Thus spake Zarathustra

The Cornerstone Funds Are Sucker Bets

My math was wrong....

I wrote: "The "sucker" buying in at a 75% premium and holding forever will realize an ongoing return of about 5.1% (9%/1.75=5.1%).

Actually, the math is more complicated, and a 75% premium level is just too high. If the portfolio total return is 9% after expenses, a 23% premium will provide a long term, tax advantaged return of 5.1% . Paying a 75% premium and holding forever results in a 0.0% net long-term return, not 5.1%.

The Cornerstone Funds Are Sucker Bets

You may have solved the mystery. In an earlier Seeking Alpha article, George Spitzer pointed out the surprising (and growing) holdings of the Renaissance Technologies Hedge Fund in both CLM and CRF. These guys are considered by many to be "the smartest guys in the room", so they must certainly have done their due diligence with regard to the Cornerstone operation.

Perhaps they have figured out how to make continued high returns on the long side of these two funds, due to the high "negative rebate fee". I wonder what the implications are for the premium to maintain its high levels. If Cornerstone resets the distribution every year at 21% of NAV, and the market continues to price these funds at a "yield" to market price of 12%, perhaps the indicated 75% premium level (21%/12%-1=75%) will go on forever!

Think about it. If the market appreciates 10% a year, the portfolios of CRF and CLM will appreciate about 9% a year after expenses but before distributions. This means their NAV will decline about 12% a year after distributions. Because of the reset, this can be repeated every year indefinitely. All that is required is for the Funds to do reverse stock splits every few years to keep stock price respectable, and to merge in new assets from other captured closed-end funds every few years to keep the Fund sizes and expense ratios reasonable. This has already been done once with the merger of MGC into CLM a couple of years ago.

The "sucker" buying in at the 75% premium and holding forever will realize an ongoing total return of about 5.1% (9%/1.75=5.1%). Since the distributions are dependable and monthly, and classified as either tax deferred return of capital or long term gains, this isn't really terrible in today's world in comparison with fully taxable CD rates. Besides, this "investment illiterate sucker" can kid himself into thinking that he is getting 12% mostly tax free (wrong, but a good cocktail brag!). In reality, this is all just an "annuity" which doesn't compare all that badly with what the insurance industry offers.

Just some food for thought....