There is only a week to go until the November 23 deadline for the congressional “super committee” panel to reach a deficit reduction agreement. The minimum level of deficit reduction needed is $1.2 trillion over 10 years.
If the committee agrees to the minimum level of deficit reduction or more, the Congress has one more month to accept or reject the package. But if a stalemate occurs, and an agreement is not reached, then $1.2 trillion in deficit reduction kicks in automatically over 10 years with about 50% in the defense sector.
I believe that our bond and stock markets will be highly disappointed if the deficit reduction package is only $1.2 trillion. This would only reduce government spending by about 3% over ten years. The markets would like to see much higher deficit reduction in the $3 trillion to $4 trillion range.
If another stalemate occurs, we could see another ratings downgrade, and we may finally start to see a negative reaction in the bond market. At some point, the Federal Reserve may be forced to raise interest rates next year to make our debt more attractive to creditors.
One closed-end fund that should perform quite well in a higher interest rate environment is the Eaton Vance Short Duration Diversified Income Fund (EVG). EVG is a leveraged fund that seeks to provide a high level of current income with a secondary objective of capital gains. The fund invests in three distinct investment categories:
1) Senior Loans: senior, secured floating-rate loans made by corporate and other business entities.
2) Foreign Obligations: bank deposits denominated in foreign currencies, debt obligations of foreign governments and corporate issuers (including emerging markets) and positions in foreign currencies.
3) MBS: mortgage-backed securities (both US guaranteed and privately issued).
Here are some key features of EVG:
1) Short duration limits interest rate sensitivity. The fund expects to maintain an average duration of less than three years including leverage.
2) Investment grade credit quality on average. The fund expects to maintain a weighted average portfolio investment grade credit quality (of at least BBB-).
3) The fund will allocate at least 25% to each of its principal investment categories- Senior Loans, Foreign Obligations and MBS.
EVG is currently selling at a discount to NAV of -9.18% compared to the 6 month average discount of -6.99%. The 6 month Z-Statistic is -1.11. This means the current discount to net asset value is a little more than one standard deviation below the mean.
EVG Distribution Policy
EVG pays Monthly distributions under a level distribution policy. Since February, 2011, it has paid out $0.09 per month. I like to look at the Average Earnings/Current Dividend Ratio. This ratio tells you whether or not a fund is earning its current dividend and the likelihood of receiving return of capital.
For EVG, the average earnings over the six months ending July were $0.0676, which is less than the recently monthly payout of $0.09. The Average Earnings/Current Dividend ratio is now 75.1%. In a recent press release, the fund said they believe that a portion of the $0.09 November distribution may not be net investment income. As of the last report, there was still a small positive value for “Undistributed Net Investment Income” or UNII of $0.0686 per share.
Portfolio Management Team
The fund is team managed. All five managers have at least 10 years experience and have earned the CFA designation.
Overall Portfolio Allocations
Domestic Senior Loans
Foreign Senior Loans
Senior Loan Country Allocation (as of 09/30/2011)
North America ex/US
Ticker: EVG Eaton Vance Short Duration Diversified Income
- Total Assets= 733 MM
- Total Common Assets= 338 MM
- Annual Distribution Rate= 6.65%
- Dividend Frequency= Monthly
- Average Duration= 1.77 years
- Current Monthly Distribution= $0.09 per share ($1.08 per year)
- Baseline Expense ratio= 1.27% (before interest expense)
- Discount to NAV= -9.18% 6 Month Avg. Discount= -6.99%
- Portfolio Turnover rate= 21%
- Effective Leverage= 24.24%
- Total Leverage= 55% (includes structural; non-1940 Act)
- Average 3 Mos. Daily Trading Volume= 145,000 shares (about $1.1 Million)
Overall, I think EVG is a reasonable way to park some cash after doing a “risk off” trade. It is also a good way to diversify your portfolio if you already own a lot of fixed interest rate higher duration investments like preferred stock. EVG is selling at a fairly high discount now, but it could attract much more investor interest (which would narrow the discount significantly) when the Federal Reserve starts to raise short term interest rates.
Disclosure: I am long EVG.