USA: Another High Yielding Equity Fund
Summary
- USA takes a different approach by investing through five different sleeves through five different investment manager groups.
- The fund has a focus on paying out 10% annually to shareholders based on 2.5% quarterly.
- Over the entire life of this fund, it has declined in price only since inception - though that masks some significant total returns due to distributions.
- This fund isn't for everyone; in fact, it is quite overvalued at the moment and should be put on the watchlist.
- This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »
Written by Nick Ackerman, co-produced by Stanford Chemist
The Liberty All-Star Equity Fund (NYSE:USA) has historically been able to put up some great performance. The main attraction is the distribution policy of 10% annually paid quarterly at 2.5% per quarter. This makes their distribution vary from quarter to quarter. Though due to said strong performance, the distribution has been covered since the 2008/09 financial crisis. This fund is quite similar to Gabelli Equity Trust (GAB) that we recently covered - with different exposures. Basically, focusing mostly on large-cap holdings. So we are looking to cover "another high yielding equity fund" today.
They hold plenty of tech positions, though also have meaningful exposure to financials, consumer discretionary, healthcare and industrials as well. With this mixture, the fund is quite diversified - I would say more so than most other plain equity funds. Therefore, giving another reason why one could potentially want to hold this position. Similar to GAB, I have held USA in the past. However, the discount had all but disappeared in 2019/2020 and I eventually sold.
Fast forward to today, and the fund has been having a rocking good year. The problem, it was more of a rocking good year for the share price performance. The fund has now gone to premium levels - last closed at a premium of 1.50%.
(Source - Fund Website)
Basics Of The Fund
The fund takes a bit of a different approach. ALPS Advisors Inc. is the investment advisor to the fund. Though the fund is actually split between five managers. Two growth-focused managers and three value-oriented managers - a 40/60% between growth and value approach.
(Source - Fund Website)
Each manager is responsible for their own sleeve of investment. Of course, all are hoping for producing fantastic returns - but to get there they take different approaches. Thus, we see why USA might be more diverse than other funds since they have specific allocations of their portfolio focused on different ways to invest.
USA isn't a new fund by any means; it has an inception date of 10/31/1986. Over that time the fund has experienced many different business cycles and several recessions. While it launched with a NAV of $9.98 versus today's $7.99 NAV, that isn't too much of a concern for me. Over the course of 35 years, "losing" $1.99 isn't significant. This is because when factoring in the significant distributions, the fund hasn't lost anything.
They don't report since inception returns. However, over the last 25 years, they have had annualized total returns of 8.69% on a NAV basis and 8.47% on a share price basis. That was as of the end of December 31st, 2020 - since then this would have only increased.
The fund is rather sizeable as well, with over $1.7 billion in total managed assets. They don't utilize any leverage, thus we can take that risk off the table. The expense ratio comes to 1.02% - which I'd say is about average for equity CEFs that don't offer a lot of complexity.
Valuation And Performance
As touched on above, the fund has gone to a premium level now. Meaning now is not too appealing of a time to be investing in the fund. Those wishing to do so will have to continue to be patient. That being said, we have seen periods of time when the fund traded at richer pricing than this. If this happens, one could be waiting even longer before entering a position.
(Source - CEFConnect)
Historically, the fund was a strong performer. The worst years for the fund coincide with the worst years for the "broader markets." Broader markets being something like the S&P 500 index. Due to them holding many similar positions - though not perfectly the same as they offer much less tech exposure - we see similar trends. Therefore, looking at 2008, 2002 and 2001 as being some of the worst years for the fund.
(Source - Fund Website)
Going forward, I find the fact that the portfolio is more diversified as being a positive. I know that tech isn't going anywhere and will probably be a strong performer long-term. But I have plenty of funds that invest in tech already, looking for a more diversified approach can be beneficial.
This is reflected by three of the five managing teams of the fund being represented by value. This goes back to the value versus growth debate. Admittedly, I'm never sure which one is going to win over any given time so I prefer exposure to both. That is even though I do view a lot of financial and energy investments as compelling at current levels.
High Yield Distribution Policy
Even though the fund invests in large-cap investments, they pay a really high distribution rate. They target 10% annually and this is set at 2.5% every quarter.
The current policy is to pay distributions on its 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.
Since the underlying positions of the portfolio are not paying those sorts of distributions, the bulk of the distribution is going to be comprised of capital gains.
(Source - Annual Report)
In fact, we see very little coming from net investment income [NII] at all. Not nearly enough to sustain the distribution policy they set forth. From a tax perspective, this is the breakdown for 2020 and 2019.
(Source - Annual Report)
We see a little bit of return of capital [ROC] in 2019. For those looking for ROC, I wouldn't determine this to be one of those reliable funds to produce ROC. For those of you fearing ROC, it also shouldn't always be viewed as a bad thing. In this case, it wasn't. We can look at the breakdown from their Annual Report above and see that they simply just didn't realize enough in NII or capital gains to pay for the distribution. When factoring in the $211+ million of unrealized appreciation on the underlying investments though, we know they had plenty and could have easily converted those gains to be realized.
There are some reasons that they might not choose to. Such as tax concerns and if it would've created a short-term gain, or they simply didn't find a compelling reason worth selling such an investment. Therefore, left the position in the portfolio.
To gauge whether a fund is earning its distribution, we can simply just watch the NAV and see where it is trending. As we mentioned previously, the NAV has gone down since its inception. So we know that at least some has been destructive along the way. However, it was over such a long period of time that I feel it is a bit more justified.
Overall, the NAV declined nearly 20% since its inception. Bear in mind this is NAV price return only. This is NOT factoring in distributions. Here is the total return chart since inception. Looks quite appealing - though it has been over a considerable amount of time. Just helps to reflect more on how some investors view CEFs negatively when their price declines over time. Yet, they can still put up tremendous total returns.
With all this being said, over the decade, the fund has earned its distribution. Of course, the longest bull market in history helped that out. Now the start of the new bull market has taken it even further.
Another way to easily view USA and if the distribution is being supported is simply by watching the fund's distribution chart. If it is rising, that means NAV is rising. Simply because their 2.5% is targeted to the NAV level.
(Source - CEFConnect)
Will It Beat Something Like SPY? Sometimes, but probably not usually.
The biggest argument against USA is going to come in the form of "just buy SPY instead, and sell the securities." That is a fair argument. With the SPDR S&P 500 ETF (SPY), we are a bit limited on how far back we can go. This is due to the inception date of that ETF being January 22nd, 1993. Which is still completely sufficient for comparing returns.
First of all and the biggest counterargument to this idea is that USA's objective really isn't to beat SPY. If it was, they would probably mirror the sector allocations a bit closer.
Then I believe the second counterargument is that this is an automated process of letting the managers liquidate positions, then pass the proceeds onto investors. Income investors and a lot of CEF investors seem to be fans of this approach. It is all about personal objectives and investment styles.
Of course, the easiest counterargument of all is that USA can be bought at significant discounts. SPY will typically not be at meaningful discounts to its NAV. Not at this time USA either, but that is why it is on my watchlist and not in my portfolio at the moment.
All this being said, we could cherry-pick time frames to show anything we want. Over the last year, and YTD so far in 2021, USA has bested SPY.
So, the final answer to this question is that longer term, USA could probably continue underperforming something like SPY, but it comes down to investor preference and objective. CEF investors can also outperform if picked up at the right discount as well.
Underlying Portfolio
A CEF is only as good as its underlying positions in its portfolio. Since it is a basket of stocks/bonds and not itself a business. Here we see the sector breakdown of the fund as of the end of March 31st, 2021.
(Source - Monthly Update)
The best performing portion of their portfolio for 2021 has come from the financial and industrial sectors of the fund. I believe this represents some of the lowering exposure to tech over the last quarter. Though portfolio turnover can be a factor as well. Last year they reported 45% turnover, but as low as 21% in 2017. Thus, they aren't just sitting on the same portfolio, but are trading around for opportunities.
Every month they list their top 20 holdings - they also provide positions that are new holdings and holdings liquidated. This is actually really great and I wish more fund sponsors would do this.
(Source - Monthly Update)
As a holder of Honeywell International (HON) myself, I hope this isn't a bad sign. Anyway, we see a lot of the portfolio's top positions are most names we are familiar with. We see plenty of these tech names elsewhere.
That being said, we do see positions like Adobe Inc (ADBE) and salesforce.com (CRM) that are popular tech names - but those that we don't see in a plethora of other funds.
These are two positions that have performed incredibly well over the years as well. Along with the whole tech movement higher, that is.
I also find it curious that we see something like General Electric (GE) in the holdings as well. This isn't by some small amount as in something like the 100th position buried deep in a portfolio, but coming in as the 13th holding. Most know that GE used to be considered a blue-chip stock and one of the top dividend stocks worth investing in. Long gone are those days, as they continue to have work to do, though have been transforming and continuing to work towards a brighter future.
On a side note, one of my personal pet peeves of calling a stock a "blue-chip" or "SWAN." Because they are until they are not.
Final Takeaway
Ultimately, USA can be an interesting fund for income investors looking to diversify away from more tech-heavy portfolios. However, at this time the best approach might be the watchlist as we are sitting at premium levels. At this time, the fund's premium of 1.50% provides for a 1-year z-score of 2.06 - which is one of the highest even in an overvalued market. The longer-term 3 and 5-year averages don't help the case either. Those averages come in at 4.85% and 8.07% discounts. Historically, the fund has traded at discounts more than premiums. Though when it did trade at premiums, it was for a considerable period. Mostly through 2000 to 2005 when the fund traded regularly at premium prices.
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This article was written by
Nick Ackerman is a former financial advisor using his experience to provide coverage on closed-end funds and exchange-traded funds. Nick has previously held Series 7 and Series 66 licenses and has been investing personally for over 14 years.
He contributes to the investing group Learn more.Analyst’s Disclosure: I am/we are long HON. 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.
This article was originally published to members of the CEF/ETF Income Laboratory on April 15th, 2021.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (127)
Nick, thank you very much. I truly appreciate that. Likely will do just that. I fact while I own some USA, I had cut back recently and switched to ASG. Will likely sell remainder of my USA. Thanks, again.
Rob
And up 2.5% today. Any thoughts? Thanks.
RE: your comment on wondering about HON-- news is out that they are switching to the Nas from NYSE- seeing themselves as the world leader in
'software industrials' ... ok.
Two points about your excellent article.
"This is due to the inception date of that ETF being January 22nd, 1993." No quarrel with that, but if you ever do need more history, you should be able to get it back to 1976 in the open-end Vanguard SP500 fund VFINX. I don't think they are selling it anymore so only the Admiral is available with the same minimum and also an ETF, but I believe they are still pricing it.Regarding GE, a number of value managers are apparently betting on a turnaround, e.g. Fidelity, Capital Group and T. Rowe Price have significant positions, and Morningstar is showing an almost 8% position in a Pzena fund that I'm not familiar with.