Please Note: This article was first published for Income Idea subscribers on Thursday along with additional analysis and implementation ideas. All data in this article is as of 5/2/2018.
I have generally been a fan of actively managed funds where the management team has the flexibility to invest in a variety of asset classes where they best see fit, in line with the investment policy statements laid out in the prospectus documents. For those reasons, many of my client portfolios will typically include a "strategic income" fund of some sort for fixed income investors. This could be either an open end mutual fund, ETF or a unit investment trust ("UIT"). Such fund typically outperform over longer periods of time however you do run into the issue where generally speaking "strategic" = "junk bonds." This applies to both taxable and tax free fixed income. Where these funds are great however is that during flat or uncertain fixed income markets, by investing in go anywhere fixed income funds you are giving up that investment decision to the portfolio manager whom you believe has a better read on the market and more importantly is able to find those opportunities which neither you or I have access to as individuals. Perhaps the most well known of such funds is the PIMCO Dynamic Credit Income Fund (PCI) which I wrote about in "PCI - Not For Me." My issue with the fund was that as great as it is performance wise there is a very hefty price, the lack of transparency around certain aspects and the exceptionally high leverage and fees. Another fund that fits this bill and sponsored by one of my favorite managers is the Guggenheim Strategic Opportunities Fund (GOF). While I have looked at it a number of times for myself, I have never written about it or invested in it myself for the simple reason that I do not buy CEFs at a premium. I did have a number of readers ask me about the fund and that is why we are taking a deep dive into the fund today, particularly as it may be just the recipe for the uncertain fixed income markets of tomorrow. Sources: CEF Connect, Guggenheim Website, and YCharts. For whatever reason the fund does a horrendous job on its website and in its marketing material to set the case for investing in the fund. On one hand, they do not need to as the fund only raises capital at its IPO or during follow up offerings but still.... why not put up a few graphics or paragraphs outlining why investors should consider it? Since the fund fails to do that job, I will attempt to. As I stated in the introduction, I am a fan of go anywhere investments, especially when they can give you uncorrelated investment exposure. A Closed End Fund structure further lets the fund use leverage and due to its structure, management does not need to have money allocated to cash for any redemptions which occur with open end mutual funds. The CEF structure also lets you, in most cases, to purchase funds below their net asset value further generating alpha. (Although this has generally not applied to GOF.) In the fund"s semi-annual report the fund manager does point out that "thorough research and independent thought are rewarded with performance that has the potential to outperform benchmark indexes with both lower volatility and lower correlation of returns as compared to such benchmark indexes." Source: GOF Semi-Annual Report Unlike in an exchange traded or an open end index fund which follow an underlying index with their generally transparent index methodologies, no such things exist in go-anywhere, actively managed funds. As such, investors generally rely on the information provided in the prospectus for the fund"s general investment guidelines. As a true "strategic income" fund, the fund may invest without any limitations in fixed income securities rated below investment grade, aka junk bonds. The fund may further invest up to 20% in non-US dollar denominated securities, including up to 10% in emerging markets. What makes the fund relatively unique is that it may invest up to 50% in equities and up to 30% in fund of funds or pass through securities. Source: GOF Website One of my personal attraction points to Guggenheim is their strong position in asset backed securities, particularly aerospace. Even though this is an actively managed go-anywhere fund, it is not overly concentrated. The top 10 holdings make up just 7.98% of the fund. Source: Guggenheim Website Looking at the fund more broadly, even though it can allocate up to 50% to equities, the fund is currently 80% allocated to fixed income with just a bit over 15% allocated to common stocks. Source: Guggenheim Website Breaking it down further shows us that more than half of the fund is allocated to floating rate bank loans and ABS, or asset backed securities. In general, these are below investment grade. Source: Guggenheim Website High yield bonds add another 14% while investment grade corporate bonds are just under 5% of the fund. This obviously shows up in the credit quality. More than 90% of the fund is either rated at or below BBB or not rated. More than 70% is either below investment grade or unrated. Source: Guggenheim Website Unfortunately due to the nature of the fund and the fund"s decision, Guggenheim does not publish some common statistics such as the average effective maturities and durations. From the transparency side this is a disservice to investors and I hope the sponsor changes it in the future. The only reference to duration which I found was in the semi-annual report. Guggeneheim does disclose that the fund had an average duration of about .7 years which is quite good. We do not however know whether that was leverage adjusted or not. In either case, what this means is that for a 1% rise in interest rates, the fund"s NAV should be expected to decline by just .7%. If we have to adjust for leverage it would be closer to 1%. The opposite is also true if interest rates decline. Looking at the risk data we can find a 5 year beta of .997. This implies that the fund has essentially been as volatile as the underlying markets. Source: YCharts The maximum draw-down which the fund experienced was 54.69%, likely during the closed end fund sell off in 2007/2008 when the leverage markets dried up and funds were forced to liquidate. Looking at the risk adjusted metrics, the fund has achieved a 10 year Sharpe ration of .7935 and a Sortino ratio of .6941. While these are not mind blowing... for a closed end fund of this nature it is quite good. Like most closed end funds, the Guggenheim Strategic Opportunities Fund(GOF) uses leverage. The fund uses two primary methods for obtaining leverage. First, the fund uses reverse repurchase agreements whereby it pledges its investments through transactions creating leverage. As of November 2017, the fund had $ 58 million in reverse repurchase agreements with its syndicate of banks on which it paid an average weighted interest rate of 1.85%. These costs would be higher today. Source: GOF Semi-Annual Report The second source of leverage is a traditional credit facility with a lender. GOF has an $ 80 million credit facility on which it pays a borrowing rate of .85% over 3 month LIBOR. On this line as of the end of November the fund had just $ 2 million outstanding as it had paid down the majority of the credit facility. Source: GOF Semi-Annual Report What is important to note here is that most of the CEF leverage which we have looked at is typically a spread of .7% to 1.2% over 1 Month LIBOR. In the case of GOF it is 3 month LIBOR which is a higher rate. While generally this was a small spread, the gap is now close to .5%! As such, the fund"s current borrowing costs on this credit facility would be over 3%! Fortunately it seems that Guggenheim is employing some smart people to run the fund, namely Scott Minerd who has been quite critical of the markets. As such, the fund has been deleveraging as of late. Source: GOF Semi-Annual Report The fund is currently distributing a market price distribution yield of 10.44% and is trading at a PREMIUM of 8.78% to its NAV, or net asset value. Over the previous year the fund has continued to trade at premiums although it did come very close to parity earlier this year. Generally speaking, the Net Asset Value has failed to grow beyond its initial IPO even though there is a growth component. THIS IS QUITE CONSISTENT with the findings of the distribution analysis. A few good years bail out many bad years however there has not been meaningful growth. Looking back over the fund"s lifetime, we can see the fund has generally traded at a premium over the previous 7 years or so however did trade at a discount in 2015/2016 and during the financial crisis when it was trading at close to 30% discounts to NAV. This is once again consistent with "junk bonds." Performance wise, year to date the fund has been sold off with most other CEFs. The fund is up a mere .21% on a total return basis accounting for the distribution. The price per share is down 3.27% while the NAV is down 3.04%. Do note at the price vs NAV action early this year when the fund was thrown out and decreased 9%. This is a risk to buying a fund which is trading at a premium as any sustained sell off turns premiums into discounts, adding more misery to the underlying losses. Over the previous year the fund did give investors a 10.28% total return. This came strictly from the distribution. The underlying price per share is down .6% while the net asset value fell 2.89%. Over distributed? AHA! Over the last 3 years the story remains the same. The fund presented investors with a 36.17% total return while the price fell 2.9%. The underlying NAV declined 2.5%. A good 2016 bailed out the fund"s track record during this time. Over the previous 5 years we have precisely the same story. The total return was all about the distribution. The underlying price per share declined 9.28% while the NAV declined 8.99%. Going back 10 years would have you purchase the fund near the lows of the financial crisis. AS such, the fund has achieved phenomenal results. The fund would have a 270.8% total return (if reinvested). The price per share increased 24.11% while the NAV grew just 8.5%. Since inception the numbers are not as good. The total return declines to 233.8% with a 4.38% price per share gain and an essentially flat NAV. The moral of the story, the fund did a PHOENOMINAL job coming out of the financial crisis but it was quite volatile and since 2011 or so, has not grown its NAV in the greatest bull market yet. Should have? Want signs of over distribution? Plain vanilla (AGG) and (MUB) grew their NAVs during this time. To put the fund into perspective, we will take a look at the fund against a number of competing products, both levered and unlevered. As far as "go anywhere" type funds, there are a number of competing closed end funds such as the BlackRock Multi-Sector Income (BIT), the PIMCO Dynamic Credit Income (PCI), and the DoubleLine Income Solutions (DSL) funds. PCI is managed by the PIMCO team and the DoubleLine fund is a representation of the famed Jeffrey Gundlach"s ideas. I also wanted to take a look at how it does against a covered call fund such as the BlackRock Enhanced Global Dividend fund (BOE). Lastly we can take a look at two unlevered open end funds, the Fidelity Strategic Income (FSTAX) and the PIMCO Total Return (PTTAX) funds. Year to date on a total return basis we can see that generally speaking, GOF has lagged for most of the year and was actually the most impacted during the sell off in February. It has since rebounded and comes in the middle of the pack. For the year however (PCI) and (DSL) have been the best performers. If we look over the last year we can see (GOF) has beat most of its peers coming in behind PCI. Interestingly (BIT) lead the way until the sell off this year. Also of note, even though also PIMCO managed, the open end Total Return Fund was the worst performer. Over the last three years we have a similar story. PCI lead the way followed by GOF, DSL and BIT. The equity focused BOE lags and is followed by the two open end funds which were quite stable. In either case, the Fidelity fund handily outperformed the PIMCO Total Return fund. Looking back 5 years we essentially have PCI and GOF leading the way, followed by (BIT). The high performing DoubleLine fund however comes in at the bottom of the CEF pack simply due to its horrible performance in 2015. Once again it shows the importance of risk management. It is not as import as to how much you make, and it is more important to focus on how much you DON"T LOSE! This is ever so important for buy and hold investors. To get a 10 year number we only have the (GOF) and (BOE) closed end funds along with our two open end funds. This is critical but we do not have any idea how (PCI), (BIT) and (DSL) would perform during a financial crisis. As we can see, the two closed end funds were decimated during the crisis. While GOF recovered, BOE never did. In fact, the plain vanilla open end Fidelity income fund would provide better total returns than an equity CEF fund. Overall, GOF has been a good fund especially if we consider that it has been generally less levered than its peers. More importantly from the risk management perspective the fund is leading the way in delevering while its peers are increasing their leverage to maintain the distribution level. Guggenheim is an experienced manager and if you want to capitalize on and follow Scott Minerd, (GOF) is a way to do so. Here is a good article on Scott Minerd"s recent thoughts. From the pricing side, it is very tough for most closed end fund investors I know of to justify purchasing it today, or even keeping it if you already own it. Over the previous year the fund traded at a premium to NAV of as low as .62% to as high as 11.33%. Source: CEF Connect As we can see, the current 8.78% premium to NAV is quite expensive over EVERY measured time period and the Z-Score solidifies that. The right time to buy it would have been earlier this year when it was trading at near parity. Overall it is certainly a peculiar time for funds like GOF, PCI and DSL. I think a great way of thinking about them is like dating a super model. Yes, they look really pretty and you have a great time dating and you get lots of envious looks. But are they the people you believe would end up being terrific soul mates to live together and raise a family? GOF, PCI, DSL and other high yield junk bond funds have certainly become the "popular guy/gal" and people are paying premiums for them. At the same time, high quality funds and munis have been left at the alter. Yes, they have performed exceptionally well in a terrific bull market for both fixed income and equities, but so did the housing market in the early 2000s. The "crazy" part comes in where on one hand we see premium prices for those funds, yet the underlying fundamentals are either turning or completely falling apart such as the distribution coverage with GOF and others. Of course, I once again have to remind, a distribution is not a dividend and you have to take an underlying look at how the fund is doing. Bottom line, this is certainly a fund worth owning, but perhaps when the prices are quite a bit better and we have another opportunity to buy in ONCE the tornado comes through. In the mean time, the BlackRock Multi-Sector Income Fund (BIT) will let you play in the same space at a far lower cost, a 10% discount versus an 8.78% premium and while I have not looked at it yet, the underlying distribution coverage can"t be as bad as (GOF)? For more information on the fund, please visit the fund"s website at Guggenheim - GOF. For more reading on the mentioned funds, please take a look at: If you liked this article, please follow me and click "Like This Article" below! Income Idea subscribers do have full access to all of my previous work as part of their subscription along with the additional Distribution Quality and Implementation Ideas sections. Test Drive Income Idea for Free in a 14-Day Trial! Enjoying the article? Want more analysis and actionable ideas? Subscribers also have access to additional analysis of the distribution quality, leverage, and the most likely risk factors. Along with the additional analysis you also have my personal opinions of the investment and implementation ideas and investment alternatives. Sign up for the Free 14 Day Trial and lock in a first year discount! Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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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