GUG: New CEF Grinding Lower

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Binary Tree Analytics
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Summary

  • Guggenheim Active Allocation Fund is a newly issued CEF with a broad mandate.
  • In March, we wrote a piece on the fund advising patience, given the very poor track record of newly issued CEFs given capital allocation pressures.
  • The fund is now down more than -28% since issuance and is currently finding its identity and trading style.
  • This article covers CEFs from our suite of products - we focus on macro portfolio allocation, CEFs and yield-producing options strategies, targeting overall returns of 9%+.

Risk and reward bags on a basic balance scale in equal position on wood table. risk management concept, depicts investors use a risk reward ratio to compare the expected return of an investment

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Thesis

In March we wrote an article on a newly issued CEF from Guggenheim, namely the Guggenheim Active Allocation Fund (NYSE:GUG). In our piece we stated the following:

"If an investor looks at historic CEF performances, they will notice a funny commonality - they all tend to lose money in the first 1-2 years. A CEF usually prices at $20/share but usually ends up lower. Not all CEFs are created equal, of course, but since launch the management team has a certain pressure to allocate capital, irrespective of timing, which might not be optimal for the ultimate investor."

Since our article the fund is down more than -16% on a price basis and down more than -28% on a price basis since issuance in November 2021. The S&P 500 is down only -14% during that time period. Yes indeed the market is down since the beginning of the year but we clearly stated that the management team feels the pressure to allocate capital which results in poor decisions. Imagine if the portfolio managers would have sat on the raised cash for longer and would now be able to take advantage of the market sell-off with plenty of dry powder.

GUG is now overweight fixed income which represents more than 70% of the fund's allocation, with the rest invested in equities. The fund is now trading at $14.3/share, down from $20/share at the November 2021 IPO. We feel a new fund with a broad mandate such as GUG will take a bit more time to find its footing and its identity, and until that happens weakness will continue. The fund has an average leverage ratio of 28% and a competitive yield of 9.97% but it is unproven and untested. A retail investor would do well to wait and follow what GUG does in terms of portfolio allocation and trading style before committing any capital.

Performance

Since issuance in November 2021, the fund has lost more than -28% on a price basis:

IRR

Performance Since Issuance (Seeking Alpha)

As expected, as a new CEF, the vehicle has underperformed. With a barbell allocation to fixed income, GUG has taken a bath as rates have increased. However the fund severely underperformed both a high-yield bond ETF (JNK) and the S&P 500 (SPY). JNK is down only -12%, while SPY is down only -14% versus -28% for GUG.

The fund would have outperformed most asset classes if it had just sat in cash and would have been able to wait for the correct opportunities to arise. However, the CEF structure which requires a high dividend distribution is unforgiving, thus forcing capital allocation at sub-optimal times.

We feel established managers should be able to have a 6 months to 1 year waiver period where they do not need to make outsized dividend distributions on a new CEF vehicle, so that they are not pressured into poor decisions. Being an established asset manager allows a team to point to a very healthy track record, hence the ability to buy time for a newly issued closed end fund.

Holdings

The fund is now overweight fixed income:

fund

Asset Class (Fund Fact Sheet)

On the fixed income side, GUG is overweight junk debt with high yield bonds representing the largest asset concentration:

assets

Assets (Fund Fact Sheet)

As a reminder GUG has a broad mandate that is dynamic, hence the portfolio concentrations can change dramatically without notice. As of now GUG allocates ~30% to broad equity indices, while the rest is invested in floating and fixed high yield debt. All done with a leverage overlay.

As stated in its semi-annual report:

"...the Fund seeks to achieve its investment objective by investing in a wide range of both fixed-income and other debt instruments selected from a variety of sectors and credit qualities, including, but not limited to, government and agency securities, corporate bonds, loans and loan participations, structured finance investments, mezzanine and preferred securities and convertible securities [...] the Fund may also invest in common stocks, limited liability company interests, trust certificates and other equity investments that the Sub-Adviser believes offer attractive yield and/or capital appreciation potential."

Premium/Discount to NAV

The fund is now trading at a very high discount to NAV of -15%:

Discount

Discount to NAV (CefConnect)

Given the fact it is an unproven fund, the investor community does not trust the forward curve for the fund. GUG needs to deliver first in order to close in the opened gap. We feel this discount is on the wider side given the liquid asset allocation in the fund, but the market does not take any prisoners in a wide risk-off environment.

Conclusion

GUG is a newly issued CEF with a broad asset allocation mandate. The fund is finding its footing and trading style with an overweight fixed income allocation profile currently. As predicted by our team, GUG has lost a substantial amount of market value since issuance, being down more than -28%. Asset allocation pressures combined with the need for a high dividend yield are the culprits for the fund's underperformance, and we feel established management teams should hold cash for longer so that correct arbitrage opportunities are exploited. GUG would have outperformed most asset classes if it had held on to cash for longer since issuance. We feel a retail investor is best served to wait, and once GUG establishes its identity and trading style it can be benchmarked against other similar funds and appropriate risk/reward ratios can be established.

This article was written by

Binary Tree Analytics profile picture
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With a financial services cash and derivatives trading background, Binary Tree Analytics aims to provide transparency and analytics in respect to capital markets instruments and trades._____________________________http://www.BinaryTreeAnalytics.com
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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.

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