Liberty All-Star Equity Fund (NYSE:USA) is a closed end fund actively managed between five different and independent investment managers. This multi-manager concept in a CEF for individual investors was pioneered by Liberty All-Star Funds back at the fund's inception in 1986. USA currently has $1.245 billion in assets under management which is managed among 5 institutional asset managers. Currently there are three managers with a "value" mandate and two covering "growth" investments. Each manager is responsible for allocating an approximately equal amount of assets across large cap stocks. The idea here is to provide not only diversification but varying sources of insight and expertise to improve returns.
- Aristotle Capital Management
- Macquarie Investment Management
- Pzena Investment Management
- Sustainable Growth Advisers
- TCW Investment Management Company
Favorably, data shows that the concept has worked with the fund outperforming the S&P 500 on a total return basis over the past decade. Investors are likely attracted to the fund's targeted 10% distribution policy. The current yield is 10.5%. USA provides a good combination of income and total return performance.
Liberty All-Star multi-manager approach. source: Liberty Annual Report
With data directly from the source, the Liberty All-Star Equity Fund has in fact beaten the S&P 500 Index over the past decade, returning 14.32% per year over 10 years compared to 13.88% for SPY. We use the SPDRs S&P 500 ETF (SPY) for comparison purposes. Note that the returns here are on a total return basis which include dividends and after deducting fund expenses.
Including data through August 12, 2019, that out-performance on an annual basis over the past decade results in an 8.4% greater cumulative return over the period. Clearly that subtle 34 extra basis points per year since 2009 adds up.
cumulative total returns. source: data by YCharts.com
USA has more significantly outperformed in the last three years, up 61.3% compared to 39.6% for SPY. This is simply a reflection of its portfolio composition that likely over-weighted some of the big winners compared to SPY during a particularly strong period in the market during 2017 through the first half of 2018. Year to date USA is again ahead of its benchmark.
The other consideration here are the risk metrics that show USA is more volatile with a beta of 1.262 relative to the S&P 500 and SPY, which is effectively 1.0. USA's max draw down of 69.04% during the financial crisis compares to a loss of 55.2% for SPY during that period. During the extreme level of volatility in December of 2018 when the S&P 500 approached a bear market down 20.2% from its low on December 24, 2018, USA fell by a larger amount at 27.77%. Even considering the strong performance of USA over the past decade, the fund has a lower risk adjusted return as measured by the Sharpe Ratio at 0.977 compared to 1.145. Investors should take this into consideration before making USA a core holding. The appearance here is that USA under performs to the downside.
USA and SPY risk metrics. source: YCharts.com
The current USA portfolio, is well represented among large and mega cap names that comprise the S&P 500. Keep in mind that the fund has a turnover ratio of 22% so holdings are actively bought and sold over the course of the year. Visa Inc (V) is USA's largest holding with a 2.25% weighting, over-weight this name by 103 basis points compared to Visa's allocation in SPY. Indeed, looking at the top 20 holdings of USA that together represent 31% of the fund total, the fund is overall more concentrated with only 150 stocks. Notably, the fund is currently under-weight Microsoft Corp (MSFT) by 230 basis points and Amazon.com Inc (AMZN) by 98 basis points. This is simply a reflection of the investment manager's current views. According to portfolio characteristics data and sector exposure, USA is currently under-weight the technology sector overall with a 20.9% representation in the fund compared to 23.5% in SPY. USA top 20 holdings performance data. source: data by YCharts/ table author
Discount to NAV
We note that USA's discount to NAV has narrowed significantly in recent years from an average discount to NAV of the past 5 years at 11.36% to a current 2.69%. One explanation for the trend is simply a reflection that the performance of USA has been impressive enough that investors place more of a premium on the opportunity to invest alongside these particular investment managers driving the discount lower. In our view the narrowing of the NAV is a structural sign of quality which can be viewed as a positive. Still, this also reflects that the fund is more expensive relative to the discount investors have been able to acquire shares in recent years. We expect the discount to again widen during a market pullback as was observed in late 2018 when the discount to NAV reached 12% highlighting the implied volatility.
As often is the case, the name of the game in this CEF comes down to the distribution policy. USA targets a 10% distribution of its NAV. This currently translates to a 10.5% yield on market price. This is made possible by regularly distributing realized gains and the investment income along with an occasional smaller portion comprised of a return of capital.
From the policy statement:
Liberty All-Star Equity Fund's current policy, is to pay distributions on its common shares totaling approximately 10 percent of its net asset value per year, payable in four quarterly installments of 2.5 percent of the Fund's net asset value at the close of the New York Stock Exchange on the Friday prior to each quarterly declaration date. The fixed distributions are not related to the amount of the Fund's net investment income or net realized capital gains or losses and may be taxed as ordinary income up to the amount of the Fund's current and accumulated earnings and profits.
USA is a solid fund with investment results that speaks for itself which effectively performs as advertised. This is a good option within the non-leveraged equity closed end fund space and investors will be hard pressed to find another actively managed vehicle with superior results.
The 10.5% yield is enticing but keep in mind that the investment results above reflect the re-investment of all distributions, essentially negating the "income" aspects of the fund.
While USA has out performed the S&P 500 and SPY across different periods over the past decade, keep in mind that volatility is typically higher and the fund appears to under-perform to the downside. We take a neutral view on the Liberty All-Star Fund at the current level and rate USA as a hold based more on our generally bearish view on the broader equity market. Keep this one on your radar and look to buy on any significant pullback targeting a discount to NAV greater than 7.50% as an entry point.
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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Investing includes risks, including loss of principal.