BGY: Limited Domestic Exposure When International Diversification Is Critical

seekingalpha06-11

The BlackRock Enhanced International Dividend Trust offers attractive geographical diversification and a high level of income with a yield of 7.28%.The BGY closed-end fund's lower yield compared to ...

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This fund has very low domestic exposure.The fund is easily covering its distribution and trades at an enormous discount to net asset value.   design master/iStock via Getty Images The BlackRock Enhanced International Dividend Trust (NYSE:BGY) is a high-yielding equity closed-end fund, or CEF, that should prove attractive to investors who are seeking to improve the geographical diversification of their portfolios and earn an attractive level of income at the same time. As of the time of writing, the BlackRock Enhanced International Dividend Trust yields 7.28%, which is well above the 1.54% trailing twelve-month yield of the MSCI World Index (URTH). However, it is a bit low when compared to other closed-end funds that employ a similar strategy:   Fund Name Morningstar Classification Distribution Yield   BlackRock Enhanced International Dividend Trust Equity-Covered-Call Funds 7.28%   Virtus Dividend, Interest & Premium Strategy Fund (NFJ) Equity-Covered-Call Funds 9.05%   Madison Covered Call & Equity Strategy Fund (MCN) Equity-Covered-Call Funds 9.86%   Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG) Equity-Covered-Call Funds 9.40%   Voya Global Advantage and Premium Opportunity Fund (IGA) Equity-Covered-Call Funds 11.50%   Click to enlarge The fact that the BlackRock Enhanced International Dividend Trust has a lower yield than many of its peers is something that might initially be rather off-putting to investors. After all, most people who would consider investing in an “enhanced equity” closed-end fund are seeking to achieve the maximum level of income possible while still retaining the upside potential that comes from an investment in equity securities. However, these funds do have to sacrifice some upside potential to achieve their high yields and in some cases, a higher current yield means that there is less potential for capital gains. This is something that we should investigate as part of our analysis today. As regular readers can likely remember, we previously discussed the BlackRock Enhanced International Dividend Trust in late January 2024. At the time, I assigned a buy rating to the fund, suggesting that it looked like a pretty good way to improve a portfolio’s international diversification while earning a high total return. The global equity market has been fairly strong since the publication date of that article, so we can probably expect that the fund has been doing fairly well. There is certainly some truth to this, as the shares of the fund have appreciated by 4.50% since the date that the previous article was published:   Seeking Alpha Unfortunately, we can see that this fund underperformed the S&P 500 Index (SP500) as well as the MSCI World Index (URTH) since that date. While this might be disappointing, it is also something that we would generally expect from a fund like this. After all, the fund’s strategy does require investors to sacrifice some capital gains potential in exchange for income. In addition, the BlackRock Enhanced International Dividend Trust only has very limited exposure to the United States, so perhaps it would be better to compare it to the MSCI All-Countries World ex-U.S. Index (ACWX) than to either of the domestic stock indices. That index increased by 7.23% over the period in question, so this fund underperformed it as well. A look at the fund’s share price performance could be misleading, however. As I explained in a recent article: A simple look at a closed-end fund’s share price performance does not necessarily provide an accurate picture of how investors in the fund did during a given period. This is because these funds tend to pay out all of their net investment profits to the shareholders, rather than relying on the capital appreciation of their share price to provide a return. This is the reason why the yields of these funds tend to be much higher than the yield of index funds or most other market assets. The above comment is particularly applicable to this fund because it is specifically designed to provide income at the expense of capital gains. As such, we need to include the distributions in our performance chart to see how well investors actually did. When we do that, we get this chart:   Seeking Alpha As we can see, the BlackRock Enhanced International Dividend Trust delivered a 7.16% total return since January 29, 2024 (the date of our previous discussion on this fund). That is still less than the S&P 500 Index or MSCI World Index delivered, but it is very close to the performance that the MSCI All-Countries World ex-U.S. Index delivered over the period. This is, overall, a level of performance that most income-focused investors will probably be happy with. After all, many investors who are trying to get income from their portfolio are willing to sacrifice a little bit of return in exchange for a higher yield. As roughly four months have passed since we last discussed this fund, we can expect that a lot has changed. In particular, American equity valuations are looking very stretched relative to foreign markets, so it might be time to rotate into a fund like this. In addition, the fund released an updated financial report, so we should take a look at that and see if there is anything in that report that necessitates a change in our thesis. About The Fund According to the fund’s website, the BlackRock Enhanced International Dividend Trust has the primary investment objective of providing its investors with both a high level of current income and a high level of capital gains. This actually makes a lot of sense given the fund’s strategy, which is explained in great detail on the website: BlackRock Enhanced International Dividend Trust’s primary investment objective is to provide current income and current gains, with a secondary objective of long-term capital appreciation. Under normal circumstances, the Fund invests at least 80% of its net assets in dividend-paying equity securities of non-U.S. companies. The Fund may invest in securities of any market capitalization, but intends to invest primarily in securities of large capitalization companies. Under normal market conditions, the Fund generally intends to write covered call and put options with respect to approximately 30% to 45% of its total assets, although this percentage may vary from time to time with market conditions. The fact that this fund invests in equity securities works well with the capital gains and long-term capital appreciation objectives. After all, that is how these securities deliver the bulk of their returns. The covered call-writing strategy provides the fund with a source of income via the option premiums that it receives from the sale of these securities. Thus, the objectives make sense. In the introduction, I stated that there could be some links between the yield of a closed-end fund and the degree of upside potential that investors have to sacrifice to obtain a higher yield. I noted this in the previous article as well: The use of a covered call strategy is a good way to obtain income, but it also forces the fund to sacrifice the potential upside from the common stocks in its portfolio. In short, the more aggressive that a fund is about writing covered call options, the higher its income but also the more potential capital gains it has to sacrifice. As the strategy description on the website suggests, this fund is not particularly aggressive with its options strategy. It only has options written against 41.66% of its portfolio right now, which is lower than many of its peers:   Fund % Overwritten   BlackRock Enhanced International Dividend Trust 41.66%   Virtus Dividend, Interest & Premium Strategy Fund Not Disclosed*   Madison Covered Call & Equity Strategy Fund 88.20%   Eaton Vance Tax-Managed Global Diversified Equity Income Fund 48.00%   Voya Global Advantage & Premium Opportunity Fund 49.74%   Click to enlarge * The Virtus Dividend, Interest & Premium Strategy Fund does not provide a figure for the percentage of its portfolio covered by call options in any of its financial statements, in its fact sheet, or on the website. For the most part, we can see that the BlackRock Enhanced International Dividend Trust has a lower percentage of option coverage than most of its peers. This was also the case the last time that we discussed it. In fact, the fund’s call option coverage has decreased since the previous article was written, as it had 43.44% back in late January. This may be one reason why the fund has a lower yield than many of its peers. It also had better price performance year-to-date than any of the funds shown above, except for the Eaton Vance Tax-Managed Global Diversified Equity Income Fund:   Seeking Alpha Price performance with closed-end funds does not always mean the most, though, because the underlying portfolios can deliver vastly different performance than the share price. In this case, though, the BlackRock Enhanced International Dividend Trust was also the second-best performer in net asset value:   Seeking Alpha Once again, only the Eaton Vance Tax-Managed Diversified Equity Income Fund managed to outperform the BlackRock Enhanced International Dividend Trust. Part of this may be due to the portfolio differences between the two funds. Eaton Vance’s funds tend to have a strong focus on the United States (even its global funds tend to be heavily invested domestically) while the BlackRock Enhanced International Dividend Trust does not. As we saw in the introduction, American large-cap stocks have outperformed the rest of the world year-to-date, so that may have acted as a tailwind to the Eaton Vance Tax-Managed Diversified Equity Income Fund. The BlackRock Enhanced International Dividend Trust does not have that advantage. As we can see here, the BlackRock Enhanced International Dividend Trust is substantially underweight the United States:   BlackRock As we can see, only 13.55% of the fund’s assets are invested in domestic equities. This is substantially less than the 70.94% weight that the United States has in the MSCI World Index. In fact, this is about the only domestic closed-end fund that I can think of that has less than 50% exposure to the United States (except for single-country funds). This works pretty well for our thesis of trying to reduce our American exposure and our concentration risk. After all, adding a fund with such a low American weighting to a portfolio should bring down the overall percentage of the portfolio that is invested in American issuers. As we will see later in this article, this continues to be important today. As we saw in the previous article on this fund, the majority of the largest positions held by the BlackRock Enhanced International Dividend Trust are foreign companies. This continues to be the case today. Here are the largest positions in the fund as of March 28, 2024:   BlackRock Here are the countries that each of these firms are located in:   Company Name Country   Taiwan Semiconductor Manufacturing (TSM) Taiwan   Novo Nordisk (NVO) Denmark   ASML Holding N.V. (ASML) The Netherlands   Baker Hughes (BKR) United States   LVMH Moet Hennessy Louis Vuitton (OTCPK:LVMHF) France   RELX PLC (RELX) United Kingdom   L’Air Liquide S.A. France   Keyence Corp (OTCPK:KYCCF) Japan   FinecoBank Banca Fineco S.p.A. Italy   AstraZeneca PLC (AZN) United Kingdom/Sweden   Click to enlarge As we can see, there is only one American company on the list of the largest holdings in the fund. While this does somewhat go against the fund’s provided strategy description that explicitly states that it only invests in non-U.S. companies, I am willing to let this slide. After all, Baker Hughes is not a company that is seen among the largest positions lists of too many funds. Indeed, I doubt that I have ever seen it among the largest positions in any actively managed closed-end fund. Thus, the presence of this one American company does not seem to negatively impact the fund’s ability to reduce the concentration risk that most American investors are burdened with. One thing that we do notice though is that there have been surprisingly few changes to the fund’s largest holdings since the last time that we discussed it. The fund previously held large positions in Atlas Copco (OTCPK:ATLKY) and Shell (SHEL), which it has apparently sold off. The new additions are LVMH Moet Hennessy Louis Vuitton and AstraZeneca. All the other companies that we see listed among the fund’s largest positions were on it back at the start of this year. The fund, therefore, has seemingly not done much in the way of trading activity despite having a 55% annual turnover. The BlackRock Enhanced International Dividend Trust does appear to be moderately inconsistent regarding its annual turnover.     FY 2023 FY 2022 FY 2021 FY 2020 FY 2019   Portfolio Turnover 55% 41% 71% 60% 28%   Click to enlarge This is probably a metric that changes with market conditions. Basically, the fund does not necessarily follow a “buy-and-hold” strategy, nor does it constantly trade securities to realize short-term capital gains on a frequent basis. It appears that the fund’s managers are willing to move assets around as necessary in response to changing market conditions. The fund still managed to keep its costs down though, as it only had a 1.10% expense ratio last year, which is rather nice to see. Then again, BlackRock funds in general tend not to have particularly high expense ratios. Strained Valuations Of American Markets As shown in the introduction, American equity markets have outperformed foreign ones year-to-date. As of the time of writing, the United States alone accounts for 70.94% of the MSCI World Index. The United States also accounts for 63.66% of the MSCI All-Countries World Index (ACWI):   BlackRock On January 25, 2024, the United States accounted for 63.42% of the same index. Mathematically, then, the United States must have seen its stock valuations increase by more than the other countries in the world over that period. The United States, however, does not account for anywhere close to 63.66% of global economic output. As of the time of writing, the most recent global gross domestic product figure was $100.13536 trillion, which was achieved in 2022. The 2022 figure for the United States was $25.744 trillion, and its 2023 figure was $27.360 trillion. No matter how you look at it, the United States is only about a quarter of global economic output. The gross domestic product growth rate in the United States has also been slowing. The Bureau of Economic Analysis revised the first-quarter 2024 growth rate down to 1.3% two weeks ago. That means that the economic growth rate in the United States has been slowing for two quarters in a row:   Bureau of Economic Analysis Yet, the American stock market continues to progress ever higher. This basically means that the market is pricing in stronger and stronger growth at a time when the actual figures say that growth is slowing. Currently, it almost seems as if the market is being driven higher by investors who realize that interest rates in the United States are still far too low to stop inflation, and so they are trying to get their money out of cash and into something that might hold its purchasing power. The New York Fed’s most recent consumer survey appears to support this conclusion. Zero Hedge posted a summary of the survey data to its website this morning. From the summary: Here is what the latest Survey of Consumer Expectations for the month of May revealed: inflation expectations declined at the short-term horizon, remained unchanged at the medium-term horizon, and increased at the longer-term horizon. Specifically, median inflation expectations at the one-year horizon declined to 3.2% in May from 3.3% in April, were unchanged at the three-year horizon at 2.8%, and increased at the five-year horizon to 3.0% from 2.8%. In other words, the report says that people expect that the Federal Reserve will not achieve its goal of reducing inflation to 2.0%. As such, they may be moving money into equities to try and maintain their purchasing power even when growth is obviously slowing. I can certainly appreciate that sentiment and, indeed, I also doubt that the 2.0% inflation level will ever be achieved given the current monetary and fiscal policy. However, the slowing economic growth while inflation remains high is starting to suggest a stagflation scenario. The last time that such a situation occurred, real estate and gold did pretty well, but equities did not. The total market capitalization-to-gross domestic product ratio is also suggesting that American equities are overvalued. As of right now, this ratio stands at 188.90%. As we can see here, this is very close to its all-time high:   GuruFocus As we can see, American equities are even more overpriced according to this ratio than they were during the peak of the Internet bubble back in 2000. This is not the case in foreign markets, however. In fact, several of them are right around their median point by this metric. For example, the United Kingdom, which is the largest country whose equities are held by the BlackRock Enhanced International Dividend Trust currently has a total market capitalization-to-GDP ratio of 108.12% (the country’s historical range is 46.49% to 177%). Therefore, this suggests that foreign equities could have more attractive valuations than American ones, so it would probably be a good idea to ensure that you have adequate international diversification across your portfolio. The BlackRock Enhanced International Dividend Trust looks like one way to accomplish that goal and earn a high yield in the process. Distribution Analysis The primary objective of the BlackRock Enhanced International Dividend Trust is to provide its investors with a high level of current income and current gains. To this end, the fund pays a monthly distribution of $0.0338 per share ($0.4056 per share annually), which gives it a 7.28% yield at the current price. Unfortunately, the fund has not been especially consistent regarding its distributions over the years. We can see that here:   CEF Connect From the previous article: As we can see, the fund has cut its distribution twice since 2015, but otherwise it has been relatively stable. In particular, neither the COVID-19 pandemic nor the fact that most central banks around the world started monetary tightening in 2022 had any impact on the fund’s distribution. This is not exactly unexpected for a fund like this, as a covered call strategy in general reduces a portfolio’s volatility. It also seems likely that this distribution history will appeal to most investors who are seeking a safe and consistent income from the assets in their portfolio. This is a common expectation among retirees or others who are using their portfolios as a way to finance their lifestyles. Let us take a look at how well the fund is covering its distribution. The most recent financial report for the fund is the annual report that corresponds to the full-year period that ended on December 31, 2023. Admittedly, this report is several months old right now, but it is still newer than the one that we had available to us the last time that we discussed this fund. As such, it should work reasonably well to provide us with an update. For the full-year period that ended on December 31, 2023, the BlackRock Enhanced International Dividend Trust received $16,986,929 in dividends from the assets in its portfolio. The fund received no investment income from any other source, but it did naturally have to pay foreign withholding taxes on the dividends that it received, which we subtract from the total. This gives the fund a total investment income of $15,413,866 for the full-year period. It paid its expenses out of this amount, which left it with $8,622,266 available for shareholders. That was not sufficient to cover the $41,157,899 that the fund paid out in distributions to its shareholders. The fund was, fortunately, able to make up the difference through capital gains. For the full-year period, the fund reported net realized gains of $25,103,078 along with $49,586,269 net unrealized gains. The fund’s assets increased by $29,010,475 after accounting for all inflows and outflows. Thus, it appears that the fund managed to cover its distributions with quite a bit of excess returns left over. It certainly appears as though the fund has managed to cover all of its distributions since the closing date of its most recent fiscal year. This chart shows the fund’s net asset value since December 31, 2023 (the closing date of the most recent financial report):   Barchart As we can see, the fund’s net asset value is up 4.07% since the start of this year. This clearly tells us that the fund has fully covered all the distributions that it has paid out this year, a continuation of the trend from last year. Overall, the fund is easily covering its distribution, and investors seeking sustainable income have nothing to worry about here. Valuation Shares of the BlackRock Enhanced International Dividend Trust currently trade at a 12.99% discount to net asset value. This is not as attractive as the 13.97% discount that the shares have had on average over the past year, but it is still a reasonable entry point. Conclusion In conclusion, the BlackRock Enhanced International Dividend Trust continues to look like a reasonable way to increase your foreign exposure and get a high yield in the process. The economic fundamentals of the United States have deteriorated so far this year, but the market does not appear to reflect this, so it might be a good idea to ensure that you are not overly concentrated in the domestic markets. This fund only has limited American exposure and has delivered comparable performance to most American indices when we look at the distributions that it pays out. The distribution appears to be easily sustainable, but the fund continues to trade at a substantial discount to net asset value.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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