Equity CEFs: 40%-Plus Swap Idea – One Year Later (DDF) (NYSE:DDF)


Want to know why CEFs can give you a leg up on other investors? Because CEFs are the ONLY security class that can immediately give you a valuation metric that the vast majority of investors pay NO attention to.

Imagine a stock that only you knew was definitively over or underpriced and all you had to do was wait until the rest of the market realized it too? That is similar to what you can get in CEFs.

Of course, you do have to do your homework and make some deductions as to whether or not a security (stock or fund) deserves a higher or lower valuation and in this case, I determined that over time, this CEF was overpriced based on the difficulty it was going to have to meet its new distribution goal.

In March of 2018, the Board of Directors of the Delaware Investments Dividend & Income fund (DDF), $8.24 current market price, $8.90 NAV, -7.4% discount, 7.7% current market yield, raised the distribution for the fund from $0.04/share per month to about $0.10/share per month, or about a 150% increase, the highest I had ever seen.

This dramatically higher distribution resulted because DDF adopted a 10% distribution policy, which was fine if it wasn’t for such a high percentage. For years, DDF flew under the radar, putting up impressive appreciation numbers for a leveraged equity based CEF but all the time trading at a wide discount with a more modest yield of around 6%. But all of that changed after March of 2018 and all of a sudden, everyone wanted a piece of DDF.

Before long, DDF was trading at a market price premium and I wrote my first article on DDF in August of 2018 called, Equity CEFs: Liberty & Independence In A Delaware CEF. I would go on to write several more articles over the next year even as DDF rose from a discount to a 10%, 20%, 30% and even a 40% market price premium, one of the highest valuations of all CEFs at the time.

What was my peeve with DDF? Nothing other than knowing the valuation was undeserved and knowing it would not last. Many of my articles take into account valuation anomalies and how much better an investor would be in if they swapped into another fund I suggested.

This was the basis of the August 1st, 2019 titled Equity CEFs: 40%+ Swap Idea, and yes, I wanted to make a splash with the headline.

In that article, which you can read by clicking on the link above, I compared DDF to a fund that would go on to become my 2020 Top Pick in the US-Value fund category, the Nuveen Core Equity Alpha fund (JCE), $12.73 current market price, $14.05 NAV, -9.4% discount, 7.1% current market yield.

Now, the two funds did not have much in common other than both being value focused, US stock based funds. So while JCE was a 100% stock fund that sold Russell 2000 small cap index options to derive income along with portfolio dividends, DDF used a more aggressive leveraged income strategy that included a roughly 2/3 stock, 1/3 fixed-income (mostly high-yield corporate bonds) portfolio that relied on dividends and interest (i.e. no option income).

However, I felt pretty confident that JCE would soon catch-up at market price based on my NAV performance expectations and the simple fact that JCE had a 33% higher NAV than DDF at the time but traded at about a -9% lower market price. That, I knew, wouldn’t last.

But other than one other big stumbling block that I will get into later, there really wasn’t anything based on market price performance up until that time that would indicate that things were about to change, but this is what I pride myself in when making bold predictions.

Here is a graph of DDF (in purple) and JCE (in orange) for the year prior to the Equity CEFs: 40%+ Swap Idea release and shows the total market price performance from 7/31/2018 to 7/31/2019:

ChartData by YCharts

And here is the graph of DDF and JCE for the year after I wrote the article from 7/31/2019 to 7/31/2020:

As you can see, pretty close to a 40% difference in performance as I suggested and one reason was the big stumbling block right out of the gate for DDF at the far left of the graph.

You want to know why the vast majority of my calls on equity CEFs, whether positive or negative, are correct? Because I do the homework on these funds and I uncover the positives and negatives and how that will affect them over time.

In DDF’s case, a simple shelf-registration in July of 2019 for a Rights Offering that would have almost doubled the size of the fund if the Board of Directors went forward with the filing, went hardly even noticed by most investors.

But I knew this would not be taken well by shareholders when the news came out even though Rights Offerings are not necessarily a negative for a fund that is trading at a reasonable valuation. But when a fund is trading at a 37% market price premium, that’s a different story since the proposed share offering to existing shareholders would have been at a substantial discount to DDF’s $15.08 market price at the time.

Though DDF would go on to rise back up (see graph above) and even hit a 40% market price premium in January of this year, it never outperformed JCE. The same is true for all of the funds I compared DDF against even though DDF had one of the greatest performance runs in equity CEF history.

If only it could have lasted.

Conclusion

On June 2nd, 2020, DDF quietly declared a $0.0509 distribution to shareholders, reflecting a new 7.5% NAV distribution policy, down from the 10% NAV distribution adopted more than two years ago.

Because between a high NAV yield and a leveraged value and REIT focused equity strategy, DDF could not overcome the disastrous effects on its underperforming portfolio from the COVID-19 virus.

YTD, DDF’s NAV is down -15.6% and its market price is down a stunning -41.9%, the largest NAV to market price performance difference of all the equity CEFs I follow:

Note: The NAV and MKT Difference column is shown in green for funds whose market price has underperformed its NAV since the thinking is that these fund’s market prices should catch up, all else being equal.

I get no pleasure in seeing shareholders get hurt like this and in fact, I applaud the managers of DDF for taking the hard step to cut the distribution policy to a more reasonable 7.5% level. Though value stocks and REITs are certainly out of favor this year, DDF’s high yield bond part of its portfolio (roughly one-third of its leveraged portfolio) has performed well.

Would I be buying DDF now? That depends on whether you believe value stocks and REITs are due for a rebound or a sustained rotation. So far, that hasn’t been the case as growth and technology stocks have left value sectors in the dust. But I’m keeping an eye on DDF now and it certainly wouldn’t be the first time that I went bullish on an equity CEF that I was bearish on for years.

Thank you for reading my article. My goal is to give you observations and actionable ideas in Closed-End funds while educating you on how these unique and opportunistic funds work.

CEFs can be one of the most exhilarating and yet most frustrating security classes to invest in, and it’s important that you have someone who can be a level head during up and down periods of the market. I hope to be that voice of calm when necessary.  ~ Douglas Albo

Disclosure: I am/we are long JCE. 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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