We look at the past three months and make some portfolio adjustments.
In October, we launched the Strategic Income Portfolio, our model portfolio of taxable fixed-income closed-end funds. For the three months ended Jan. 21, 2014, the portfolio logged a total return of 2.71% on a share price basis. Meanwhile, the Morningstar Category of multisector-bond funds returned an average 1.21%, and the Barclays Capital Aggregate Bond Index gained 0.26%. The short time frame makes it difficult to draw meaningful insight about risk-adjusted returns, but let's take a closer look at the key drivers of the SIP's performance. Then we will discuss some adjustments to the portfolio.
A Closer Look at Performance
- source: Morningstar Analysts
The SIP was admittedly much more volatile than its benchmark(1): It hit a low point on Dec. 6, 2013, down 1.58%, while the multisector-bond fund category average fell just 0.27%. But as the above chart shows, the following six weeks more than made up for the initial malaise. This was due primarily to fluctuations in discounts. The weighted average discount of the funds in the portfolio started at about 6.6% on Oct. 22 but widened to about 8% by the middle of December before narrowing to about 5% by Tuesday, Jan. 21. Overall, the weighted average discount in the SIP narrowed by 149 basis points over the period, while the average taxable fixed-income CEF's discount only narrowed 60 basis points. Net asset value performance was fairly underwhelming over the period; ignoring discounts, the SIP would have returned 0.81%.
The portfolio's 25% weighting to Templeton Global Income GIM was a big detractor on both a share price and NAV basis. Even after accounting for its sizable year-end distribution of $0.2499 per share, the fund lost 0.37% on a NAV basis and 0.81% on a share price basis over the three-month period. This is not particularly surprising given the fund's large weighting to emerging-markets debt (emerging-markets debt funds lost an average 2.85% for the period). Western Asset Global High Income EHIalso had a large allocation to emerging markets (31%) as of September 2013 but still returned 2.8% on a share price basis and 1.8% on a NAV basis.
On the plus side, the remaining funds in the portfolio generally saw strong NAV returns and narrowing discounts, which helped share price returns. Of particular note, AllianceBernstein Income's ACG 8.0% share price return for the period was the biggest contributor to the SIP's share price performance. This leveraged, long-duration fund's NAV was essentially flat for the quarter, but pending shareholder action helped the discount narrow rapidly. (On Jan. 7, AllianceBernstein issued a press release announcing that the board of directors received a proposal from shareholders to open-end the fund. While the discount had slowly narrowed to 11.8% from 15.7% at the end of November, it closed another 355 basis points in the two weeks following the announcement.)
With a 9.9% weighting in the portfolio, it accounted for more than a fourth of the portfolio's share price return. MFS Intermediate Income MIN, at 25% of the portfolio, logged a 3.1% share price return, driven primarily by its contracting discount. Nuveen Build America Bond NBB and BlackRock Limited Duration Income BLW, each with a 7% weighting, logged 6.7% and 6.6% on a share price basis for the period, respectively. PIMCO Dynamic Income's PDI 7.7% share price return for the period also helped out, despite the small 2.6% weighting in the portfolio.
Even though there is a chance that AllianceBernstein Income's shareholders will approve the proposal to open-end the fund, this is not particularly likely, in our opinion. AllianceBernstein notes that at least two thirds of all outstanding shares must vote in favor of the action. For CEFs, merely mobilizing this many shareholders to vote would be an uphill battle. Even if all institutional shareholders with more than 0.50% vested in the fund (about 20% of outstanding shares) approved the proposal, another 47% of shares would be required for the measure to pass. Some long-term shareholders may decide that the ability to use cheap and plentiful leverage is more valuable than a quick gain of narrowing the discount, and would not view the move to be beneficial over the long haul. If the fund open-ended, the best-case scenario for investors would be a 9% gain from closing the gap between NAV and share price. If the proposal doesn't go through, the discount could quickly gap back out to the tune of 15% (its discount as of early December). In short, the added share price uncertainty may outweigh the potential benefits of a further narrowing discount.
With this uncertainty in mind, we view MFS Government Market Income MGF to be a good substitute for AllianceBernstein Income at current valuations. Like cousin fund MFS Intermediate Income, MFS Government Market Income is nothing special on a NAV basis, but its sizable discount and persistent return of capital give it some beneficial attributes. MFS Government Market Income takes on less interest-rate and credit risk than AllianceBernstein Income, but its modified earning rate at share price(2) is still higher than AllianceBernstein Income's. Given these factors, we are swapping AllianceBernstein Income for MFS Government Market Income. Because MFS Government Market Income does not use leverage, its 15% weighting will replace AllianceBernstein Income's 10% weighting.