The most anticipated distribution cut of all equity closed-end funds (CEFs) was finally announced on Tuesday, May 1, after the market close when BlackRock (BLK) declared that they would cut the distribution for the BlackRock Global Opportunities Equity Trust (BOE) by 28%, from $0.5688/share per quarter to $0.41/share per quarter.
This was highly expected and in four articles I have written over the past year on the BlackRock option-income funds, I had warned investors that CEFs with overly high NAV yields, which I identified as over 12%, could be vulnerable to distribution cuts. In the first article on May 30, 2011, which you can read here, I identified five BlackRock option-income funds that fell into that category. Since that time, all five funds have now cut their distributions. To be fair, other option-income funds from other fund families, including ING, Eaton Vance and Nuveen, have also cut distributions over the past year as well but none as large a percentage as the BlackRock funds.
In October of last year, I specifically called out the BlackRock International Growth and Income Trust (BGY) and BOE as exceptionally vulnerable to distribution cuts when NAV yields hit 16.8% and 15.3% respectively in a difficult market environment for global funds last fall. These were dramatically higher than even the 12% I identified as in the danger zone so it was pretty clear to me that both funds were going to have to cut their distributions or risk seeing continued NAV erosion. You can read that article here.
Then on March 1, 2012, BlackRock finally lowered the boom on BGY and cut its distribution by 35%, from $0.34/share per quarter to $0.22/share per quarter. The resulting fallout in BGY's market price I felt was a good buying opportunity especially after finally putting the distribution cut behind it and I even wrote as much in this article here.
Once the cut in BGY occurred, it was all but inevitable that a cut in BOE was on the horizon. This seemed to be common knowledge on Tuesday when in an otherwise strong market, BOE was ramp down all day, closing down -1.4%. Not exactly a huge fallout and even on Wednesday, after the declaration, BOE suffered only a minor additional -2.9% hit. This is in contrast to the fallout that BGY took in March on its distribution cut and another BlackRock option-income fund, the BlackRock Enhanced Capital and Income fund (CII), which cut its distribution last June of 2011 and also got hit exceptionally hard. I'm not quite sure why BOE gets the benefit of the doubt since there is nothing in its NAV performance to suggest that it has any advantage over the other BlackRock funds. More on that below.
Where do we go from here?
With all of the distribution adjustments that I anticipated now behind them, where do we go with the BlackRock option-income funds? Though I still feel leveraged CEFs are where investors want to be in 2012 over option-income CEFs, BlackRock has a number of low coverage option-income funds that can have as good of NAV upside as most any leveraged fund in a strong global market. In the world of high yielding equity CEFs, the two most popular income strategies are the leveraged strategy and the option-income strategy. Last year in a mostly flat U.S. market and down global markets, the most defensive option-income funds, the ones with up to 100% option coverage on their stock portfolios, had the best Net Asset Value (NAV) performances. In 2012, the leveraged and low option coverage (around 50% or lower) funds offer the best upside potential. So which BlackRock funds should investors look to? Let's first take a look at a few tables.
The first table sorts the BlackRock fund's valuations based on their discount/premium prices. Funds in green are at discounts and funds in red are at premiums. All valuations are as of May 2, 2012.
Table 1: Sorted by Discount/Premium Valuations
The first item I would like to point out is that no BlackRock fund has an NAV yield over 12% anymore. Hooray. This should keep the funds safe from any more distribution cuts but obviously any downturn in the markets for an extended period of time could result in another round of rebalancings resulting in additional cuts.
The second item I would like to point out is that even after the distribution cut, BOE still has a relatively rich valuation compared to the other funds. Whereas BGY and CII dropped precipitously after their distribution cuts, BOE has suffered no such fallout so far. So is BOE a buy now after its distribution cut? The best way to tell is by evaluating high yielding equity CEFs by their NAV performance over different time periods. This can tell you a lot about which funds deserve to be at premiums and discounts and which funds do not.
The following three tables sort the BlackRock funds by NAV performance over three time periods. The first is NAV performance YTD, the second is NAV performance over one year and the third is NAV performance over three years. NAV performance includes all distributions added back to give total return performances through May 2, 2012. Also shown is the fund's market price total return performances over the same time frame for comparison.
Table 2: Sorted by YTD NAV Performance
Table 3: Sorted by 1-Year NAV Performance
Table 4: Sorted by 3-year NAV Performance
To remind investors, NAV performance is the true performance of the fund whereas the market price performance is more subjective and can be based more on investor sentiment and market volatility. This can result in funds moving to extreme over and undervaluations based on their discount/premium market prices. Some of these discounts and premiums might be justified, others not. Evaluating CEFs by their NAV performance can give more sophisticated investors an advantage since funds that have dropped to wide discounts that have had otherwise good NAV performances can present buying opportunities. This is why waiting until after a distribution cut on funds with unsustainable distributions is a better strategy than trying to chase yield.
So which BlackRock option-income funds now offer the best investment opportunities? Table 1 provides a good first look. My top pick is the BlackRock International Growth and Income Trust, or BGY. BGY is an aggressive pick with a mostly international portfolio of large cap stocks. After its distribution cut in March, BGY dropped to a double-digit discount but I felt that was the best time to invest in BGY in years due to finally putting the distribution cut behind it and finally allowing the fund to show more NAV upside potential in a global market recovery. Indeed, BGY's NAV performance YTD has been very good for a global fund (Table 2) and with the largest market price distribution yield at 11.5% and a wide -9.8% discount, BGY offers the best risk/reward valuation in my opinion.
For more moderate risk picks, the BlackRock Enhanced Dividend Achievers Trust (BDJ) and the BlackRock Enhanced Capital and Income fund would be my first choices. Both of these funds have diversified portfolios of mostly U.S. based stocks and both sell more defensive 55% option coverage on their portfolios. Though neither fund's NAV has kept up with the averages so far this year, over a one-year time frame (Table 3), both funds look much better and should ride out any downturn in the markets more so than any of the other BlackRock option-income funds.
One final pick is the BlackRock Resources & Commodity Strategies Trust (BCX). This is also a more aggressive selection and a play on strong energy, gas, metals and mining sectors. BCX has gotten hit hard this year and as a new fund only about a year old, does not have much of a track record. Still, with a low 28% option-coverage, BCX has plenty of upside potential on par with leveraged CEFs should the commodity sectors the fund invests in turn around.
And what about BOE? I just don't see it. BOE has not shown any superior NAV performance over the other BlackRock funds over any time frame to warrant my interest. Its 3-year NAV and market price performance (Table 4) is one of the worst of all the BlackRock funds. Now that the distribution cut is behind BOE, I think investors can at least point toward better NAV performance going forward rather than an oversized distribution yield, but I still think some of the other BlackRock option-income funds are more attractive even after BOE's distribution cut.
For more information on equity CEFs please visit my website here.