Evaluating CEFs: NAV Erosion Is A Bit Of A Concern For BIT
Summary
- The 8% yield of BIT looks very attractive if the distribution can be maintained.
- I continue my series digging into CEFs beyond the yield with a look at BIT.
- NAV has been on a slow decline since the fund's inception.
- I think BIT's distribution is just a bit larger than it can support.
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Investment Thesis
This article will take a look at BlackRock Multi-Sector Income Trust (NYSE:BIT). BlackRock is a great manager of Closed-End Funds and I have liked several of their funds. So I turned to BIT expecting to like it too. With a yield of just over 8%, it could be a great income vehicle if it can support its distribution. It did okay over the last 12 months, even growing NAV some, but over longer periods it isn't fully covering the distribution. Even more disturbing is that NAV has been on a slow but steady decline over the last 10 years. And while the distribution did see a small bump during the last 10 years, I think it is not entirely safe.
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. My thinking is that rather than the share price, how the portfolio of the fund behaves and the income it generates is the determining factor in the reliability of the distribution. I look at a specific CEF and apply that method to determine if the fund has been supporting the distribution. Then based on current holdings and past performance, I try to determine 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.
BlackRock Multi-Sector Income Trust
As usual, I will start my analysis of BIT by looking at the returns on its portfolio over the last 12 months. How did BIT do?
Producing returns of just over 11% would be pretty good in a normal year but is a bit low over the last year considering the pace of economic growth. That should be okay provided these returns are enough to cover the distribution. How did NAV due?
NAV grew over the last year. While some may say that 2.67% is a bit modest given the pace of economic growth, I am fine with growth as it points to the distribution being covered. I am somewhat concerned however that since April the NAV seems to be trending downward. What do the distributions look like?
Source: CEFData
It is a good sign that there was not cut in the distribution. Some of the distribution was designated as ROC, but since NAV has been increasing (mostly anyway), it isn't likely that this ROC is destructive. I am a bit concerned however that none of the distributions came from realized gains. It could be that BIT is just holding on to shares and not realizing gains, which would be fine. But it raises a concern for me.
Distributions totaled $1.4844 over the last 12 months. Using the average NAV of $18.26 produces a yield on NAV of 8.13%. Based on the peak NAV of $18.62 I calculate a yield on NAV of 7.97%. With NAV increasing and both of those yields below the total NAV return of 11.35%, I see the distribution as covered over the last 12 months.
Long-Term Trends
The COVID crash and the recovery from it provides a very good example of how timing and luck can impact the results of a single year. So I like to look at longer periods to get a better understanding of the job management has done in covering the distribution before I project that performance into the future.
So what were the returns on BIT's portfolio over the last 3 years?
At just over 23%, the returns look pretty good. Even the 7.24% CAGR looks good. But was it enough to cover the pretty generous distribution?
Well, NAV over the last 3 years didn't do nearly as well as it did over just the last year. In fact, the current NAV is below where it was 3 years ago. And it has been declining at a rate of almost 1.2% a year.
The good news is that the distribution was raised a bit over the last 3 years. A bump of 0.7 cents a month towards the end of 2019. So distributions totaled $4.3622 over the last 3 years. Using the average NAV that is a total yield on NAV (not an annualized number) of 24.4%which is just a bit above the total NAV return of 23.3%. Using annualized figures the 8.14% average yield on NAV is above the 3-year total NAV return CAGR of 7.24%. So that small bump in the distribution in 2019 wasn't quite as good as it first appeared.
How has the NAV been doing over even longer periods?
Sadly, since its inception, BIT has seen a slow but steady decline in NAV.
Source: CEFData and Author's graphing using Excel
The distributions since inception don't immediately look bad. And I would say they are bad even on closer examination. We can see a small bump in the regular distribution and several special distributions. Based on the NAV performance, it looks to me like BIT covers the distribution most of the time, but sometimes it fails to cover it. And over time, it doesn't quite make up the shortfall in coverage.
Future Distribution Coverage
Investing is all about the future. I look at past performance in order to get an idea of how the fund will do in the future. My next step is to examine the current holdings of BIT and see if it looks like they can extend the performance of the last year into the future (as they covered the distribution this last year). I also want to look for holdings that might be expected to produce a bigger drag on performance than they did last year.
Source: CEFData
BIT focuses on debt investments. With the economy growing, both in the U.S and the world, these should do okay. But I think economic growth will slow. That might make it harder for BIT to continue covering the distribution. This doesn't raise a huge red flag, but it doesn't build my confidence that BIT won't revert to its longer-term weak distribution coverage.
Source: CEFData
Looking at its industry exposure and top holdings gives me a bit more confidence in BIT's ability to support the distribution going forward. I like the banks and holding Fanny Mae. I think that will do well. I think telecommunications will do well over the next few years. This reinforces the idea that it's not BIT's holdings that are the issue, but rather it is looking more and more like the fund is paying out a distribution that is just a little bit too generous.
Source: CEFData
Looking at how its peers have done, BIT is mostly in the top half, even hitting the top third, of its peers. While the 8% yield is attractive, I like PIMCO Dynamic Credit and Mortgage Income Fund (PCI) which has a yield that is around 140 bps higher and has better 5-year returns (both on a market price and NAV basis). With its long-term shortfall in distribution coverage, I am not confident in how long it can continue to pay the current distribution.
Conclusion
BIT covered its fairly generous distribution in the last year. And that distribution results in a current yield of just over 8%. It would be far more attractive to me if NAV had been on a slow decline since inception. This indicates weak distribution coverage at best. I think there are better picks with safer distributions. While I don't see the distribution in immediate danger, there is still a risk of a cut.
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This article was written by
Beginning on October of 2018 I began working with Rida Morwa and his team at HDO. I both write articles in collaboration with the HDO team and on my own. Contributing authors, if any, will be listed after the bullet points at the start of articles.
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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 17 years ago. I used to follow a value oriented strategy, but after I saw how that worked less well than I liked during the financial crisis, I began to switch over to a more income based approach.
I had always thought that dividends were important but didn't have a systematic way to evaluate stocks that paid them until I found SA and DGI. Starting around 2010, I have switched my portfolio to a DGI strategy.One of my most profitable picks turned out to be Freddie Mac, which I originally chose because I liked the dividend and because I once worked there. When it first ran into problems I increased my holdings because it still looked like a good value to me. I eventually managed to buy several thousand shares at a cost of $0.50 (I knew that was a good value) and eventually exited the stock at a price that was $5 a share above my average share cost.
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