Evaluating CEFs As Dry Powder Assets

Summary

• A barbell investment approach which combines higher- and lower-quality assets has a number of benefits.
• Higher-quality or "dry powder" assets provide diversification and a more stable source of capital that can be used to rebalance into weaker assets during drawdowns.
• We evaluate MGF, WIW and WIA which hold high-quality assets as potential "dry powder" CEFs for income portfolios.
• Our takeaway is that none of the funds ticks all the boxes which is why we would tilt to open-end funds to fulfill this portfolio need.
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A popular way to construct investment portfolios is to use a barbell approach, that is, combine higher- and lower-quality assets. This approach has a number of advantages. It provides diversification across the quality spectrum, opportunities for rebalancing and a source of dry powder to spend during drawdowns. Normally, this higher-quality allocation takes the form of government or investment-grade bonds.

In this article, we take a look at whether the few CEFs with significant government bond allocations can play this role in investor portfolios. In particular, we evaluate the following CEFs:

• MFS Government Markets Income Trust (MGF)
• Western Asset/Claymore Inflation-Linked Securities & Income Fund (WIA)
• Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW)

We evaluate the funds on a number of what we call dry powder criteria which are:

• Low NAV/price drawdows
• NAV/price resilience
• Robust leverage mechanism
• Cost effectiveness

Our main takeaway is that these funds fail to tick all the boxes which is the reason why we would tilt to open-end funds to fulfill the role of dry powder assets.

A Look At The CEFs

All three funds are at the very high end of portfolio quality in the CEF space.

MGF holds about 85% in Treasuries, Agencies and other AAA securities with another 13% in investment-grade bonds. It holds about 11% in BBB-rated assets and has low single-digit high-yield holdings. MGF carries no leverage and has a 0.75% total fee on net assets. The fund also has a managed distribution policy of 7.25% of the monthly NAV. MGF closed Wednesday at a 3.5% discount and a 7.5% current yield.

The Western Asset funds have slightly lower-quality portfolios. They hold about 76-78% in AAA securities, 6-8% in BBB bonds, about 5% in high-yield and another 5% in unrated paper. The funds hold about 35% of leverage. WIA closed Wednesday at a 12.4% discount and a 3.67% current yield. WIW closed at

Analyst’s 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.