OPP: 2 Strong Firms Collaborated To Create Interesting Offering

Summary

  • I like to add closed-end funds trading at a discount to NAV to my portfolio.
  • DoubleLine and RiverNorth are strong fixed income investing firms.
  • This closed-end fund trades at a slight discount to net asset value.
  • The portfolio looks very interesting, and the firms aren't benchmark hugging but truly looking to add value.
  • Looking for a portfolio of ideas like this one? Members of Special Situation Report get exclusive access to our model portfolio. Learn More »

"Before Museums Open: Great Works By Picasso And Mondrian On View And Open To The Public" At Christie"s

"Before Museums Open: Great Works By Picasso And Mondrian On View And Open To The Public" At Christie"s. DoubeLine's firm name is a in reference to Mondrian's famous style of painting.

Tristan Fewings/Getty Images Entertainment

RiverNorth/DoubleLine Strategic Opportunity Fund, Inc. (OPP) is an interesting and unusual closed-end fund. I prefer to hold these types of funds when trading at a deep discount to net asset value. It is common for these vehicles to trade at a sizeable discount. This vehicle is currently trading at a 2.47% discount to net asset value. Usually, that's not enough to entice me.

I tend to hold until the discount to NAV comes in somewhat, or I find something that I like more. In many cases, there are sizeable distributions while waiting for the discount to NAV to revert to the mean.

The distribution of around ~16% (based on Morningstar figures) annually is likely another thing that attracts shareholders here and keeps the fund's size in the sweet spot.

But I wanted to review this fund because of its unusual premise and strong associated firms in RiverNorth and DoubleLine. The fund basically allocates assets opportunistically between two strategies managed by different managers, as per the prospectus:

Investment Strategy RiverNorth allocates the Fund's Managed Assets among two principal strategies: Tactical Closed End Fund (CEF) Income Strategy (managed by RiverNorth) and Opportunistic Income Strategy (managed by DoubleLine). RiverNorth determines which portion of the Fund's assets is allocated to each strategy based on market conditions. The Fund may allocate between 10% to 35% of its Managed Assets to the Tactical CEF Income Strategy and 65% to 90% of its Managed Assets to the Opportunistic Income Strategy. The Tactical CEF Income Strategy typically invests in CEFs, business development companies (BDCs) and exchange-traded funds (ETFs) seeking to derive value from the discount and premium spreads associated with CEFs. The Opportunistic Income Strategy primarily invests in agency and non-agency residential mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS) seeking to derive value from inefficiencies within the subsectors of the fixed income market while maintaining active risk constraints.

Adding value is further complicated by the allocation bands. If the Tactical CEF Income Strategy is an incredible steal while the DoubleLine fund is temporarily overvalued, the manager can still only allocate 35% towards the former.

If you're wondering what the difference is between a Tactical Income Strategy and an Opportunistic Income Strategy (I was), it is explained as follows:

The Tactical CEF Income Strategy typically invests in CEFs, business development companies (BDCs) and exchange-traded funds (ETFs) seeking to derive value from the discount and premium spreads associated with CEFs.

The Opportunistic Income Strategy primarily invests in agency and non-agency residential mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS) seeking to derive value from inefficiencies within the subsectors of the fixed income market while maintaining active risk constraints.

Tactical Income invests in quite a few adventurous vehicles like BDCs, CEFs or ETFs and is trying to take advantage of valuation discounts and premia within these markets. I think that's a sound strategy but keep in mind BDCs and CEFs are often leveraged vehicles.

The Opportunistic Strategy is focused on the MBS market and has historically been an area of strength for DoubeLine. This vehicle is interesting in that it seems to combine strong areas of different firms within one vehicle. An unusual offering few firms dare or choose to offer in my experience.

Fees aren't exactly low for a fixed-income product, but they aren't unusual within the closed-end fund space either:

The Fund pays the Adviser a management fee payable on a monthly basis at the annual rate of 1.00% of the Fund's average daily Managed Assets for the services it provides. In addition to the fees of the Adviser, the Fund pays all other costs and expenses of its operations, including, but not limited to, compensation of its directors (other than those affiliated with the Adviser or the Subadviser), custodial expenses, transfer agency and dividend disbursing expenses, legal fees, expenses of independent auditors, expenses of repurchasing shares, expenses of any leverage, expenses of preparing, printing and distributing prospectuses, shareholder reports, notices, proxy statements and reports to governmental agencies, and taxes, if any. The Adviser (and not the Fund) pays the Subadviser a subadvisory fee payable on a monthly basis at the annual rate of 0.50% of the Fund's average daily Managed Assets for the service it provides.

Morningstar estimates the fund has an adjusted (that means without interest costs) total expense ratio of 2.1%.

Note that this fund has a leverage ratio of roughly ~35%. That means there is going to be quite some volatility, especially as it invests in some leveraged companies like BDCs as well.

I looked at the portfolio and, as to be expected, given the strong firms involved, the holdings aren't run-of-the-mill. Even if you don't like the fund there could be interesting investment ideas in its portfolio. The fund holds a bunch of SPACs that have not de-SPACed (which is a tactic I like); Legato Merger Corp. II (LGTO). Watch out as that one has found a target. Avalon Acquisition Inc. (AVAC), Lionheart III (LION) and others. SPACs are often qualified as equity holdings, but as long as the de-SPACing transaction has not occurred, I view them more like government debt instruments with an equity option included. How "safe" they are depends on the price paid more so than what these instruments are called. On the more traditional bond side, the firm holds a lot of mortgage instruments, very few treasuries and a lot of unique things like a Carvana (CVNA) Auto Receivables Trust and the PennantPark Floating Rate Capital Limited (PFLT). You really get a lot of creativity with this fund, and you're not paying management fees to get your money put in a standardized index or something.

The fund has a lot of flexibility on how it invests. I like to take a quick look at some higher-level statistics about the portfolio. Sometimes this shows what the management teams are thinking about the economic outlook and/or markets. Duration risk is currently limited. The fund has almost nothing allocated above 7 years of duration.

Duration

Morningstar data (Morningstar.com)

In terms of credit risk, it has quite a bit. Or at least it has a bit of Below B, BBB and BB while a good chunk is unrated.

Credit ratings

Morningstar data (Morningstar.com)

If you expect a recession is imminent, it is probably not a great option to hide. Overall, I like this fund, but the discount to net asset value is not where I'm buying it. I'd be perfectly fine holding this if I already owned it. I'm looking for this fund to drop to a discount to net asset value of at least 5%-10% or so, and then I'll be very interested. Because these managers are very well regarded, I'm not sure if that will happen anytime soon. However, other DoubleLine funds eventually got there. For example, the DoubleLine Income Solutions (DSL) currently trades at a ~6% discount to net asset value while the 3-year average discount is only 2.45%. Until that happens here as well, I'll just have to be patient.

I write the Special Situation Report. I look at special situations like spin-offs, share repurchases, rights offerings and a lot of M&A events. The point is to make money with risks under control. Check it out here. Follow me on Twitter here

This article was written by

Bram de Haas profile picture
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Professional risk-taker focused on smart bets and risk control.
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Disclosure: I/we have a beneficial long position in the shares of DSL either through stock ownership, options, or other derivatives. 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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