Sometimes it takes a swift kick in the pants to remind investors the price they are paying for an investment. Take for example two popular Closed-End funds (CEFs) from the Alpine family of funds, the Global Dynamic Dividend fund (AGD) and the Total Dynamic Dividend fund (AOD). Both of these funds are known as dividend harvest or dividend capture funds and if you go to Alpine’s website you will read all about their strategies to scan the globe looking for dividend and growth opportunities. Essentially, these funds attempt to harvest multiple dividend periods by overweighting dividend yielding global stocks ahead of their ex-dividend dates and then rotating assets to overweight other or alternating dividend yielding global stocks ahead of their ex-dividend dates. The end result is a treasure chest full of investment income for the fund that can be distributed as tax-qualified dividends. But is this fool’s gold?
The table below will show the total Net Asset Value (NAV) returns (including dividends and capital gains) for the funds since inception. I have included the total returns of two other global CEFs, the Eaton Vance Tax-Managed Diversified Equity Income fund (ETY) and the Eaton Vance Tax-Managed Global Diversified Equity Income fund (EXG) as comparisons. ETY and EXG are good performance comparables to AGD and AOD because they came public around the same time at $20 per share (minus a sales credit gives inception NAV price), and have global equity portfolios and similar inception dividends and yields.
The difference between the funds is that ETY and EXG use an option-income strategy on their underlying portfolio while AGD and AOD use a dividend capture strategy. ETY and EXG by no means represent the best of the NAV performances among option-income funds and in the case of EXG, which is the largest equity income CEF at $3.47 billion in assets, the fund got started closest to the market meltdown in late 2007 and with a portfolio of mostly international stocks. Still, both ETY and EXG have trounced the total return performance of AGD and AOD since inceptions.
The purpose of this comparison is to show investors the misconceptions of equity based high yielding CEFs and how they can lead to arbitrary market price valuations. The perception that dividend harvest funds such as AGD and AOD have “good” distributions because their dividends are tax-qualified as opposed to “bad” dividends from option-income funds which are mostly return of capital (ROC) is pure nonsense. One has to look at the bigger picture of what the real cost for these distributions has been. Not only have the option-income funds NAVs held up far better than the dividend capture funds since their inceptions, even with their high ROC; one could argue that return of capital is more tax-advantageous than tax-qualified dividends. ROC is tax-free in the period received though an investor would need to lower their cost basis in the fund by the ROC amount. Still, ROC is essentially tax-deferred until the investor sells the fund.
So what is the big draw of AGD and AOD to investors when the strategy has not proved that it can outperform, let alone just keep up with the markets? I can only imagine that it is the tax-qualified income since it certainly cannot be the fund’s NAV performances, which are among the worst I follow. Through December 2010, the NAVs on an absolute basis are down 64% for AGD and 68% for AOD since inception and yet investors still seem willing to believe in this strategy. At what price does one have to pay to receive tax-qualified income? In the Spring of 2010, I warned investors, even as AGD rose to a 60% premium and AOD to a 40% premium, that both funds were headed for disaster as their NAVs had not recovered nearly enough from the market lows of March 2009 to justify the continued exorbitant dividends they were paying. Then on June 24, 2010 the Board of Trustees for Alpine finally announced dividend reductions of 45% and 55% for AGD and AOD respectively and the market prices fell precipitously. The dividend cuts certainly have helped balance the fund’s earnings and distributions and it has improved their NAV performance for the second half of 2010, however their NAVs are still so depressed that I question if they will ever be able to recover to their former levels short of additional dividend cuts or a global bull market for the next decade.
Even in a rising market like we’ve seen, the funds would still be adhering to their income strategy of buying and selling positions as they rotate assets ahead of ex-dividend dates. Over the past two fiscal years, this has created a very large turnover in the portfolios, annualized at 400% to 650% according to Alpine’s latest annual reports. As most investors know, when a stock goes ex-dividend, the stock price is reduced by the amount of the dividend so the funds would have to first make up the amount of the dividend before the position could start contributing to the NAV. In a strong market environment this may not be a problem but the question is how long can an investor rely on being bailed out by a strong market? Dividend harvest may be a great strategy for earning lots of dividend income but history has shown that it has been a disaster for the NAV of the funds.
As I write this article, some of the dividend harvest funds again seem to be rising to higher market price premium levels while the option-income funds continue to languish at discounts. Though one would expect the dividend harvest fund’s NAVs to solidly outperform the option-income funds in a strong market environment, this was not necessarily the case in 2010. Perhaps the dividend harvest strategy is now coming into its own and the risk trade will finally pay off in these funds as opposed to the more defensive option-income funds which perform better in trendless markets. However if history is any guide, one should not expect global markets to proceed in a straight up or orderly fashion and if that is the case, then the fund manager’s at AGD and AOD will have their work cut out for them to build back the fund’s NAVs from their depressed levels. In the meantime one thing is for certain…the true term "return of capital" in which investor assets are simply returned to them in the form of distributions seems so far to be more a case for the dividend harvest funds than the option-income funds.
Note: Each fund's portfolio of securities is unique. This analysis only compares certain parameters of these funds and does not take into account each fund's portfolio of securities which also contributes to overall NAV performance.
Disclosure: I am long EXG, ETY, Short AGD
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