Time To Buy This Opportunistic Mortgage Closed-End Fund?

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Includes: JLS
by: George Spritzer, CFA
The Nuveen Mortgage Opportunity Term Trust (ticker: JLS) is a closed-end fund that was formed in November 2009. At the time, there were other private equity/hedge funds also being formed to invest in the US Treasury’s Public-Private Investment Program (PPIP). PPIP is one of the initiatives coming out of the TARP program, and was designed to provide liquidity for “toxic assets” on the balance sheets of financial institutions.
The main objective of the fund is to generate attractive total returns through opportunistic investments in mortgage securities. The fund invests primarily in non-agency residential MBS both directly and through a “feeder” fund that participates along with the US Treasury and other institutional investors in a master fund organized to invest directly in MBS and other assets eligible under the US Treasury’s PPIP program. The fund may be leveraged up to an effective leverage of 33%.
JLS plans to have a limited term of 10 years. At that point, all net assets will be distributed to shareholders.
This is the security type breakdown as of August 31, 2011:
Asset allocation
Residential MBS
72.1%
Commercial MBS
14.4%
Agency CMO
7.8%
Asset-Backed
2.7%
Agency Pass Thru’s
0.6%
Cash
2.40%
Top 5 Sectors
Non-agency RMBS Prime
35.03%
Non-agency RMBS Alt-A
24.18%
Non-agency RMBS Subprime
12.86%
Other Agency CMO’s
7.75%
CMBS AM Tranche
6.63%
JLS had an inception share price of $25, and an original net asset value of $23.83 reflecting the sales commission and expenses of the IPO. Unlike most other closed-end fund IPOs, JLS actually appreciated in price above the IPO price the first few weeks after issuance and the premium widened to as much as 8%. But within six months, a small discount developed.
JLS had good initial NAV performance. In calendar year 2010, the NAV was up 16.06%, and the market price was up 10.47%. The difference is largely due to the elimination of the premium over NAV. This year, performance has been much worse. As of October 13, the NAV is down -6.25%, and the market price has dropped -13.61%. Some of this is likely due to a general slump in performance of lower rated bonds this summer.
Credit Quality (Moody’s)
AAA
0.2%
AA
10.2%
A
5.2%
Baa
7.1%
Ba
4.0%
< Ba
70.0%
N/A
3.1%
Fund Management
JLS is managed by two firms. It combines the closed-end fund expertise of Nuveen Investments with the mortgage securities expertise of Wellington Management. Nuveen Asset Management determines the overall investment strategy, monitors Wellington’s performance and decides whether and to what extent to invest in the PPIP feeder fund:
  • Michael F. Garrett, VP and Fixed Income portfolio Manager of Wellington Management. He leads his firm’s Mortgage-Backed Investment team. Michael received a BA in Economics from Yale (1991).
  • John Miller, CFA and Chief Investment Officer at Nuveen Asset Management. John joined Nuveen as a credit analyst in 1996. He became managing director in 2006 and CIO in 2007. John received a B.A. in Economics and Political Science from Duke, and an M.A. in Economics from Northwestern University, and an MBA with honors in Finance from the University of Chicago.
Here are some summary statistics on JLS:
Nuveen Mortgage Opportunity Term Trust (ticker: JLS)
  • Total Common assets: 353.73 Million
  • Annual Distribution (Market) Rate= 9.96%
  • Last Regular Monthly Distribution= $0.1725 (Annual= $2.07)
  • Fund Expense ratio: 1.30% Discount to NAV= -8.33%
  • Portfolio Turnover rate: 109%
  • Credit Rating: 70% below Ba
  • Effective Duration: 1.54
  • Effective Leverage: 19.07%
  • Average Daily Volume (shares) = 40,000
  • Average Dollar Volume = $0.965 Million
JLS is currently selling at a discount to NAV of -8.33% compared to the 6 month average discount of -3.43%. Here are the Z-Statistics for the discount from NAV:
  • The 1-Year Z-Statistic is -2.37. This means the current discount to net asset value is more than two standard deviations below the mean.
  • The 6 month Z-Statistic is -1.83.
  • The 3 month Z-Statistic is -1.24.
JLS has only moderate trading liquidity. It often trades with a bid-asked spread of more than four cents, so care must be used when trading blocks of 500 shares or more. JLS may be an attractive purchase at current levels for investors looking for lower rated fixed income investments. JLS is currently selling at an 8% discount. But if you are willing to hold JLS until 2019, the fund will be liquidated and you will be able to realize the full net asset value at that time.

Disclosure: I am long JLS.

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