RIV: Nice Yield But Questions About Sustainability (NYSE:RIV)

Side view closeup of woman hand showing fan of dollar banknotes, arm holding cash, lot of money.

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Although the Federal Reserve’s monetary tightening policy has increased the income that investors can obtain from safe assets such as bonds, certificates of deposit, and even saving accounts, there is still a need among many people for income. This is because of the havoc that today’s high inflation rates have wrought upon the budgets of most households. This inflation has done so much damage that it has even forced many people to take on second jobs or begin working in the gig economy in an effort to obtain the extra money that they need to eat or keep themselves warm this winter.

Fortunately, as investors, we have other options that we can use to obtain the extra money that we need to cover our bills and other expenses in today’s environment. One of the best of these methods is to invest in a closed-end fund that focuses on the generation of income. These funds are nice because they provide access to a professionally-managed diversified portfolio of assets that can usually provide a higher yield than just about anything else in the market.

In this article, we will discuss the RiverNorth Opportunities Fund, Inc. (NYSE:RIV), which yields a jaw-dropping 15.72% at the current price. Admittedly, a yield that is this high can be a sign that the market expects that the fund will be forced to cut in the near future so we want to take a close look at the fund’s financial situation. This article will, of course, do that along with our usual overview and commentary on the fund as an investment. Let us proceed and see if this fund could be a worthy addition to a portfolio today.

About The Fund

According to the fund’s webpage, the RiverNorth Opportunities Fund, Inc. has the stated objective of providing its investors with a high level of total return, consisting of current income and capital appreciation. This objective is not exactly unusual as most investors want to get a high total return. After all, we generally prefer capital gains to capital losses and current income provides us with direct payments that we can use to invest in other assets. This fund is a little unusual in how it attempts to achieve this objective because it invests in both common equity and fixed-income assets. Most closed-end funds only invest in one or the other. This fund is actually fairly reasonably balanced between the two asset types as well, with fixed-income accounting for only a bit less than common equity across the portfolio:

RIV Asset Allocation

CEF Connect

Some readers will undoubtedly notice that the stock and fixed-income allocations total more than 100%. This is because this fund is utilizing leverage as part of its strategy to boost its total return, which we will discuss later in this article. The fact that it is fairly well-balanced between stock and fixed-income securities could work out fairly well over the long term. One reason for this is that common stock provides more potential for capital gains. This is because fixed-income prices are directly linked to interest rates. When interest rates decline, fixed-income prices rise, and vice versa. As there is a limit as to how low interest rates can go, there is an implicit limit as to how high fixed-income prices can go. The same is not true of common stocks since they are theoretically linked to the growth and prosperity of the underlying company. After all, we have seen common stocks like Netflix (NFLX), Amazon (AMZN), Tesla (TSLA), and many others deliver well over 1000% gains over the past decade. However, common stocks usually do not have nearly as high a yield as fixed-income securities. The fact then that the fund contains both common equity and fixed-income securities provides us with the best of both worlds.

Another benefit that we get from having both types of security in the portfolio is safety. After all, fixed-income securities are generally considered safer investments than common equity. This is because fixed-income securities sit higher in the capital stack than common equity. As a result, the holders of these securities have a superior claim to the company’s assets in the event of bankruptcy or a liquidation event. In effect, the holders of these securities must be made whole before the holders of the common stock are eligible to receive anything. Thus, common stockholders are more likely to lose all of their investments in a worst-case scenario.

This preference for fixed-income securities also applies to dividends and similar payments. The issuing company must make all payments to its fixed-income investors before it can make any dividend payments to the common stock investors. In the case of those companies that place a lot of emphasis on the dividends that they pay to the common stockholders (like utility companies), this rule means that the issuing company will likely do everything in its power to ensure that the fixed-income investors receive all of their promised payments.

The RiverNorth Opportunities Fund, Inc. has a very different portfolio than many other closed-end funds. We can immediately see that by looking at the largest positions in the fund. Here they are:

RIV Top Ten Holdings

Fund Fact Sheet

As we can immediately see, the fund is mostly invested in other funds. This partially explains its high yield as many of these entities boast very high yields themselves. At this point, there may be some readers that point out that business development companies, which account for 14% of the portfolio, are not closed-end funds. In fact, they are a very specialized form of closed-end fund that invests in private companies as opposed to public ones like most closed-end funds. A special purpose acquisition company is a different animal as they are usually intended as a way to take a private company public without the private company needing to go through the complicated and expensive process of conducting an initial public offering.

Unlike business development companies or closed-end funds, though, special-purpose acquisition companies usually do not have especially high yields. The fund’s investments in these companies appear to be intended as an attempt to secure capital gains following the acquisition company actually purchasing a private company. In contrast, many of the other things in this portfolio are generally considered to be income investments. Thus, we once again see an attempt by the fund’s management to obtain both capital gains and current income for its investors.

Unfortunately, the fund’s balance between capital gains and income has not saved it from the difficult market that we have seen this year. The fund is down 21.19% year-to-date:

RIV YTD Stock Chart

Seeking Alpha

This is partly because of the Federal Reserve’s switch from a loose monetary policy to one of monetary tightening and rising interest rates. As fixed-income security prices vary inversely with interest rates, the rising interest rates have pushed these down over the period. However, there is somewhat less of a correlation between interest rates and common equity prices. At least, there was prior to the last financial crisis. The decade-long policy of zero interest rates caused a lot of traders to put their cash into stocks and similar assets because there was no point in holding cash in an interest-bearing account when interest rates are at zero. As a result of the cash rushing into the market, supply and demand pushed up stock prices which then fed on itself as traders began to borrow money at incredibly low rates to buy stocks, further pushing up prices. The switch to a rising interest rate policy increased the attractiveness of cash, prompting market sell-offs as people attempted to convert their gains into cash and many traders started getting hit with margin calls.

With that said, the RiverNorth Opportunities Fund, Inc. has not done that badly in terms of performance. In fact, when we look at total return, the fund has generally beaten the S&P 500 index (SPY) over the course of 2022:

RIV Total Return vs. S&P 500

RiverNorth

This is certainly nothing to be disappointed about. In fact, it makes this one of the few funds that outperformed this year. However, we can see that its long-term performance has not been nearly as good. With that said, though, it seems likely that most people buying this fund are purchasing it to receive the income that it provides as opposed to just wanting to outperform the market. Still, though, the fact that the fund does tend to beat the index during times of declining markets is something of a bonus.

Leverage

As mentioned earlier in this article, the RiverNorth Opportunities Fund, Inc. utilizes leverage in order to boost its yield. Basically, the fund is borrowing money to purchase business development companies, closed-end funds, and similar entities. As long as the yield of the purchased assets is higher than the amount that the fund needs to pay in interest on the borrowed funds, this strategy works pretty well to boost the yield of the portfolio. As the fund can borrow at institutional rates, which are much lower than retail rates, and the purchased securities tend to have very high yields, this is usually the case.

However, the use of leverage is a double-edged sword. This is because debt boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage since that would expose us to too much risk. I generally do not like to see a fund’s leverage be above a third as a percentage of its assets for this reason. The RiverNorth Opportunities Fund, Inc. is slightly above this threshold as its leveraged assets currently comprise 33.63% of the portfolio. With that said, though, this is barely above that one-third limit so it is probably okay. The fund appears to be striking a reasonable balance between risk and reward.

Distribution Analysis

The primary objective of the RiverNorth Opportunities Fund, Inc. is to provide its investors with a high level of capital appreciation and current income. In order to achieve this objective, the fund invests in a levered portfolio consisting of business development companies, closed-end funds, and other high-yielding assets. As such, we can probably assume that the fund itself boasts a very high yield. This is certainly the case as it pays a monthly distribution of $0.1700 per share ($2.04 per share annually), which gives it a 15.72% yield at the current price. This is easily one of the highest yields of any closed-end fund. Unfortunately, the fund has not always been consistent with its payout as the distribution has varied somewhat over the years since its inception:

RIV Dividend History

CEF Connect

These variations may reduce the fund’s appeal in the eyes of those investors that are seeking a stable source of income with which to pay their bills. It is likely comforting that the fund’s distributions consist almost entirely of dividend income though, although the latest quarter did include a considerable amount of return of capital:

RIV Distributions by Type

Fidelity Investments

The reason why this could be comforting is that dividend income is by far the most sustainable form of distribution for a fund. This is because this money comes from dividends or interest payments that the fund receives from the assets in its portfolio. As it is quite rare for a company to reduce its dividends, the fund should continue to receive the same amount from period to period. This is a much better situation than depending on capital gains to cover the distribution. The latest quarter is somewhat concerning though given the high level of return of capital distributions. This is because a return of capital distribution can be a sign that the fund is returning the investors’ own money back to them. This is obviously not sustainable over any sort of extended period. However, there are other things that can cause a distribution to be classified as a return of capital, such as the distribution of unrealized capital gains or the distribution of money received from certain closed-end funds. As these are both things that the RiverNorth Opportunities Fund, Inc. may be engaged in, we should investigate its finances further to determine exactly how it is getting the money to cover these distributions and how sustainable they are likely to be.

Fortunately, we do have a relatively recent report that we can consult for that purpose. The fund’s most recent financial report corresponds to the full-year period ending July 31, 2022. Although this report will not include data regarding the fund’s performance over the past few months, it should still give us a pretty good idea of how it handled the early stages of the monetary tightening regime as well as the market decline. During the full-year period, the RiverNorth Opportunities Fund received a total of $7,302,247 in dividends and another $577,127 in interest from the investments in its portfolio. This gives it a total income of $7,879,374 during the year. The fund paid its expenses out of this amount, leaving it with $3,010,738 available for investors. This was nowhere close to enough to cover the $38,234,643 that the fund actually paid out to its investors over the period. Not only is this somewhat concerning but it also tells us that the fund’s distributions are almost certainly misclassified since it is not financing them solely out of net investment income.

There are other ways by which the fund can obtain the money needed to cover its distributions though, which may assuage our concerns somewhat. One of these methods is through the generation of capital gains. Unfortunately, it failed at this task during the period. The fund reported net realized gains of $484,152 but this was more than offset by net unrealized losses of $20,966,192 during the period. Obviously, the fund came nowhere close to covering its distributions solely from its ordinary operations. However, the fund issued new shares during the period, netting it $98,018,703. That influx of new money due to the share offering did allow the fund to increase its assets under management during the period even after accounting for the distribution payments, but it still failed to actually earn enough money through its investments to cover the distribution. This is a change from the prior year, in which the fund did manage to cover its distribution solely through operations. The fund can probably sustain this going forward assuming that its poor recent performance was just a one-off event, but I will admit that I do not like to see a fund relying on taking in new money just to provide money to the existing investors.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return on that asset. In the case of a closed-end fund like the RiverNorth Opportunities Fund, Inc., the usual way to value it is by looking at the fund’s net asset value. The net asset value of a fund is the total current market value of all of the fund’s assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to purchase shares of a fund when we can acquire them at a price that is less than the net asset value. This is because such a scenario implies that we are buying the fund’s assets for less than they are actually worth. That is unfortunately not the case with this fund today. As of December 14, 2022 (the most recent date for which data is available as of the time of writing), the RiverNorth Opportunities Fund had a net asset value of $12.56 per share but the shares actually trade for $13.02 a piece. This gives the shares a 3.66% premium to the net asset value. This is substantially more expensive than the 0.63% discount that the shares have averaged over the past month. It therefore may make sense to wait until the price declines somewhat before buying.

Conclusion

In conclusion, the RiverNorth Opportunities Fund, Inc. is an interesting fund that invests primarily in business development companies and other closed-end funds, which is out of the ordinary. All of these assets tend to boast fairly high yields though, which allows this fund to boast a fairly high yield itself. Unfortunately, it failed to cover the distribution during the most recent full-year period and only managed to get the money to distribute by selling shares to new investors. This is unlikely to be sustainable over an extended period so we need to keep a close eye on its finances to ensure that this is not a recurring problem. The RiverNorth Opportunities Fund, Inc. is also quite expensive today, so it may not make sense to buy it until the price falls to a more reasonable level.

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