In previous articles, I've tried to pinpoint the tipping point for regional Closed End Funds -- the point when discounts or premiums are so stretched they can't go much further. The trick is not just finding a CEF with a huge discount or premium, but finding one that is out of step with its historical trend and close to earlier extremes.
In one article, I fingered the Chile CEF (CH), when it hit a 30% premium, suggesting a short position in CH and along position in the Chile ETF (ECH). Since then, ECH has risen 8.5% while CH has dropped 8.2%. In another article, I identified the ING Asia Pacific Dividend ETF (IAE), which reached a 9% discount. It is now down to 4% and headed lower. The biggest standout right now is the ING Emerging Market Dividend CEF (IHD). IHD invests in Emerging Market Stocks with large dividends. Like many country CEFs, it increases returns with a covered call strategy, writing calls for as much as 50% of its portfolio.
IHD has traded at premium for much of the last two years.
So what happened? On September 13, ING announced distribution cuts to a number of its CEFs. IHD got one of the biggest cuts, dropping its quarterly payout from .36 to .288 (and its yield from 11% to 9%). This was expected by most who follow these CEFs. IHD's recent payouts included substantial returns of capital (ROC). It just doesn't make sense to keep paying peoples' own money back to them and calling it a dividend on a continuing basis.
As you can see, the last few distributions included substantial ROC.
|Ex-Date||Ord. Dividends||Capital Gain||Return of Capital||Total|
The reaction to the distribution cut was delayed, with the stock moving higher for the next three days, before it started to drop. Frankly, we think any negative reaction to the cut is silly. Is it really helping shareholders to pay them back their own capital and calling it a dividend? Of course not.
So, on the contrary, cutting a meaningless distribution to reflect actual returns just ends the charade. It's really better for shareholders because the company is keeping the money invested when the underlying stocks are weak rather than paying it out. IHD is more desirable after the cut than it was before.
This is all underscored by the fact that IHD's discount, at nearly 7%, is the biggest in over a year. We think this discount is stretched very close to the tipping point. The last time it reached these levels, it quickly dropped and the stock reverted to a substantial 5% premium within weeks.
The last two days of heavy volume in IHD and huge "iceberg" orders suggests a single large holder liquidating its holdings in IHD. Once that liquidation is done, we expect IHD's discount to narrow just as it has in the past.
IHD's portfolio includes a number of Emerging Market dividend stocks we really like:
|OAO Gazprom ADR (OTCQX:GZPFY)||2.31%|
|Vale S.A. Pfd Shs -A- (VALE)||1.92%|
|MTN Group Limited (OTCPK:MTNOY)||1.26%|
|China Mobile Ltd. ADR (CHL)||1.23%|
|Sasol, Ltd. (SSL)||1.19%|
|PT Indofood Sukses Makmur TBK||1.19%|
|Itau Unibanco Holding S.A.||1.18%|
|Taiwan Semiconductor Manufacturing (TSM)||1.18%|
|Foschini Group Limited (OTCPK:FHNIY)||1.18%|
|Industrial And Commercial Bank Of China||1.17%|
In particular, the MTN Group and China Mobile, are set to capitalize on the explosive growth in EM mobile data.
IHD's country concentration is:
Of course the discount in IHD could get even larger. However, we think it is now very stretched. With a great portfolio of dividend-paying stocks in Emerging Markets, we think IHD is good value at this point.