SOR is one of the few (perhaps the only) CEF that focuses on mid-cap growth.
The CEF format has advantages over ETFs for some investors.
How does SOR stack up to the three largest ETFs in this space: IJK, IWP and VOT?
Source Capital, Inc. (NYSE:SOR) is the only CEF I have found that is specifically aimed at mid-cap growth equities. It has been around since 1968 with management that has been in place for almost a decade. The management team is Eric S. Ende, Steven R. Geist and Gregory A. Herr.
There are a number of ETFs that focus on mid-cap growth, the iShares Russell Midcap Growth ETF (NYSEARCA:IWP), the iShares S&P MidCap 400 ETF (NYSEARCA:IJK) and the Vanguard Mid-Cap Growth ETF (NYSEARCA:VOT) are the largest ones. How does SOR stack up?
Data from Morningstar (5/15)
SORs price total returns over ten years trail IJK and IWP by a significant amount. The NAV total returns are lacking but the difference is much less significant.
Over five years SOR trails the ETFs on NAV total return and beats on price total return. This difference highlights a benefit of buying a CEF at a discount, SOR was able to outpace the ETFs on price because the discount was shrinking. However, I consider NAV total return the more important metric so I would rate all the ETFs as having better returns over the five year time period.
Over the shorter time periods SOR has the better returns. The difference is most significant over the last three months.
There has been a lot of debate here on SA and else where on how to measure risk. I've chosen to use the Sharpe Ratio because it is widely used and well understood.
Sharpe ratios from Morningstar (4/30/2014)
Based on the Sharpe Ratios the ETFs have performed better on a risk-adjusted basis over all time periods.
1 year average
3 year average
5 year average
SOR is trading close to its historical discount. Its discount/premium range for the last year has been between -4.55 and -12.11. If an investor was looking to add more mid-cap exposure to their portfolio the current discount would seem to indicate this is a decent time to enter this CEF.
In my view, one of the advantages of closed end funds is their market seems to be a little less efficient. A patient investor may want to wait hoping the market will give them a better opportunity.
SOR does not use leverage.
As expected the ETFs have lower expenses. This difference in expenses is an advantage for the ETFs and is responsible for at least part of the difference in total returns between the ETFs and the CEF.
SOR is currently paying $0.80 per quarter. In 2013 it was paying $0.75 per quarter and paid one extra payment of $0.14 in December that consisted of income. In 2011 it was distributing $0.70 per quarter and made one extra distribution of $0.53 in December.
We can see there was a steep drop off in distributions during the great recession. With its reliance on capital gains to pay distributions, this is hardly a surprise. The distributions have recovered nicely and based on the closing price of 67.55 on 3/15/2014 the distribution rate is 4.74%.
For my purposes I prefer the distributions a CEF provides, it allows me to decide if I want to re-invest or use the funds for another purpose. With an ETF, I could theoretically sell some shares every quarter but for a small investor the transaction costs would make this too expensive.
The current level of SOR's UNII is $.0023.
The top-ten holdings for SOR are given in the following table. When I buy a CEF I'm looking for management to provide returns, and if they do, I generally trust them to manage the portfolio. However, I like to have at least a perfunctory look at the holdings and their valuations. Below are the top ten holdings:
MKT CAP (billions)
5 year avg
Signet Jewelers Ltd.
WABCO Holdings Incorporated
Zebra Technologies Corporation
Heartland Express, Inc.
Knight Transportation, Inc.
Holding as of 3/31/2014. Source CefConnect. PE Data is from Morningstar
As shown in the following table - SOR is invested heavily in some sectors and other sectors are totally missing from the portfolio. For an investor requiring diversification across all sectors, SOR would not be a good choice.
Return on Equity
Based on the small set of valuation metrics shown here the valuation of the portfolio seems to be inline with the broader mid-cap market.
IWP - tries to match the Russell Midcap Growth Index.
IJK - tries to match the S&P MidCap 400/Citigroup Growth Index.
VOT - tries to match the MSCI US Mid Cap 450 Index.
For risk adjusted total return IJK and IWK have historically provided better returns.
However there a number of reasons SOR may still be of interest:
- Exposure to the mid-cap growth while generating income.
- The ability to play the discount either waiting for a better entry point or buying if you believe the discount will shrink.
- Its recent performance has been better than the ETFs performance.
Overall SOR is not a screaming buy but is a valid alternative to the ETFs in this space.
I encourage all investors to do their own due diligence and please share your findings. I strongly believe that one of the best things about Seeking Alpha is the sharing of ideas. Please comment, divergent opinion are welcome.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.