On May 30, I
released an article
on Seeking Alpha in which I warned investors that some of the
option-income funds may be vulnerable to a dividend cut based on
their high dividend to Net Asset Value ((
)) percentages, some approaching 13%.
Two days later, on June 1, BlackRock announced quarterly
dividend declarations which included dividend cuts for 3 of the 5
funds I had listed, the
BlackRock Enhanced Capital and Income fund (
BlackRock EcoSolutions Investment fund (
BlackRock Enhanced Equity Dividend Trust (
. Since the declaration date, all three of the funds have gotten
hit hard. In fact, the hardest hit fund has been
which I specifically called out in
on Seeking Alpha just a month prior.
My intention is not to give myself a pat on the back but to
point out how due diligence can reveal red flags among these funds
and one of the most important is a high dividend to NAV ratio. The
reason is because a fund's dividend is derived from the NAV and
thus, the NAV yield is the true yield the fund is paying even if an
investor receives the market price yield. Too high an NAV yield and
the fund may be subject to a dividend cut if its income strategy
can't support it.
This was a reason cited by
when they initiated coverage of a popular bond fund, the
PIMCO High Income fund (PHK)
at an underperform rating on June 3. Even though
market price yield seemed fairly reasonable at 10%, its premium
market price of around 50% masked its NAV yield, which was a
whopping 15.6%. Even a leveraged high-yield bond fund would have a
difficult time maintaining that yield!
Dividend cuts are one of the few news events that can have a
large impact on CEF market prices because most investors buy CEFs
for their high dividend yields. Fund sponsors, however, can have
different reasons for a dividend cut and not all of them are
necessarily negative. In the case of the
BlackRock Enhanced Capital and Income fund (
, I believe the cut had less to do with the need to pump up NAV
performance and more to do with simply reducing the NAV yield to a
more manageable level and more in line with most other domestic
(non-global) option-income funds.
NAV yield before the cut was about 12.8% and now it is a much more
manageable 10.1%. That may not seem like a lot but for a $619
million fund, but the net reduction in dividend payments is about
$22 million per year.
For the past two years,
had traded at mostly premium valuations due to its exceptionally
large dividend and superior NAV performance for an option-income
has always had one of the highest average premium/discount
percentages of all the BlackRock option-income funds. The following
graph shows this premium/discount over the past year, in which it
rarely strayed from a premium valuation.
click to enlarge images
All of that changed on June 1 when the dividend was cut from
$0.485 to $0.36 per share and investors exited the fund en masse.
This is shown in the far right portion of the graph when
valuation went from a roughly 4% premium price to its current -6.7%
market price drop was even more dramatic as it suffered 11 down
days out of 13 and is now essentially at a 52-week spike low.
Dividend cuts are never a positive for a fund in the short run
but ironically, this is the time you want to be buying
for the following reasons:
a) NAV yield goes from 12.8% to 10.1%. Much more manageable and
takes away any threat of another cut.
b) 4% premium goes to a -6.7% discount. Lowest valuation level
in 2-years for a fund with excellent historical NAV performance
which should get even better now with the lower dividend.
c) Because of the fund's discount, the market price yield to
investors is a still robust 10.8%, a windfall over the fund's NAV
yield but lower than the 12.4% yield before the dividend cut.
d) Option-income funds NAVs can outperform the broader market
during flat to range bound market periods.
option strategy includes selling individual stock options on about
54% of its portfolio, leaving the rest of its large cap portfolio
to rise and fall along with the market.
only includes about 50 domestic stock positions in its portfolio
and its top 5 sectors and top 5 holdings are shown below.
After being negative on the BlackRock funds going into the
dividend declaration because of their premium valuations and high
dividend to NAV ratios, I am now long
. In my opinion, the fund now reflects even stronger fundamentals
than before the dividend cut and I believe the outlook is even
better. Investors' over-reaction to the dividend cut has created an
excellent opportunity to invest in one of BlackRock's best funds at
one of its lowest valuations in years.
I am long
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