Evaluating CEFs: NCZ Is At A Large Discount
- NCZ pays a distribution of 3.75 cents a month (for an 8.75% yield). Attractive if it can support it.
- NAV performance over the last 3 years has been good, but not so good over the last 10.
- The distribution has been well supported, but that is with distribution cuts.
- With new management, a larger than average discount, and no distribution cut in April, there could be an opportunity here.
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In a series of articles evaluating CEFs (Closed-End Fund), I started by looking at two from Cornerstone with very high yields. I evaluated them looking at their ability in the past to support their very generous distributions and to pay a shareholder a dependable stream of income in the future. I concluded neither fund had been supporting the distribution in "How To Evaluate A CEF: A Look At CLM" and "Evaluating CEFs: A Look at CRF." Both funds are overpaying their distributions and this is the primary cause of the declining NAV and distribution payments.
I want to own CEFs that pay me a stable flow of income. I have developed a method of determining whether a specific CEF could provide a reliable stream of income. I developed my method after reading this article. Each article in the series looks at a specific CEF and applies that method to determine if the fund has been supporting the distribution. Then based on current holdings and past performance, I predict whether or not the fund will be able to support the distribution in the future. You can read an explanation of my method and get links to the other articles in the series here.
The series doesn't just cover funds that I don't think are covering their distributions. I have looked at funds that are covering their distributions. In "Evaluating CEFs: A Look at USA" and "Evaluating CEFs: A Look at DNP" I found two funds that I like that are covering their distributions: Liberty All-Star Equity Fund (USA) and DNP Select Income Fund (DNP). I liked USA so much that I ended up buying shares in the fund. And I recently bought shares in DNP as well based on my research.
This article will take a look at the AllianzGI Convertible&Income Fund II (NYSE:NCZ). NCZ has the investment objective of providing total return through a combination of capital gains and high current income. NCZ will invest at least 80% of its total assets in a diversified portfolio of convertible securities and non-convertible income-producing securities. It can hold up to 20% of other types of securities.
AllianzGI Convertible&Income Fund II
Funds support their distributions with a combination of capital gains and income from their holdings. To determine if the fund is fully able to support its distributions, the easiest way is to check to see if the Total NAV Return (change in NAV plus distributions) exceeds the yield on NAV (the ratio of the distribution to the NAV). Because the COVID crash and subsequent recovery started just over a year ago, I will look at the whole year of 2020 (rather than the last 12 months). So how did NCZ do?
By growing total NAV return just a bit over 20%, NCZ at first look did quite well. So how did the NAV perform?
Unlike a lot of funds, NCZ produced its peak NAV at the end of the year. We can see the impact of COVID on NAV. The peak NAV for the year was $5.60 while the average was just $4.634. COVID caused the NAV to be above 40% below the peak for the year. Recovery from that drop has been quite impressive although it has since leveled off.
Distributions totaled $0.4525 including a cut from 4.5 cents a month to 3.75 cents a month. Uncut the distributions would have been $0.54. Based on the average NAV for the year the yield on NAV was 10.20%. Based on the peak NAV of $5.60, the yield on NAV was 8.44%. Based on the excess total NAV return and the increase in NAV for the year, the distribution looks well supported. It doesn't look like the ROC was destructive.
As I have pointed out during the series, one year can be good or bad. We need to look at a longer span of time to get a better picture of how well NCZ has been supporting its distributions. So let's see how the last 3 years went.
Here we can see that the total NAV return has been just short of 40%. Two things I note here. First, while 40% is pretty good, it is just twice what the fund did in 2020. Second, I notice that the total return on NAV was fairly flat for nearly a year at the beginning of this period.
Looking at NAV over the last 3 years, I see that NAV has slightly declined (by less than 0.2%) mostly due to a decrease late in 2018. But in its favor, the current NAV is higher than the 3 year average of $5.062. Distributions totaled $1.66 so the yield on NAV was 32.8%. This is well below the 40% total NAV return, so the distribution is well covered. However, this coverage was maintained by cuts in the distribution in 2020 and 2019.
The 10-year performance of the NAV has been less than impressive. In the last 5 years, the fund has managed to do a better job at maintaining NAV. Unfortunately, some of that has been due to reducing the distribution.
Price-wise, the discount is far wider than it has averaged over the last 10 years. Given the recent run-up in NAV and the fact that the April distribution payment was not cut as it has been in the prior 2 years, I think the larger than normal discount could be a good opportunity. I suspect the market is waiting to see what impact adding Virtus to the management team has on performance.
The distribution changes over the last 10 years are not what I like to see. I want a flat or an upward trend. This downward step pattern is not what I like to see.
One chart that CEFData presents that seems useful to me, is that they show total return (both on price and on NAV) for the fund and compare it to a set of its peers. So while I like how the fund has done over the last 3 or so years, I am not as happy with it over the last 10. How does it compare to similar funds?
Not so good as it turns out. NCZ comes in at or very near the bottom in just about every period. In its best performance before the management change, it was in 6th place out of 10 funds. With the change in management starting in February, so far the fund hasn't done any better.
Future Distribution Coverage
Looking at the fund's holdings, I mostly don't see much that would indicate a big change either way in distribution coverage and general fund performance. Tesla (TSLA) however is clearly a wild card. Convertibles have their performance driven in part by interest rates and part by the stock market. That is one of their main attractions that you get some of each. I think the stock market should trend upwards over the next year or so, and interest rates are also likely to increase. That trend in interest rates is likely to be quite moderate as the Fed holds the short end of the curve near 0 however.
NCZ is an okay fund. It isn't a great one, and it looks to me like there are better funds in this area. For one, I own the Calamos Dynamic Convertible and Income Fund (CCD) which looks to be a better fund even if it has a lower yield. As an okay fund, with a yield of 8.75% and a discount to NAV over 9%, this fund does have its attractions.
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I have been a software engineer developing applications in various fields for over 30 years. I began investing in mutual funds for my 401(k) back in 1988.I started investing outside of my retirement account a little over 23 years ago. I used to follow a value oriented strategy, but after I saw how that worked during the financial crisis, I began to switch over to a more income based approach. I have been an income investor since around 2009 and have only written income investor focused articles for SA.I long ago switched my portfolio to a DGI strategy but more recently focused on the more immediate income implementation of that strategy..
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