformed everything else year-to-date. For example, the S&P 500 Index is up 9.74% since the start of the year, convertibles are up 0.87% and investment-grade bonds are down 1.44%:   Seeking Alpha Historically, common stocks tend to outperform bonds over any sort of extended horizon. This makes logical sense as stocks are theoretically riskier and one of the fundamental rules of finance is that higher risk should translate into higher potential returns. The Bloomberg U.S. Aggregate Bond Index (AGG) has only delivered a 15.91% total return over the past decade compared to the 181.77% total return of the S&P 500 Index, so this has certainly held true in recent years. As such, the fund appears to be in a better position to reward its investors than one that is invested entirely in bonds or convertibles (the S&P 500 Index has also outperformed the Bloomberg U.S. Convertible Cash Pay Note Index over just about any multi-year period). Interest rate risk is very much a concern with bonds and convertibles right now. As we are all well aware, bond prices tend to rise when interest rates fall and vice versa. The same is true of convertible securities, although convertibles also exhibit a certain degree of correlation with common stocks. Investors and other market participants widely expect that the Federal Reserve will reduce interest rates by 75 basis points over the next nine months, a view that central bank officials have reinforced. However, Torsten Slok, chief economist at Apollo Global Management (APO), recently released a note detailing why that may be wishful thinking on behalf of investors and Federal Reserve officials. His basic argument is that the strong economic data and signs of reaccelerating inflation make it virtually impossible for the central bank to cut rates without causing resurging inflation. Simon White, Bloomberg’s macro strategist, appears to believe the same thing. I must admit that their arguments make a lot of sense, and indeed I have been suggesting that readers not get too comfortable with the prevailing rate cut wisdom as it may prove to be incorrect. If we accept this view, it will probably not be good for the convertible securities in the fund’s portfolio. However, common stocks have historically been able to perform quite well in a rising rate environment. This is because the general theory is that central banks should raise interest rates in a strong economy. Stocks also do well in a strong economy. This is why both the S&P 500 Index and the federal funds rate rose in the 1990s:   MacroTrends Arguably, the Federal Reserve kept interest rates too low for far too long after the 2009 financial collapse and weakened the historically positive correlation between common stocks and interest rates. However, the fact still holds that stocks should be less interest rate-sensitive than bonds. As such, the fact that this fund is primarily weighted towards stocks should be a better positioning for it than the opposite. One of the big problems with covered call-writing funds like the Virtus Dividend, Interest & Premium Strategy Fund is that the call-writing strategy caps the upside potential of the common stock portfolio. After all, if the stock price goes above the strike price of the option then the fund will be unable to benefit from it as the stocks are likely to be called away when the option is exercised. As such, we do not want too much of the fund’s portfolio to be covered by options as the higher the level of overwriting on the portfolio, the more the upside potential is capped. This is why, for example, the fund’s peers (with the exception of the Madison Covered Call & Equity Strategy Fund) only write options against approximately half of the common stocks in their portfolios. This allows the fund to still generate a certain level of income from the common stocks without needing to sacrifice all of the upside potential of the common stocks. Curiously, the Virtus Dividend, Interest & Premium Strategy Fund does not disclose the degree to which its portfolio assets are covered by options. Neither the fact sheet nor the fund’s web page includes this information. The fund’s most recent financial statements also do not include any information about the degree to which the fund’s portfolio is overwritten by options. This is disappointing, as that information is quite important so that we know the extent to which the fund is sacrificing capital appreciation potential in order to obtain income. This does not look good from a transparency perspective. Distribution Analysis As mentioned earlier in this article, the primary objective of the Virtus Dividend, Interest & Premium Strategy Fund is to provide its investors with a very high level of current income and current gains. In pursuance of this objective, the fund invests its assets into a portfolio consisting of both dividend-paying common equities and convertible bonds. The fund receives dividends and coupon payments from these two asset types, which it pools together with any money that it manages to realize in the form of capital gains. After all, both common stocks and convertible bonds can deliver fairly substantial capital gains in certain circumstances. This fund takes things a bit further, as it writes covered calls against the stocks that it holds in its portfolio. The premium that the fund receives from this sale acts like a synthetic dividend, and as I pointed out in a previous article, the effective yield can be remarkably high. The fund then pays out all of the money that it manages to earn from these various strategies to its shareholders, net of its expenses. We might assume that this would allow the fund’s shares to boast a very high yield. This is indeed the case, as the Virtus Dividend, Interest & Premium Strategy Fund pays a quarterly distribution of $0.28 per share ($1.12 per share annually), which gives it an 8.92% yield at the current price. As we have already seen, this is a very competitive yield to that offered by similar funds. Unfortunately, this fund has not been especially consistent with respect to its distribution over the years. As we can see here, the fund has both raised and lowered its distribution a few times over its history:   CEFConnect The fund’s most recent action was a distribution increase, which comes on the heels of a distribution increase in early 2022. However, prior to that the fund had cut its distribution twice consecutively. Overall, this distribution history might be a bit of a turn-off for those investors who are seeking to receive a safe and consistent level of income to use to pay their bills or finance their lifestyles. However, many investors who are actively seeking such a goal would also likely prefer the monthly payment schedule offered by some of this fund’s peers. This is one of the few closed-end funds that have actually increased their payout over the past few years, which is fairly nice given the high level of inflation that has been plaguing most nations in the developed world in the post-pandemic period. After all, a higher distribution payment helps to offset some of the decline in purchasing power that would accompany a static distribution. As is always the case though, we want to have a look at the fund’s finances and see how well it is covering its distribution. After all, we do not want the fund to be paying out more than its portfolio actually earns and destroying its net asset value in the process. This scenario is not sustainable over any sort of extended period. Unfortunately, we do not have an especially recent document that can be used for the purposes of our analysis. As of the time of writing, the fund’s most recent financial report corresponds to the six-month period that ended on July 31, 2023. As such, this report will not include any information about how well the fund performed over most of the second half of 2023. That was a period in which both stocks and bonds exhibited a significant amount of volatility due to investors’ expectations of a 2023 pivot by the Federal Reserve being dashed by a July rate hike. The final two months of 2023 were generally a good time for stocks and bonds though, and it could have allowed the fund to recover any money that it lost over the summer. Indeed, the distribution increase in March 2024 suggests that the fund did manage to recover any losses that it took during the period. With that said though, covered call-writing funds usually hold up a bit better than ordinary equity funds during bear market swings though due to the call premiums offsetting some of the market declines. For the six-month period, the Virtus Dividend, Interest & Premium Strategy Fund received $2.331 million in interest and $12.392 million in dividends from the assets in its portfolio. From this, we subtract the money that the fund had to pay in foreign withholding taxes to arrive at a total investment income of $14.685 million for the six-month period. The fund paid its expenses out of this amount, which leaves it with $8.429 million available for shareholders. As might be expected, that was nowhere close to enough to cover the distributions that the fund paid out over the period. Over the course of six months, this fund paid $46.453 million to its shareholders. At first glance, this may be concerning as the fund was clearly unable to cover its distributions using its investment income. However, there are other methods through which the fund can obtain the money that it requires to cover the distribution. For example, it receives a call premium every time it sells an option against the stocks in its portfolio. The fund might also be able to sell some common stocks or convertible bonds that have experienced price appreciation. Realized capital gains and option premiums are not considered to be investment income for tax or accounting purposes, but they obviously represent money coming into the fund that can be paid out to the shareholders. The Virtus Dividend, Interest & Premium Strategy Fund enjoyed a great deal of success at obtaining money via these alternative sources during the period. It reported net realized gains of $102.836 million and had another $2.560 million net unrealized gains during the period. Overall, the fund’s net assets increased by $67.372 million after accounting for all inflows and outflows during the period. Clearly, the fund managed to cover all of its distributions with a substantial amount of money left over. However, this report only covers the period through July 31, 2023. As such, there has been quite a bit of time that has passed since then that could have caused the fund to lose some of the profits that it earned during that period. Fortunately, that does not appear to be the case. This chart shows the fund’s net asset value per share since July 31, 2023:   Barchart As we can see, the fund’s net asset value is down a bit since that date, but 2.55% is not a huge decline. This chart shows the fund’s net asset value per share since January 1, 2023:   Barchart Here, we can see that the fund’s net asset value per share has increased by 10.84% since the start of last year. This means that the fund has covered all of the distributions that it has paid out since the beginning of 2023 with a substantial amount of money left over. In short, we should not have to worry about the fund’s ability to sustain its distribution. It appears that it is in pretty good shape and will not have to reverse course unless we get a market crash in 2024. Valuation As of March 21, 2024 (the most recent date for which data is currently available), the Virtus Dividend, Interest & Premium Strategy Fund has a net asset value of $14.66 per share but the shares currently trade at $12.51 each. This gives the fund’s shares a 14.67% discount on net asset value at the current price. This is relatively in line with the 15.18% discount that the fund’s shares have had on average over the past month. A double-digit discount is generally representative of a decent entry price for any closed-end fund. As such, today’s price looks like a reasonable price to pay if you wish to add this fund to your portfolio. Conclusion In conclusion, the Virtus Dividend, Interest & Premium Strategy Fund is one of the more unique funds in the market as it is one of the only ones that combines a covered call strategy with convertible bonds. This has, unfortunately, cost it somewhat in terms of performance as the fund has substantially underperformed its peers that do not have the convertibles weighing them down. The fund does appear to be reasonably positioned for the current market and can easily cover its very high current yield. The valuation is also not too bad right now. The only real problem here is the fund’s performance.  A ”hold” rating is probably appropriate for this fund today. I cannot see any reason to dispose of it if you have it as there is no near-term downside catalyst right now. The fund might decline somewhat if the Federal Reserve remains hawkish heading into the summer, though. The current economic data does suggest that this is a very real risk, but at the same time, the central bank might cut rates anyway. I somewhat doubt that this fund will outperform its peers over the long-term though, so I cannot see any reason to rush out and purchase it.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2422274615"}