Written by Nick Ackerman, co-produced by Stanford Chemist
If you are looking for a unique fund that could possibly play both the value and growth area of the market LMP Capital and Income Fund Inc (NYSE:SCD) could be it. The fund was brought up by a reader of the Income Lab and it looks truly unique. The top sectors are tech, MLP and financials - even some material industrial and utility exposure to boot.
This exposure helped stave the fund off from the deep declines that most energy funds had last year. Though it also limited the upside the fund could have had too with its tech exposure as energy dragged the fund down. Total returns weren't terrible considering the year, a decline of 6.17% on a NAV basis. The total share price return was another story. That declined 15.44% for 2020.
Yet, that is what brings up the appeal of the fund as it is still at a fairly deep discount relative to the CEF space. Hard to truly value this fund though as I'm not aware of any peer funds with a tech and MLP exposure at top allocations to compare with.
This is a Legg Mason fund that has now been brought into the Franklin Templeton (BEN) fold in 2020. It is managed by ClearBridge Investments which is a subsidiary of Legg Mason - a subsidiary of Franklin Templeton. For now, it seems that nothing has changed drastically. Investors will just note the Franklin Templeton logo on various fund materials.
They describe SCD as providing "a broad-based portfolio that can invest in a range of equity, and fixed-income securities of both U.S. and foreign issuers, including MLPs, stocks, REITs and fixed income." The fund will seek "total return, emphasizing income."
With this flexible approach, that is how we end up with a unique portfolio spread across various asset classes.
The fund is a fair size, though could be seen as too small, with just shy of $300 million in total managed assets at the end of 2020. They operate with a modest amount of leverage through borrowings at 18.55%. The expense ratio is also rather reasonable at 1.25% - when including leverage this comes to 1.65%.
Performance - Attractive Discount
Historically the fund has performed rather well for its hybrid approach. That is, even as we highlighted the losses last year.
(Source - Fund Website)
The above is the total returns annualized for the period ending February 28th, 2021. Well, the market has been quite volatile as of late, so also wanted to provide an updated YTD performance chart with more updated information.
As we can see, the fund has been doing rather well and holding up during this tumultuous time for tech. Tech has entered correction territory as of late, while energy and financials continue to hold their own.
The real attraction for SCD is the discount the fund currently has. Historically this fund has traded at some significant discounts - there is no arguing that. However, it could be argued that at this time the discount doesn't go too much further than this too. Meaning that a buffer could be built in, at least in that regard, from keeping the fund's share price declining too much more significantly.
The discount right now is 10.93% - the 1-year average comes to 12.83%. The longer-term 5-year average comes to 10.88%. We can see that the fund was making significant progress towards closing its discount at the end of 2019 and heading into 2020; then only to be hit with the black swan event of COVID. Thus, widening the discount back out from all the "progress" it made.
(Source - CEFConnect)
Distribution - 8.13% Yield Paid Quarterly
This fund had started out as a monthly paying fund before 2008 hit. They haven't bothered switching back to the more appealing monthly rate. Though I always like to mention, that even though monthly is more attractive, I don't think we should make a buy decision on that alone.
They had cut the distribution last year, but it was right at the end of the year. That likely left a sour taste in some investors' mouths. After all, it would have seemed like they were in the clear only to get a surprise later.
(Source - CEFConnect)
Despite this, I do believe the 8.13% distribution yield is still attractive. On a NAV basis, this works out to 7.24%.
In terms of how they cover the distribution; it will include dependence on capital gains. This is typical of most equity CEFs. However, SCD also holds some fixed-income exposure so we see the evidence of this is some higher net investment income [NII] coverage too.
(Source - Annual Report)
NII coverage came to 45%. This was an increase from last year as NII for the year increased. Primarily from reduced interest expenses as the interest rate on their debt averaged 2.98% at the end of November 30th, 2019. Compared to 1.44% for the same period ending 2020.
This isn't telling the whole story though either. As we know the fund holds a fairly significant portion in MLPs. Therefore, paying out return of capital [ROC] on a significant portion.
Also, note though that they did deleverage year-over-year. Previously they had a bit over $82.5 million in borrowings. YoY that declined to just shy of $63 million. This was probably factored in for the need to reduce the distribution. As NII going forward, likely will be reduced from what we see in their latest report.
That being said, the distributions to shareholders will also be reduced. So there is a good chance that coverage will stay relatively flat when we see their next report. Based on shares outstanding and if they maintain the current quarterly rate throughout the rest of 2020 - they will need a grand total of $18,702,663 for shareholders.
For tax purposes, the breakdown shows that the distribution is mostly ROC. As we touched on above, the fund holding MLPs will naturally have quite a bit of ROC anyway. Making the ROC not all destructive in this case. In fact, we know in 2019 it wasn't destructive at all.
(Source - Annual Report)
Holdings - Unique Blend
As we've been mentioning the top sector allocations, here are the actual breakdowns of each sector.
(Source - Fund Website)
What we can see is that it is actually pretty well-diversified without one sector taking a considerable amount of being overweight. Also note the tech and MLPs being the top sectors, which is interesting on its own.
The financial and industrials exposure are also "value" oriented sectors at this time. Which are the sectors that have been working really well - thus, we see that SCD has been performing well so far into 2021.
As far as asset allocation, the fund is heaviest in common stocks. However, they break out MLPs and equity REITs into their own asset classification as well. That seems a bit strange, but not completely unwarranted. They don't typically have a lot of correlation, so it can make sense.
(Source - Fund Website)
However, at first glance, that could make someone believe they aren't as heavily invested in equities as it might appear. Though they still do have a material amount of exposure to convertible preferred stocks as part of their fixed-income sleeve. Convertible bonds don't make up a material amount of exposure at this time.
Along the lines of breaking down the asset allocation in this manner, they also break down their top holdings between; MLPs, Equity REITs and Equity. The largest exposure is to equity and the MLPs also make up a fair amount of the allocation on the fund, so we can take a look there as well.
(Source - Fund Website)
For equities, the top holdings are some of those that we would expect; Microsoft (MSFT) and Apple (AAPL). Broadcom (AVGO) is also a fairly popular tech-oriented holding as well - though not highly held in a lot of tech CEFs. Broadcom "designs, develops, and supplies semiconductor infrastructure software solutions." They are a tech giant at over $193 billion in market cap. A stock that has been working incredibly well in terms of price appreciation.
We also have Qualcomm (QCOM) which is another large tech player at a nearly $149 billion in market cap. They "engage in the development and commercialization of foundational technologies and produces are used in mobile devices and other wireless products..."
Another stock that had been performing relatively well - especially recession-resistant as we saw throughout 2020.
Both pay dividends and have been aggressively raising. In the case of AVGO - they have been the most aggressive with a 10-year CAGR of 67.25%. QCOM's 10-year dividend CAGR comes to 13.22%, according to Seeking Alpha. Below is the annual dividend chart for AVGO.
(Source - Seeking Alpha)
For SCD, we can also highlight the top MLP holdings. We see that they make up a significant portion of the fund's assets. The larger positions are a meaningful part of SCD's portfolio as well.
(Source - Fund Website)
At the top, we have Enterprise Product Partners (EPD) and Magellan Midstream Partners (MMP). Both of which are viewed as probably the most conservative and solid MLPs available. In regards to stock performance, both have been hit considerably by the damages of 2020. Though they have come back significantly from the lows; as have a lot of the energy sector.
Revenue was down over 2020 and so was distributable cash flow [DCF]. Of course, that isn't too shocking. DCF is a go-to metric for MLPs. As income-producing investments, most investors are just looking to see if distributions can continue and at what level coverage comes to. They reported that the annual DCF declined from $1,297.5 million in 2019 to $1,044.5 million in 2020. However, they still reported 1.13x distribution coverage.
EPD likewise had revenue decline and DCF decline for 2020 too. Again, not too shocking considering the year. Though it held up considerably better than MMP as DCF went from $6.624 billion to $6.407 billion. That worked out to 1.6x DCF coverage.
This difference in declines is presumable from the way these two operate. EPD is more exposed to natural gas and MMP more in crude oil.
Conclusion
SCD is a rather unique fund that tilts its portfolio in two sectors that have been performing in opposite directions. Throughout most of last year, the tech sector was the big winner while energy/MLP saw huge declines. However, energy/MLPs have now been the winner this year and tech has been taking a bit of a breather overall. Though not declining nearly as rapidly as we witnessed with energy last year.
This fund can provide a meaningful amount of exposure to both. I believe even the financial allocation should perform well too. That is another area of the market that had been hit harder in 2020 that is coming roaring back in 2021. It also doesn't hurt with interest rates expected to rise at some point in the future - that should help support the financial sector further.
Overall, SCD provides a unique approach that could be right for some investors. The attractive 8.2% distribution rate means investors will be able to collect a healthy income along the way. The deep discount of 10.93% is also certainly attractive as well.
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