You don't have to go back that far, a little over two years in fact, to see when most of the BlackRock (BLK) equity based high yielding Closed-End funds (CEFs) were on top of the CEF world based on their premium valuations for many of their option-income funds. I, of course, was not so smitten back then and in fact was taking a more negative view of these funds due to their high Net Asset Value (NAV) yields that generally breached the 12%+ red flag level. I argued, beginning with this article in May of 2011, Which Option CEFs To Buy, that 12%+ NAV yields were unsustainable without NAV erosion and that the end result would be continued destructive Return-of-Capital (ROC) that would eventually force the fund sponsors to cut distributions, and the sooner the better. In fact, I recommended that investors swap out of the BlackRock option-income funds and into the Eaton Vance (EV) and Nuveen option-income funds which had already started reducing their distributions beginning in early 2010 to more manageable levels but had fallen out of favor as a result and were generally trading at -10%+ discounts.
My how far we have come. It is now the Eaton Vance and Nuveen option-income CEFs which trade at much narrower discounts due to their better overall NAV and market price performances and it is now the BlackRock funds which are treated mostly with disdain. This is because it's been the BlackRock option-income funds which have been doing most of the distribution cutting over the past year and now it's their turn for income investors to turn their back on them.
Of course, that is exactly the time when investors should be buying these funds and I liken this period for the BlackRock equity CEFs to what Eaton Vance went through back in 2011 when none of their funds got any respect and traded at some of the widest discounts of all equity CEFs. But now that virtually all option-income CEFs from all fund families have reduced their distributions down to more manageable 7% to 9% levels, I have been recommending more and more of the BlackRock option income funds such as the BlackRock International Growth & Income fund (BGY) and the BlackRock Global Opportunities Trust (BOE). These two funds may not yet be showing strong NAV recovery yet, and a lot of that is due to their heavy exposure to overseas markets, but with their NAV yields now down to 7.8% each, they should be able to both pay their distributions and grow their NAVs back over time.
The disrespect for the BlackRock option-income CEFs has gotten so bad in fact that even funds that were never in danger of cutting their distributions have suffered simply due to guilt by association. For one such fund, the BlackRock Energy and Resources Trust (BGR), it has reached the absurd level and has created one of the best opportunities to own a high yielding CEF in a sector that is performing very well.
First, let me show you BGR's 1-year Premium/Discount chart, which is essentially a ramp down.
This is in contrast to the energy sector which has essentially been a ramp up over the past year. Keep in mind that BGR's portfolio focuses almost entirely on N. American stocks (82% US, 11% Canadian) in the oil, gas and energy equipment & services sectors, not exactly out of favor sectors. Though metals and mining is BGR's third highest sector exposure, it only represents 1.9% of its overall portfolio as of the end of the 3rd quarter, 2013. So should BGR be trading at one of the widest discounts of all equity CEFs, -11.5%, or is this an opportunity for investors to own stocks in popular sectors at a significant discount?
Well, let's take a closer look at BGR and see if this underappreciation is warranted. BGR is an options-income fund that writes (sells) individual options against 31% of its overall stock portfolio. That's a fairly low option coverage for a defensive strategy option-income fund, which means that BGR can capture quite a bit of NAV upside when the sectors the fund invests in are on a roll. BGR only owns about 40 stock positions which is similar to the number of holdings that the SPDR Select Energy Sector ETF (XLE) owns, a comparable ETF which I will use as BGR's benchmark.
XLE, as the most popular energy sector ETF trading 12 million shares daily, makes a good benchmark comparable for BGR though XLE's portfolio is more market capitalization driven whereas BGR can allocate its portfolio among large, mid or even small cap stocks. In fact, one of BGR's largest positions currently is Gulfport Energy Corporation (GPOR), a relative unknown compared to say, ExxonMobil (XOM), Chevron (CVX) or Schlumberger (SLB), the top 3 holdings of XLE. Here are BGR's top 10 holdings as of 4/30/2013.
BGR Compared to XLE
So is BGR a better alternative to XLE? Well, let's look at a couple comparisons. One of BGR's biggest advantages over XLE is that it offers a current 6.3% market yield vs. 1.7% for XLE. Another advantage, in my opinion, is that BGR is more actively managed both in its portfolio and its option overlay whereas XLE is non-managed. This does give XLE one advantage over BGR and that is in the area of management fees. XLE has a very low 0.18% annual expense ratio whereas BGR has a 1.27% expense ratio.
But let's take a look at what matters most, total return performance. Here are three tables looking at BGR's total return NAV performance vs. XLE's total return performance. Total return performance is defined as appreciation (or depreciation) plus all distributions, dividends and capital gains added back but not on a reinvested basis. I also use a CEF's total return NAV performance, i.e. not the market price performance, when comparing to an index or benchmark since a CEF's NAV is the true apples-to-apples comparison.
For performance comparison purposes, instead of a 5-year and 3-year period, I like to use from roughly the high of the equity markets back at the end of the 3rd quarter 2007 and from roughly the low of the equity markets back at the end of the 1st quarter 2009. This gives a good comparison of how these funds performed during both a bear and bull market environment. And finally, I include a shorter 1-year comparison to reflect the current market environment.
Other notes to go along with these tables. Green represents up quarters for the overall market and red represents down quarters. All distributions, dividends and capital gains are added back each quarter to give you a running total return performance. First table shown is from close to the high of the market on 9/30/2007.
The second table shows the performance comparison from the low of the market at roughly the end of the 1st quarter of 2009.
And finally, here is a 1-year table.
As you can see, in two out of these three tables, BGR's NAV has actually outperformed XLE. So why is BGR trading at a market price -11.5% below its NAV when other energy sector CEFs I follow trade at much narrower discounts? Is it simply because it's a BlackRock option-income fund and nobody wants to own funds from BlackRock right now? If that's the reason then this is a wonderful opportunity for income investors to pick up an actively managed CEF with a sustainable 6.3% current market yield and own the fund's assets at a significant discount. One other thing to keep in mind...BGR has never cut its distribution and in fact, raised its distribution back in late 2008. Compare BGR's discount with other CEFs which have never cut their distribution and many of them trade at lofty premiums.
When I see how many disastrous equity CEFs there are that trade at premium valuations because they have unrealistically high yields they can't sustain (Cornerstone funds anyone?) and yet here is a fund trading on sale at a significant discount with a sustainable 6.3% market yield, it just boggles my mind how shortsighted most investors are in these funds.
And finally, for those who think equity CEF NAVs do nothing but go down over the years after paying out their large distributions, BGR went public at the end of 2004 with a $23.83 NAV. BGR's current NAV is $29.09. In fact, I wouldn't be surprised to see BGR raise its distribution again sometime this year.