Aberdeen Asia-Pacific Income Fund: Still Over Distributing, But Worth A Look

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About: Aberdeen Asia-Pacific Income Fund (FAX), Includes: AGG, EMB, GIM, IGOV, JGH
by: Maks F. S.
Summary

FAX is a closed-end fund sponsored by Aberdeen Standard Investments, seeking a level income with incidental capital appreciation.

The fund currently yields a 7.89% managed distribution and is trading at a discount of 13.84% to its net asset value.

In-depth update of the fund since our initial article on 9/25/2017.

While they have never been a huge sponsor, one of the companies that I very much respected and liked is Aberdeen Asset Management, now known as Aberdeen Standard Investments.

The company is truly global and strongly believes in local knowledge. As such, unlike many other sponsors, they generally offer investments in areas where they see themselves as experts and have boots on the ground.

One such fund that we covered in the past is the Aberdeen Asia-Pacific Income Fund (FAX). We looked at it in the article "FAX - Between A Rock And A Hard Place," which I wrote in September, 2017.

Despite the solid management, the fund's distribution was quite high and unsustainable. Finally, the fund did cut the distribution, as Stanford Chemist covered in his article, "Aberdeen Asia-Pacific Income Fund: The Inevitable Cut Could Not Be Delayed."

So where's the fund today and is it worth your investment?

Let's take a look!

Fund Basics

  • Sponsor: Aberdeen Standard Investments
  • Managers: Teams based in Singapore & Sydney
  • AUM: $1.728 billion in investment exposure, $1.186 billion common assets.
  • Historical Style: Global Fixed Income
  • Investment Objectives: The Fund seeks current income with incidental capital appreciation through investment in Australian and Asian debt securities.
  • Number of Holdings: 252
  • Current Yield: 7.89% based on market price, monthly distributions
  • Inception Date: 4/24/1986
  • Fees: 2.67%, (as of 10/31/2018)
  • Discount to NAV: 13.84% Discount

Sources: CEF Connect, Aberdeen Website, and YCharts.

Fund Updates

Being focused on foreign markets, this fund is going to be quite exotic in its holdings.

As we can see, as of the end of June, the vast majority of the top 10 holdings were Australian and Indonesian sovereign bonds.

Source: FAX Fact Sheet 6/30/2019

The top 10 holdings make up just under 23% of the portfolio.

Even though the top 10 holdings are predominantly sovereign bonds, sovereign and government bonds represent just about half of the portfolio, the other half being made up by corporate debt.

Source: FAX Fact Sheet 6/30/2019

This also appears in the credit quality.

A bit more than 44% of the fund is rated A or better. The fund is well diversified in credit as well with a good amount of BBB exposure and unrated credits, or issues that may be too small to rate.

Once again, unrated does not necessarily mean junk. It may simply mean that if the fund was able to take out the entire offering, they may not want to have the issuer spend money rating it and would rather have the increased yield.

Source: FAX Fact Sheet 6/30/2019

Looking at the geographic breakdown we find a fairly well diversified fund with Australia, China, Indonesia and India having the largest exposures.

Source: FAX Fact Sheet 6/30/2019

As this is a global fund, we do have to take currency exposure into the fund.

Despite being an Asia-Pacific focused fund, about 46% of the holdings were denominated in the US dollar.

Source: FAX Fact Sheet 6/30/2019

The Australian dollar accounts for a bit more than 1/4 of the fund with the balance being made up by others.

We have to keep in mind that the fund is leveraged so the duration will be impacted.

Source: FAX Fact Sheet 6/30/2019

The fund has a modified duration of 4.34 years. This means that for every 1% increase in interest rates, the fund's NAV should be expected to decline by 4.34%. The inverse would also be true. A 1% decrease in interest rates would imply a 4.34% increase in NAV.

What we do not know is whether that number is leverage adjusted or not.

Looking further at the risk data we find that the fund's beta is 1.249. This implies that the fund is about 25% more volatile than the S&P 500.

Source: YCharts - 4/8/2019

The maximum draw-down which the fund experienced remains the same at 56.7%, likely attained during the closed-end fund sell off in 2007/2008 when the leverage markets dried up and funds were forced to liquidate.

Leverage

As with many closed-end funds, FAX uses leverage.

As we discussed in our previous article, the fund had a variety of leverage vehicles including two term loans, a revolving credit facility, three different secured notes and a 10-year mandatory redeemable preferred share.

Source: FAX Semi-Annual Report 4/30/2019

As per the report,

We believe the Fund has been able to lock in an attractive rate of borrowing and extend the maturity of the leverage facility while diversifying its borrowing structure during what we believe to be a favorable current interest rate environment.

For a detailed look at the leverage, please take a look at the Semi-Annual report.

The first form of leverage is the Preferred Shares.

The fund has issued $50 million in Series A preferred shares with a mandatory redemption date of June 27, 2023, on which they pay an annual fixed rate of 4.125%.

Source: FAX Semi-Annual Report 4/30/2019

The bulk of the fund's leverage comes through senior secured notes.

As of the latest update, the fund had four series of notes for a total amount of $350 million with interest rates ranging from 3.05% to 3.87% and maturities from 2020 to 2032.

Source: FAX Semi-Annual Report 4/30/2019

Finally, the fund has a credit agreement with a syndicate of banks for $100 million on which it pays a 2.38% interest rate.

Source: FAX Semi-Annual Report 4/30/2019

Distribution Quality

The fund currently distributes a $.0275 per share monthly distribution. The distribution took a meaningful cut in April from the previous $.0350 per share.

Source: CEF Connect

The current market distribution yield is 7.89% as of 8/6/2019.

In the past the fund had issues with over distributions.

As per CEF Connect, the fund continues to distribute return of capital as part of the distribution, albeit at a lower level.

Source: CEF Connect

Next, we can look at the latest income statement found in the annual report for the period ending April 30, 2019.

As this is an income fund, the majority of the income should be coming from net investment income.

For the six months ending 4/30/2019, the fund earned $38.1 million in income.

Source: FAX Semi-Annual Report 4/30/2019

The fund had a total of $16.484 million in expenses for the six months including $4.7 million in management fees and a bit more than $9 million in leverage expenses.

The net investment income ended up at $21.619 million.

Source: FAX Semi-Annual Report 4/30/2019

The fund is actively managed and does trade securities. As such we also look at the realized gains/losses and the changes in the underlying value in the portfolio.

The fund ended up taking $23 million in realized losses, about half of which was related to the foreign currency transactions.

On the other hand, the fund had a good amount of unrealized appreciation.

Between the realized losses and unrealized gains, the fund gained $80.6 million and the total increase in net assets went up to $102.25 million.

Source: FAX Semi-Annual Report 4/30/2019

Putting it together, we can find that the fund had net investment income of $21.69 million, but paid out more than $50 million in distributions for the first six months ending 4/30/2019. The over-distribution came from the gains in the portfolio.

Source: FAX Semi-Annual Report 4/30/2019

The results for the six months ending April 30, 2019, is quite a bit different than for the prior 12 months ending 10/31/2018.

In either case, the fund's distributions are not just coming from the net investment income and indeed coming from gains and return of capital.

Is this bad?

Not so much in this case as part of the fund's distribution policy is to over-distribute.

Source: FAX Distribution Policy

Why are we looking at income statements? Why is any of this important? If you are a new subscriber or have not done so yet, please take a look at my article discussing distributions, CEF School - Distributions 101 - Distributions Are NOT Dividends.

The Numbers

The fund is currently distributing a market price distribution yield of 7.89% and is trading at a discount of 13.84% to its NAV, or net asset value.

Source: CEF Connect

Over the previous year, the fund's NAV has been fairly stable while the price per share took a bit more of a tumble in Q4 2018.

As the fund has a policy of over-distributing, we should expect the NAV to take gradual declines in flatter markets.

Performance wise, year to date, the fund achieved a 12.66% total return. The price per share increased 6.98% while the NAV increased 3.2%. This implies the discount to NAV shrank by about 3% since the start of the year, helping the overall performance.

Chart Data by YCharts

Over the previous year, the fund gave investors a 7.6% total return. The price per share declined 2.13% while the NAV declined 1.43%. This implies that over the previous year, the discount to NAV opened up slightly.

Chart Data by YCharts

Since our last article on 9/25/2017, the fund did not do as well.

During this time, the fund's total loss was 4.65% while the NAV declined 12.64%. The price per share took an even deeper tumble, a 19.46% loss, driven by the substantial opening of the discount to NAV.

Chart Data by YCharts

Going back three years the overall pictures becomes a little bit better.

During this time, the fund achieved a total return of 3.42% while the price per share and net asset value declined 20.84% and 17.41%, respectively.

Chart Data by YCharts

To put the fund's performance into perspective, let's take a look at how it does against a number of peers and benchmarks.

The competing closed-end funds are the Nuveen Global High Income Fund (JGH), the Templeton Global Income CEF (GIM). Furthermore, we can take a look at it against a number of ETFs such as the iShares JPMorgan USD Emerging Markets Bond ETF (EMB), the iShares International Treasury Bond ETF (IGOV) and the iShares US Aggregate Bond Index (AGG).

Since the start of the year all of the funds have been positive. The Aberdeen fund trailed the Nuveen Global High Income fund but came ahead of the Templeton fund.

Interestingly, FAX has matched the performance of the emerging bonds ETF. The play here is between unleveraged riskier assets versus leveraged higher quality.

Chart Data by YCharts

The same situation plays out over the previous 12 months although we do see a significant difference between the leveraged closed-end funds vs. unlevered ETFs when it comes to volatility.

Chart Data by YCharts

Since our last article we do see that the Aberdeen Fund has been the laggard, primarily due to its 2018 performance. Interestingly, the difference in the funds has not been that much different. The one standout here is the Templeton fund which performed in line with unlevered ETFs.

Chart Data by YCharts
Going back three years, we do see that the Aberdeen Asia Pacific fund performed in line with the iShares International Treasury Bond fund rather than the more aggressive Nuveen Global High Income and Templeton Global Income funds.

This may simply be that they have a broader investment mandate rather than being locked into the Asia Pacific market.

Chart Data by YCharts

Bottom Line

In my initial article I wrote,

The fund is an investment grade portfolio of fixed income securities in a market environment with extremely low market rates. Without employing much more massive leverage, it's a challenge to generate the current targeted distribution.

As we can clearly see the current distribution is unsustainable. Fortunately investors are most likely aware that the fund is choosing to destroy its NAV in order to maintain the distribution rate as the sponsor does a good job disclosing their managed distribution policy.

As an investment the fund is run by a good manager but I believe there were better times to enter it. Most of all, income investors who would be living off of the income would quickly see their NAV decline.

Source: "FAX - Between A Rock And A Hard Place"

All of the above is still true. What's different this time is that the fund is a better value.

Source: CEF Connect

Overall, you have an interesting proposition now.

On one hand, you have a fairly high quality income fund that's over-distributing. As such, this would be a big "avoid" for me.

In this case, however, we have to take into consideration that the fund is trading at a meaningful discount to NAV.

As such, the return of capital is then, in essence, being returned to you at NAV, while you invested at a discount.

Heading into a lower interest rate environment, this fixed income fund just may be worth considering.

For more information on the fund, please visit the fund's website at Aberdeen - FAX.

I hope you found this article helpful, especially the Income Idea look at the distribution quality.

I look forward to your questions and comments!

Disclosure: I/we 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.