ECF: Very Attractive Yield And Valuation, But Performance Disappoints

seekingalpha04-05

The Ellsworth Growth and Income Fund Ltd offers a high level of income without sacrificing potential upside from common stocks.The ECF closed-end fund's recent performance has been disappointing, with...

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PM Images The Ellsworth Growth and Income Fund Ltd (NYSE:ECF) is a little-known and underfollowed closed-end fund, or CEF, that investors can employ as a way of obtaining a fairly high level of income without the need to sacrifice the potential upside that they can achieve from an investment in common stocks. This is something that could be important in today’s world, as there is a very real possibility that inflation will be with us for much longer than many market pundits and officials seem to believe. As we are all no doubt well aware, common stocks are generally considered to provide better protection against inflation than fixed-income securities, which is what most closed-end funds that wish to provide high levels of income invest in. However, the downside to common equity funds is that their yields are almost always lower than what the best fixed-income funds can provide. For example, the Ellsworth Growth and Income Fund only yields 6.54% at the current price. While this is higher than most equity indices and individual common stocks, there are fixed-income funds out there with double-digit yields that might be more attractive for an investor who is just seeking to maximize their current income. Morningstar classifies the Ellsworth Growth and Income Fund as a “Fixed Income – Taxable – Convertibles” fund, but its holdings do not consist entirely of convertible securities. Here is how this fund’s distribution yield compares to that of similar funds:   Fund Name Morningstar Classification Distribution Yield   Ellsworth Growth and Income Fund Fixed Income – Taxable – Convertibles 6.54%   Advent Convertible and Income Fund (AVK) Fixed Income – Taxable – Convertibles 11.92%   Bancroft Fund (BCV) Fixed Income – Taxable – Convertibles 8.17%   Calamos Convertible&High Income Fund (CHY) Fixed Income – Taxable – Convertibles 10.54%   High Income Securities Fund (PCF) Fixed Income – Taxable – Convertibles 11.41%   Virtus Convertible & Income Fund (NCV) Fixed Income – Taxable – Convertibles 12.55%   Click to enlarge Although their strategies vary, all of these funds invest in some combination of convertible securities, fixed-income securities, and common stock. The Ellsworth Growth and Income Fund, for example, does not include the fixed-income securities that some of the other funds on this list include but it does invest in both convertible securities and common stock. As some readers are no doubt well aware, convertible securities in general have not performed particularly well over the past few years. This is partly because these securities were in a massive bubble back in 2020 and 2021 as they were a pretty good way to obtain at least a marginal yield without needing to sacrifice the upside potential of common stocks. This was extremely attractive during a period in which interest rates were close to all-time lows and a substantial amount of newly printed money was making its way through the economy. This bubble burst when interest rates began rising and convertible securities lost much of their appeal. As such, we might assume that the Ellsworth Growth and Income Fund delivered a rather disappointing performance over the past few years. This is indeed the case, as shares of the fund have declined by 41.67% over the past three years. This is much worse than the 20.91% decline of the iShares Convertible Bond ETF (ICVT) as well as the 27.80% gain of the S&P 500 Index (SP500) over the same period:   Seeking Alpha This poor trailing three-year performance will likely reduce the appeal of this fund in the eyes of any investor, including those who are primarily interested in achieving a high level of income. After all, income investors might be willing to sacrifice some capital gains in exchange for income, but nobody wants to lose money over a multi-year period. A 41.67% loss is a pretty big loss for anybody to stomach. However, investors in closed-end funds such as the Ellsworth Growth and Income Fund typically do better than the share price performance of a fund might suggest. As I explained in a recent article: However, as I have pointed out in various previous articles, a simple look at the price performance of a closed-end fund does not tell the whole story. This is because funds such as the Ellsworth Growth and Income Fund typically pay out all of their investment profits to the shareholders in the form of distributions. The basic business model is to keep the size of the fund’s portfolio relatively stable over time while giving the fund’s shareholders all of the profits that are produced by the portfolio. These distributions provide the fund’s investors with a return that is not reflected in the share price performance. In short, the fund’s shareholders will always do much better than the share price performance would suggest. This chart shows the trailing three-year performance of the Ellsworth Growth and Income Fund incorporating the positive impact of the distributions that it paid out over the period:   Seeking Alpha As we can see, investors in this fund still suffered a 26.13% loss over the period, which is once again worse than either of the indices produced. This is not as disappointing as the 41.67% share price decline, but it is still almost certainly going to be a turn-off for most investors. With that said, a fund’s past performance is no guarantee of its future results. Anyone who purchases the fund today will not be adversely affected by the poor performance that the fund has delivered in the past. A new investor only needs to worry about the fund as it is today and how it is likely to perform going forward. We will investigate this over the remainder of this article. About The Fund According to the fund’s website, the Ellsworth Growth and Income Fund has the primary objective of providing its investors with a combination of current income and capital appreciation. This is a reasonable objective considering the strategy that the fund intends to employ in pursuit of this objective. As the website explains: Ellsworth Growth and Income Fund Ltd. operates as a closed-end, diversified, management investment company and invests primarily in convertible securities and common stock, with the objectives of providing income and the potential for capital appreciation; which objectives the Fund considers to be relatively equal, over the long-term, due to the nature of the securities in which it invests. As I have pointed out in the past, common stocks in general have very low yields. This has been the case for many years now and is immediately evident by looking at the trailing twelve-month yields of various index funds that track the major common stock indices:   Index Fund Index Tracked TTM Yield   SPDR S&P 500 ETF Trust (SPY) S&P 500 Index 1.30%   iShares Russell 2000 ETF (IWM) Russell 2000 Index 1.33%   Vanguard Total Stock Market ETF (VTI) CRSP US Total Market Index 1.36%   Click to enlarge All three of these indices, which should include most American stocks, will only provide an annual income of less than $14,000 for every $1 million invested. That is a very low yield, and it has been the case for quite some time. After the past fifteen years, an enormous quantity of money was printed by the Federal Reserve and it made its way into the capital markets, boosting asset valuations and suppressing yields. After all, the zero-interest rate policy that was in place for most of the past fifteen years made it nearly impossible to achieve any sort of reasonable return on fixed-income securities, so investors moved their money into common stocks. This caused the price of common stock to appreciate and yields to decline. The fact that the U.S. tax code also makes it preferable for a company to reward investors via share buybacks instead of dividends also contributed to this state of affairs. This has been one of the appeals of convertible securities over the past fifteen years. These securities frequently provided a yield that was better than common stock but still allowed investors to participate in the capital gains potential of the common stock. Business development companies and similar firms frequently liked these securities for this reason. I will admit that any time that I was involved in doing a private placement funding round for a start-up company, these were the securities that I attempted to obtain for my clients who wanted to get some amount of income to live on. For the most part, this combination of current income and upside potential was attractive for investors who would otherwise favor fixed-income securities, as the yields offered by traditional fixed-income securities were too low to be attractive during the period. Curiously, neither the fund’s website nor its fact sheet provides an asset allocation. Investors will almost certainly want to know what percentage of assets the fund has invested in convertible securities compared to common stocks. This does not look good from a transparency perspective. Fortunately, the fund does include a breakdown of its asset allocation in its quarterly holdings reports. As of December 31, 2023, the fund’s assets were invested as follows:   Security Type % of Total Assets   Convertible Corporate Bonds 68.3%   Convertible Preferred Stocks 0.4%   Mandatory Convertible Securities 2.4%   Common Stocks 19.6%   U.S. Treasury Debt 9.3%   Click to enlarge As we can see, the fund currently has no traditional fixed-income securities except for the U.S. Treasury securities. However, these are all U.S. Treasury bills that have maturity dates prior to May 31, 2024. As such, these securities appear to represent the fund’s cash position. Basically, it is buying Treasury bills instead of parking its cash into a money market fund like just about every other closed-end fund does. It therefore seems logical that the fund will reduce this position when and if an opportunity arises to deploy its capital into something more productive. It might also be holding cash equivalents to fund its distribution, but that is a very large cash position for that purpose. The fact that this fund has such a large cash equivalent position could be a drag on its performance overall. After all, common stocks have been delivering a pretty solid performance year-to-date. The iShares Convertible Bond ETF is up 0.98% year-to-date so convertible bonds have too:   Seeking Alpha As such, there are probably better options available for the fund than simply keeping the money in short-term U.S. Treasury bills. Of course, the most recent quarterly holdings report is dated December 31, 2023, so it is possible that the fund managers have bought something with this cash equivalent position, and we simply do not know about it yet. The Ellsworth Growth and Income Fund appears to invest in somewhat different positions than many other closed-end funds. Here are the largest positions provided on its website:   Gabelli Funds Microsoft (MSFT) and Broadcom (AVGO) are top holdings in just about every common equity fund, but the rest of the companies on this list are somewhat less commonly found. This may be somewhat attractive to those investors who have a lot of money invested in common equity indices and want to diversify their portfolios away from the “Magnificent 7” stocks that account for a substantial percentage of just about every common equity index that includes American large-cap stocks. There could be some reason to doubt that all of these holdings are common equities, however. The fund’s fact sheet shows that the fund had these top holdings as of December 31, 2023:   Fund Fact Sheet The fact sheet is dated December 31, 2023, so obviously it is a bit older than the holdings shown on the webpage. However, some of the companies are the same. The Microsoft, Equinix (EQIX), T-Mobile US (TMUS), and Broadcom positions are all common equities, but the remainder of the things on this chart appear to be convertible bonds. Therefore, there might be reason to believe that the Bandwidth Inc. (BAND), Chart Industries (GTLX), and PPL Capital Funding (PPL) positions shown on the more recent chart on the webpage could all be convertible bonds as opposed to common equities. It is uncertain what the remaining three positions shown on the website’s chart are, but if the fund has continued its propensity for favoring convertible bonds over common stock for the past three months, the Merck & Co. (MRK), Halozyme Therapeutics (HALO), and PG&E Corporation (PCG) positions might not actually be common equities. With that said investors who own convertible bonds do still have exposure to the common equity of the issuing company. The reason for this should be fairly obvious, as convertible bonds have the ability to be converted into common equity of the issuing company under certain circumstances. Due to this conversion feature, these bonds trade with a certain level of correlation to the common stock. For example, take a look at the price performance of the U.S. convertible bond index against both investment-grade bonds and the S&P 500 Index year-to-date:   Seeking Alpha Long-term interest rates have been rising year-to-date as investors have begun to realize that the Federal Reserve will not be cutting interest rates six or seven times in 2024 as was the prediction at the start of this year. As such, the Bloomberg U.S. Aggregate Bond Index (AGG) has declined year-to-date. The convertible bond index has actually delivered a positive return despite rising interest rates, however. This is due to the rising stock prices of most companies, which has caused investors to increase the price that they are willing to pay for the conversion feature on the bonds. That was sufficient to offset the adverse impact of rising interest rates. This suggests that the Ellsworth Growth and Income Fund might be a way for investors to keep some exposure to a rising stock market while still receiving a higher yield than could be obtained from common stocks. That might be an interesting proposition for some, but the fact that this fund has been consistently underperforming both common stocks and convertible bonds is a major strike against it. As we can see here, the fund is down year-to-date even when we consider the distributions that it has paid out:   Seeking Alpha The fact that this fund has underperformed both the convertible bond and common stock indices over both the trailing three-year period and the year-to-date period even when we consider the boost that the distribution provides to the fund’s total return suggests that investors who like the concept of owning convertible bonds and common stocks would be better off just buying a 50/50 or 75/25 portfolio of the two index exchange-traded funds. The income produced by such a play would be lower than the Ellsworth Growth and Income Fund provides, but the total return would almost certainly be better. Leverage As is the case with most closed-end funds, the Ellsworth Growth and Income Fund employs leverage as a method of increasing the effective yield and total return that it earns from the assets in its portfolio. I explained how this works in a number of previous articles, one of which I linked in the introduction. To paraphrase myself:  Basically, the fund borrows money and then uses that borrowed money to purchase convertible bonds and common stocks. As long as the purchased assets deliver a higher total return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield and return of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, this will ordinarily be the case. However, it is important to point out that the benefits of using leverage are much less today with borrowing rates at six percent than they were a few years ago when money could be borrowed for essentially nothing. The use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage because that would expose us to an outsized level of risk. I generally do not like a fund’s leverage to exceed a third as a percentage of its assets for this reason.  As of the time of writing, the Ellsworth Growth and Income Fund has leveraged assets comprising 24.00% of its portfolio. This is a reasonable level of leverage that is well below the one-third level that we would ordinarily like to see. However, we should still compare the fund’s leverage to that of its peers as part of our risk assessment. Here is a chart doing so:   Fund Name Current Leverage   Ellsworth Growth and Income Fund 24.00%   Advent Convertible and Income Fund 41.93%   Bancroft Fund 22.00%   Calamos Convertible & High Income Fund 37.48%   High Income Securities Fund 0.00%   Virtus Income & Convertible Fund 37.54%   Click to enlarge (all figures from CEF Data) As we can see, the leverage of the Ellsworth Growth and Income Fund generally compares pretty well with that of its peers. Indeed, the fund’s leverage is significantly lower than that of several of the funds on this list. This is something that risk-averse investors should appreciate as it suggests that the fund is exposing its shareholders to a much lower level of risk than its peers. Overall, we should not have to worry too much about this fund’s use of leverage. It appears that the Ellsworth Growth and Income Fund is striking a fairly reasonable balance between the risks and the rewards associated with leverage. Distribution Analysis As mentioned earlier in this article, the primary objective of the Ellsworth Growth and Income Fund is to provide its investors with a high level of current income and capital appreciation. In pursuance of this objective, the fund invests in a portfolio that primarily consists of convertible bonds and common equities. As of right now, the focus appears to be on convertible bonds, but the exact allocation varies. Common stocks and convertible bonds both deliver a significant proportion of their total investment return in the form of capital gains, which results in the fund realizing some investment profits when it sells a security that goes up in price. Convertible bonds also pay out a regular coupon to the fund, which provides it with a source of income. The fund pools together the money that it receives from these two primary sources. It then borrows money, which it uses to purchase more common stocks and convertible bonds. This allows it to collect capital gains and coupon income from more securities than it could control simply through reliance on its own equity capital. The fund then pays out the money that it earns from these various operations to its shareholders, net of the fund’s own expenses. When we consider the yield of convertible bonds, the level of capital gains possible with common stock, and the boost that these things receive from the fund’s use of leverage, we can clearly see that the fund’s shares should be able to achieve a fairly high yield. This is indeed the case, as the Ellsworth Growth and Income Fund pays a quarterly distribution of $0.13 per share ($0.52 per share annually), which gives the fund a 6.54% yield at the current price. As we saw in the introduction, this is certainly not the highest yield available among closed-end funds, but it is certainly better than most common stock or fixed-income indices are able to deliver. The fund’s long-term distribution history is not particularly attractive, but it has done better in recent years than many peers:   CEF Connect As we can see here, the fund’s distribution steadily declined during the 1990s and 2000s in the years leading up to and immediately following the most recent financial crisis. However, that is considered to be ancient history by many investors today. This fund did manage to hold its distribution steady following the end of the convertible bubble in late 2021, which is a much better performance than the Virtus funds managed following the same event. Overall, this distribution history is not perfect, but it still might be attractive enough for an investor who is looking to achieve a safe and consistent level of income from the assets in their portfolios. As is always the case, we should have a look at the fund’s finances to see how well it is covering its distribution. After all, we do not want a fund to be paying out more than it can actually afford and destroying its net asset value in the process. A fund cannot sustain the destruction of net asset value indefinitely and such a fund will eventually have to cut its distribution as the portfolio will not be able to earn sufficient returns to maintain a specific payout. This is the same problem that may cause retirees to outlive their money. Unfortunately, we do not have an especially recent document that we can consult for the purposes of our analysis. As of the time of writing, the most recent financial report for the Ellsworth Growth and Income Fund corresponds to the full-year period that ended on September 30, 2023. As such, it will not include any information about the fund’s performance for most of the past six months. This is quite disappointing as most of the period was characterized by a strong bull market for common stocks that undoubtedly gave the fund the potential to earn some realized gains. The fund may have also earned some profits from the convertible bonds in its portfolio, as the convertible bond index has risen in aggregate over the past six months. The most recent financial report will not give us any idea of how well the fund was able to earn profits for its shareholders during this period. However, this report should give us a good understanding of how well the fund performed during the summer of 2023. As everyone reading this can certainly remember, that was a period of time that was characterized by rising yields and generally declining asset prices. As that was a very difficult period of time in which to earn a profit, it undoubtedly tested the skill of the fund’s management team. This report should give us a good idea of how they fared. For the full-year period that ended on September 30, 2023, the Ellsworth Growth and Income Fund received $1,239,998 in dividends and $4,256,805 in interest from the assets in its portfolio. The fund had no income from any other source, so this gives it a total investment income of $5,496,803 for the full-year period. The fund paid its expenses out of this amount, which left it with $3,629,419 available for shareholders. As might be expected, that was nowhere near enough to cover the $7,147,910 that the fund paid out to its investors over the period. At first glance, this could certainly be concerning as the fund failed to generate enough investment income to cover its distributions. However, the fund does have other methods through which it can obtain the money that it requires to cover its distributions. For example, it might be able to sell common stocks or convertible bonds that go up in price and realize some capital gains. Realized capital gains are not considered to be investment income for either tax or accounting purposes but they clearly do result in money coming into a fund that can be paid out to investors. Fortunately, the fund did have some success at earning money via these alternative sources during the period. For the full-year period, the Ellsworth Growth and Income Fund reported net realized gains of $6,835,736 that were partially offset by $4,146,493 net unrealized losses. Overall, the fund’s net asset value declined by $2,927,758 during the period. This was the second straight year in which the fund’s net asset value declined, although this year’s $2,927,758 was not nearly as bad as the $70,005,999 decline that the fund experienced during the preceding fiscal year. This is quite concerning as it suggests that the fund is consistently failing to cover its distributions. However, one thing to keep in mind here is that the fund’s net investment income plus net realized gains totaled $10,465,155 for the most recent fiscal year. That was enough to cover the distribution that the fund paid out with some money left over. The reason that the fund failed to cover its distribution is because of the unrealized losses. As we are all well aware, unrealized losses can be very quickly erased by any market strength. This has been the case over the past six months, as we can see here:   Barchart This chart shows the fund’s net asset value per share since the closing date of the most recent financial report. As we can clearly see, it has risen by 6.11% over the period. This tells us that the fund has fully covered all of the distributions that it has paid out over the past six months as well as corrected at least some of the net asset value decline that it reported in the annual report. As such, we probably do not need to worry too much about the fund’s distribution sustainability right now, but it is possible that this will change should the market decline again. We should therefore keep an eye on the fund’s assets, but for now, it should be fine. Valuation As of April 3, 2024 (the most recent date for which data is currently available), the Ellsworth Growth and Income Fund has a net asset value of $9.55 per share but the shares currently trade for $7.99 each. This gives the fund’s shares a 16.34% discount on net asset value at the current price. That is an enormous discount that is well above the 14.99% discount that the shares have traded at on average over the past year. The current price looks very attractive as an entry point. As I have pointed out numerous times in the past, a double-digit discount generally always represents a reasonable entry point for any closed-end fund. Conclusion In conclusion, the Ellsworth Growth and Income Fund is a very underfollowed fund that has a rather unique investment strategy compared to many other closed-end funds. Unfortunately, that strategy has not done the fund any favors as it has been consistently underperforming both the common stock and convertible bond indices on a total return basis. As such, a better return can probably be obtained by investing in exchange-traded funds tracking convertible bonds and common stocks.  However, Ellsworth Growth and Income Fund Ltd’s yield is higher than would be obtained from such a strategy, if that is the most important thing for you. The Ellsworth Growth and Income Fund also has a very attractive valuation, although there is no near-term catalyst that will close the discount. Overall, this fund is okay but nothing spectacular.","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/2425348678"}