NIE: A Portfolio Mix Of Growth Equities And Convertible Securities, 5.02% Distribution Yield

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Summary

  • NIE offers a quarterly distribution of $0.38 per share, which makes up a 5.02% yield, as of 09/18/2021.
  • The quarterly distribution rate has been steady and changed only a couple of times over the last decade.
  • NIE's market price has been trading at all-time highs so far in the second half of 2021.
Different Approach - Different Direction
Eoneren/E+ via Getty Images

We would like to continue our coverage on CEFs issued by Virtus Allianz GI, thus picking this time AllianzGI Equity & Convertible Income Fund (NYSE:NIE). This CEF was incorporated back in 2007 and has an exposure of approximately 60% towards the type of equities that we can find Russell 1000 Index equities and the rest consists of convertible debt & notes, corporate bonds, and preferred debt securities & equities. NIE has shown great resilience during the global market sell-off in March 2020. Both market price and NAV bounced back quickly and have reached new all-time highs over the last couple of months. In our article, we will take a look at whether our readers should consider investing in this CEF or if they might be better off if they invest in corresponding ETFs that replicate the performance of NIE’s underlying benchmarks. We are also interested in how safe historical distributions have been over the last couple of years and whether they might change in the near future.

Portfolio Holdings

NIE portfolio holdings

(Source: Seeking Alpha)

According to the figure above, the top 10 holdings list consists of the biggest US growth companies, which can be commonly found in major growth-related ETFs like Vanguard Growth ETF (VUG). The following companies - Microsoft (MSFT), Amazon (AMZN), Apple (AAPL), and NVIDIA (NVDA) have reported solid quarterly results for Q2 21, primarily driven by strong demand for their flagship products as the COVID-19 pandemic has triggered the digitization of every aspect of our daily lives and business needs.

We anticipate this secular trend of enhanced digitization to continue over the next couple of quarters. In our view, the COVID-19 pandemic might even lead to a higher rate of hospitalizations during the upcoming winter months and another risk might be potential major disruptions in the global supply chain.

For instance, the UK might even face potential food supply shortages as the price of natural gas has spiked over the last couple of weeks. If we combine both variables, the COVID-19 pandemic, and inflationary pressures, then we are pretty sure any major business will have to digitize as many business processes and automate as many tasks as possible to save costs and remain profitable in the near future.

One basic example might be a manufacturing company that needs raw material to produce prototypes or to innovate certain products. By using advanced IT modeling tools like building a double twin it can save money and do most of it virtually. That way there might be no need for additional costs to buy raw materials at higher prices.

To sum it up, we are very optimistic about the near-term performance of most of the companies mentioned primarily due to the rapid digitization we have been facing as the result of the COVID-19 pandemic. In addition, we believe that it will even accelerate over the next couple of years, as Elon Musk has even said that artificial intelligence might overtake humans by the end of 2025.

NIE stocks % per industry

(Source: Seeking Alpha)

According to the figure above, NIE has the highest exposure towards technology, consumer cyclical, and communication industries which all three together make up a weight of roughly 41.65%. We find this weight adequate enough given the COVID-19 pandemic-related business environment that most advanced economies have been challenged with over the last 2 years. Our readers should keep in mind that NIE is also invested in corporate bonds, convertible debt securities, and preferred equities. Therefore, they should not only evaluate this CEF only based upon its equity holdings.

NIE investments in securities

(Source: Annual Report FY 20)

According to the figure above, convertible bonds & notes and convertible preferred stocks made up approximately 26.6% and 6.2% of total assets at the end of FY 20. Our readers should also keep in mind that the entire investment in convertible bonds & notes of $227.5 million - consists of Level II pricing. That basically means that investors might face a risk of potential reevaluation of investments as they are not reported by Level I - quoted market prices.

Level II and Level III pricing might not become an issue during normal market conditions, but we are more concerned that some unexpected market shocks might happen that could force portfolio managers to sell assets over a shorter period of time. In that case, they might even face lower prices for their Level II or Level III assets as there would not be enough market liquidity. In fact, counterparties might take advantage and cut the prices of underlying assets. In addition, NIE had invested only slightly less than $0.5 million in corporate bonds & notes at the end of FY 20.

To sum it up, we like the portfolio structure of this CEF, but our readers should evaluate this CEF as what it is: a mix of equities, convertible bonds & notes, and convertible preferred stocks. Therefore, it is really important to check the performance of this CEF compared to its underlying composite benchmark that consists of 60% Russell 1000® Growth Index and 40% ICE BofA All US Convertibles Index.

Market Performance

Virtus AllianzGI Equity & Conv. price

According to the figure above, market price and NAV have been trading way above the pre-pandemic levels (roughly 25% higher) over the last couple of weeks. During the global market sell-off in March 2020, NIE had reached a bottom of $14.68 on March 18, 2020. Afterward, NIE has even managed to double its market price compared to its March 2020 bottom.

NIE’s portfolio management has provided the following information about the market price and NAV performance in FY 20:

“For the fiscal year ended January 31, 2021, the Fund’s NAV returned 31.78%, and its market price returned 28.21%. For the same period, the Fund’s composite benchmark, returned 39.31%. The underlying indices returned 34.46% for equities and 46.54% for convertible securities.”

(Source: Annual Report FY 20)

Unfortunately, NIE had achieved a solid market price performance in FY 20, but it had fallen behind its composite benchmark by more than 10%. Well, the fiscal year 2020 has been a very turbulent year, with a lot of uncertainties and unexpected market shocks surrounding the COVID-19 pandemic. Therefore we would like to check the total return performance over a longer period of time.

Virtus AllianzGI Equity & Conv. total return

According to the figure above, NIE has fallen behind both iShares Russell 1000 Growth ETF (IWF) and SPDR Bloomberg Barclays Convertible Securities ETF (CWB) by a margin of more than 15 percentage points between January 1, 2020, and September 18, 2021. We believe that both ETFs replicate the performance of both benchmarks that track equities and convertibles listed by the NIE’s portfolio management team.

Virtus AllianzGI Equity & Conv. total return

If we take a longer time horizon over the last 5 years, then NIE has underperformed CWB by a slight margin of 1.9 percentage points. Unfortunately, it has underperformed IWF by an even greater margin of 63.2 percentage points.

This relative performance shows us an interesting picture of how NIE has performed well compared to an ETF tracking solely convertible securities, while it has greatly underperformed the Russell 1000 growth equities index. In our view, maybe investors who are looking for mixed exposure towards both growth equities and preferred securities could be better off if they just construct their own type of portfolio with ETFs that are replicating the performance of major-related indexes in both investment fields. However, we do recommend our readers who are looking for longer-term investments talk with their own personal investment advisors or try to find the most appropriate asset management companies. Professionals should be able to help them pick the right asset management products, ETFs, CEFs, Mutual Funds, or even individual stocks/debt securities to reach their longer-term investment objectives. Now, we would like to see how NIE has performed compared to its relevant peers in the CEF universe.

Virtus AllianzGI Equity & Conv. total return vs peers

According to the figure above, NIE has been the middle performer compared to the following four peers: Calamos Convertible and High Income Fund (CHY), Calamos Convertible Opportunities and Income Fund (CHI), John Hancock Premium Dividend Fund (PDT), and Nuveen Preferred Securities Income Fund (JPS). In fact, JPS and PDT have underperformed NIE by a wide margin of more than 35 percentage points, while CHY and CHI have outperformed NIE by more than 12 percentage points.

NIE total return chart

If we take a look into the relative performance of the last 5 years, then NIE has increased its outperformance compared to JPS and PDT, while it has fallen behind CHI and CHY by 8.4 percentage points and 38.4 percentage points, respectively. However, our readers should keep in mind that NIE has a higher percentage of growth equities in its holdings compared to 4 other CEFs, which have a higher exposure towards convertible and preferred equities and debt securities.

Virtus AllianzGI Equity & Conv. discount or premium to NAV

According to the figure above, NIE has been trading at a discount to NAV in the range of 6% - 12% over the last five years. Although, discount to NAV managed to drop below 20% for a short period of time as the result of the global market sell-off back in March 2020. Nevertheless, the market price has recovered quickly after the bottom of domestic stock market indexes at the end of March 2020, leading to a swift return of discount to NAV to the lower part of the previously managed historical range of 6% - 12% over the last 5 years. We see this as a great indicator of how resilient the portfolio structure of this CEF is, as market prices return quickly towards a reasonable discount/premium to NAV value.

Dividends and Financial Statements Analysis

NIE dividend history 5 year look

(Source: Seeking Alpha)

According to the figure above, the quarterly distribution of NIE has been consistent at $0.380 per share over the last 5 years. In fact, it was raised from $0.28 per share to $0.38 per share all the way back in September 2014.

NIE dividend history all time

(Source: Seeking Alpha)

If we take a longer time horizon using a max feature on Seeking Alpha’s dividend history tab, we can clearly see that a quarterly distribution rate decreased from $0.56 per share (period of 2007-2008) to $0.28 at the beginning of 2009. The major catalyst for such a rapid decrease was most likely the credit crunch crisis leading to a major financial markets meltdown back in 2008. Nonetheless, we like the fact that distribution payments for this CEF are consistent over a longer period of time. However, as we could see this CEF might not be that resilient in the case of a major ‘black swan’ event like the financial crisis back in 2008. In fact, it could take a very long period of time (2009-2014) before shareholders can reach a higher distribution rate. Furthermore, this CEF was paying a $0.14 per share higher quarterly distribution rate back in 2007-2008 than it has been over the last couple of years.

NIE dividend yield history

(Source: Seeking Alpha)

According to the figure above, we can see that the average dividend yield of this CEF has been in the range of 5% - 8.5% over the last 10 years. For instance, the difference between max and minimum dividend yield was around 1.7% in 2019, while that gap has widened to approximately 5% in 2020. Therefore potential investors could experience quite a decent variability in the dividend yield within a year in the period of volatile and choppy financial markets like was the case in 2020. However, we do recommend our readers to take at least a 10+ years investment horizon, when they are considering investing in any CEFs, ETFs, or Mutual Funds. Now we would like to see how this CEF generates money for its shareholders. Is it from income, market value portfolio gain or does it purely return capital to its shareholders?

NIE long gains

(Source: CEF Connect)

According to the figure above, the entire distribution amount has been generated from long gains in the market value of its portfolio holdings over the last year. However, we would like to warn our readers that the CEF Connect website sometimes reports inaccurate numbers. One example, you can see in Q3 2019, when distribution rate was $0.38 per share while income was $0.1292 per share and all other - long gain, a short gain, and return of capital were $0.000 per share which in the end does not add up to $0.38 per share. Therefore, our readers should always look into all of the fund's fillings, semi-annual and annual reports for the most accurate data.

NIE investment operations

(Source: Annual Report FY 20)

According to the figure above, total distribution to shareholders amounted to $42.1 million in FY 20, and net realized gain well surpassed that amount by approximately $10 million. On the other hand, the net investment income was only $1.73 million in FY 20 and $4.86 million in FY 19. In our view, that amount is not sufficient enough to cover the target distribution payment of $42.1 million and is also not sufficient enough for long-term investors to generate a noticeable compounding interest return over a longer period of time. If we do a simple calculation of net investment income of $1.73 million in FY 20 divided by net assets of $689.85 million at the beginning of FY 20, then we get a return on total net assets of approximately 0.25%. That is even less than the current ‘risk-free’ 10 Year US Treasury yield of 1.287%. On the other hand, both net realized gain and net change in unrealized appreciation/depreciation totaled approximately $207.2 million in FY 20, while a year before that amount was approximately $102.6 million. Consequently, the net increase in net assets after we deduct distributions to shareholders amounted to $166.8 million in FY 20 and $65.3 million in FY 19, which makes up a total increase in net assets of approximately 25% y/y and 10% y/y, respectively.

To sum it up, investors have high exposure to the market value performance of the NIE holdings and should consider that when they are constructing their portfolio over a longer run. We believe that this CEF might not be suitable for those who are looking for income-generating financial products and are looking to take advantage of compounding interest over time.

Conclusion

We will initiate our coverage with a NEUTRAL rating, primarily due to the COVID-19 pandemic and all the geopolitical risks we have been facing lately - f.i. a potential domino effect on global financial markets if Chinese authorities let Evergrande go bankrupt. We find this CEF suitable for investors who are looking to gain exposure towards growth equities and convertible securities but are not willing to construct their own portfolio through certain relevant ETFs or individual securities. Based on our historical analysis, NIE has not shown any kind of strong outperformance compared to relevant ETFs or other peers in the CEF universe. Nonetheless, the portfolio management team has done an excellent job to keep a quarterly distribution of $0.380 per share over a longer period of time. We see this as a major plus for our readers who are looking for consistent and steady quarterly distributions derived from the types of financial assets this CEF holds into its portfolio. In terms of key short-term risks, investors should consider the following: (1) worsening of the global COVID-19 pandemic, (2) a relative underperformance of convertible & preferred equities/debt securities compared to general equities/debt securities, and (3) potentially higher than expected return of capital or a cut in quarterly distribution over time.

This article was written by

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We are investment research professionals covering a broad range of equities, REITs and other asset classes as well. Our philosophy is based upon a wise statement from Peter Lynch: "The secret of making money in stocks is not to get scared out of them."That is why we strive to provide high-quality information so our followers can make wise investment decisions even during exuberant times, while other market participants claim: "This time it’s different."Please make sure to follow us and get updated with our latest stock picks.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: This article does not constitute a bid or an invitation to bid for the purchase or sale of the financial instruments in question. Neither is it intended to provide any kind of personal investment advice, therefore, readers should conduct their own due diligence. Investing in financial instruments may always be associated with risk. Please contact your personal financial or investment advisor for any additional questions or materials regarding this article. We shall not be liable for any type of damage or loss arising from the use of the information contained in this article.

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