- GDL is a unique fund from the Gabelli lineup; this one focuses on "merger arbitrage transactions."
- The fund is currently deeply discounted and carries a distribution yield of over 5%.
- Despite the interesting nature of the fund and the typically attractive features of a CEF being present, this fund has performed poorly.
- 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 GDL Fund (NYSE:GDL) is a unique closed-end fund from Gabelli. Going off of the name alone doesn't give investors a real sense of what this fund is investing in. Additionally, it has never been one that has come up on my radar either; until a reader asked for my thoughts on the fund. To be upfront, this fund doesn't seem to have a lot of promise. I believe that it could be best to avoid this fund.
On the other hand, if you want exposure to an incredibly unique set of holdings, then this could be the one for you. The top ten all include names that I've never seen included in any other portfolio. Considering that the fund has a total NAV return of just 2.93% annualized over the last ten years - I'm going to say that's a good thing. This could also be why the fund trades at a 15% discount. In fact, I'm surprised it doesn't trade even wider than this.
- 1-Year Z-score: 0.76
- Discount: 15.75%
- Distribution Yield: 5.41%
- Expense Ratio: 1.73%
- Leverage: 19.33%
At first, GDL sounds like it would be quite an interesting investment. The fund is a "diversified, closed-end management investment company whose investment objective is to achieve absolute returns in various market conditions without excessive risk of capital." They define absolute return as "positive total returns, regardless of the direction of securities markets." That's a fairly commendable objective. They are making it sound like this fund would be a great fit for investors who are more worried about downside risk.
In fact, I'd say they've done a great job of achieving that objective too. The fund's NAV had declined just 4.06% in 2008. The fund had launched in January of 2007, so it was a full year of operation in 2008 as well. The S&P 500 itself had fallen nearly 39% for context. The only other down year was 2018, at a decline of 1.65%.
Then I believe the fund gets even more interesting in how they attempt to achieve this objective. At first, you'd probably assume they will be entirely invested in bonds or other relatively safe assets. This is true to a degree. About half of the portfolio they are invested in U.S. Treasuries.
However, they will also "invest primarily in securities of companies (both domestic and foreign) involved in publicly announced mergers, takeovers, tender offers and leveraged buyouts and, to a lesser extent, in corporate reorganizations involving stubs, spin-offs, and liquidations."
In my time of covering closed-end funds, I've never run across another fund with this approach. That could have made it exciting, but the performance has been quite terrible, as we will touch on below.
Not helping the fund's performance is the fact that the leverage they use is quite expensive. The fund's expense ratio is 1.73%. When including the preferred leverage that they utilize, it comes up to 2.74%. They are utilizing preferred as leverage and this isn't unique to GDL. Many other Gabelli funds also employ this form of leverage. Though, they've had greater success with returning performance to shareholders above these often higher dividends that are paid on the preferred.
Another offsetting feature of GDL is the fund's size. It is quite small, with just $181 million in total managed assets. The 4% Series C Cumulative Puttable & Callable Preferred (GDL.PC) was around $35 million of the managed assets.
(Source - Fact Sheet)
Performance - Enticing Idea, Poor Execution
The fact that this fund focuses on investing in a way to take advantage of mergers and other corporate actions is enticing; I admit that. Especially considering they are targeting "absolute returns," which they've also been able to pull off since the fund's launch mostly. However, it just hasn't added up to acceptable returns for shareholders.
It is fine to target lower returns looking for safety if you are risk-averse; total return isn't always the main objective of every investor, despite some others saying it is the only important factor. Combining this portfolio that invests almost 50/50 in equity securities and U.S. Treasuries has led to poor returns over any time frame you look at. A bit of this is to be expected when you last report 45.6% in U.S. Treasuries Bills yielding 0.005% to 0.09%.
(Source - Fund Website)
Apparently, the other half of the portfolio that is in the merger and corporate actions just haven't been paying off.
This has translated into the fund carrying quite a significant discount. However, the discount has been narrowing as we go through 2021. Across the board, we have seen discount tightening in the CEF space. The chart below is for the last five years.
Distribution - 5.41% Distribution Yield
I'll admit that the distribution yield is quite attractive considering what the alternatives are out there. However, since it hasn't been returning those same types of returns to investors, we know it hasn't been covered. That has resulted in the fund trimming over the years. However, they increased in 2020; it doesn't seem as though it was a warranted boost.
(Source - CEFConnect)
The Treasury Bills that they are invested in are certainly not going to be covering the distribution; it doesn't even cover the preferred dividends that the fund has to payout. When you earn between 0.005% and 0.09%, then pay 4% to preferred shareholders, the math doesn't work out. It means you will be relying on capital gains to fund a distribution. This isn't that unusual, but they just haven't been able to execute on achieving the appreciation required.
(Source - Semi-Annual Report)
In this case, the return of capital is most definitely destructive to the NAV as they overpay. Some return of capital isn't bad for short periods of time, or some ROC is even part of the underlying holdings or strategy of the fund. For GDL, it is just bad ROC, no other way to put it.
The largest part holding this fund back seems to be its absolute returns objective. That has forced them into investing significantly into holding safe assets such as Treasury Bills. In today's interest rate environment, it just doesn't work out for an enriching experience for investors.
Instead, this fund could be even more attractive if it just focused on the corporate actions arbitrage in the other half of the portfolio. Of course, that would change the direction of the fund entirely. There would be some years with some massive losses - but also have a much better chance of being a worthwhile investment.
In general, I believe it is a bad idea to hold any Treasuries in a closed-end fund structure for extended periods. Due to the interest rate environment and the relatively higher expenses of CEFs, it just doesn't work out in the investor's favor.
They have some other things going on in this portfolio, but it just isn't worth going too much further in-depth. GDL will always just be held back by these Government obligations since they are such a high allocation.
(Source - Semi-Annual Report, highlights from author)
This is just a shame because when looking at the top ten holdings, there are some rather unique positions. I don't recall seeing these types of positions in such large allocations with any other funds I cover. That could have provided for a fair bit of diversification added to my portfolio. The arbitrage angle could have even been quite exciting. Unfortunately, the payoffs here have to be just so large that they overcompensate for the meager returns of the U.S. Treasury sleeve of their portfolio.
(Source - Fact Sheet)
GDL seems an exciting idea in theory. However, in practice, it just doesn't work. Given the current interest rate environment, the significant exposure to U.S. Treasuries holds this fund back too much. Of course, that is the primary goal of the fund to deliver these absolute returns. In that sense, it helps with the fund's primary objective, which they've been able to deliver on with only shallow losses.
Except, this overshadows the other focus of the fund, which is merger arbitrage and potentially other corporate actions. In my opinion, this is a mixture of two strategies that don't mesh well together. Gabelli would be better off getting out of the absolute returns portion of the portfolio and turning this fund into an exciting corporate action investing fund. At least, that's all in my opinion. For now, I think investors will be better off avoiding this one.
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