Written by Nick Ackerman, co-produced by Stanford Chemist
We last covered the Virtus Dividend, Interest & Premium Strategy Fund (NYSE:NFJ) at the end of 2023. Since then, the fund has moved mostly sideways, but with distributions reinvested as reflected by the total returns, we do see some positive results. Unfortunately, a larger portion of this was from the discount narrowing alone and not actual underlying portfolio performance.
With the discount narrowing, it could make it even less appealing than the last time we looked at this fund.
NFJ Basics
- 1-Year Z-score: 1.54
- Discount: -12.98%
- Distribution Yield: 9.13%
- Expense Ratio: 0.96%
- Leverage: N/A
- Managed Assets: $1.337 billion
- Structure: Perpetual
NFJ’s investment objective is “to seek current income and gains, with long-term capital appreciation as a secondary objective.” To achieve this, the fund will “invest approximately 75% of its total assets in equity securities and approximately 25% in convertible securities.” They will then “employ an option strategy of writing covered call options on equity securities held in the fund.”
Performance – Continues To Lack Results
In the last update, we did note how the fund’s discount was looking relatively attractive, but the track record wasn’t great with this one. It is a hybrid fund that brings a flexible approach to also incorporating writing options, which can make it difficult to find a true peer to stack the fund up against. However, they themselves list the fund’s benchmark as 75% Russell 1000 Value and 25% ICE BofA U.S. Convertibles Index.
In looking at ETF comparisons, which are also unleveraged like NFJ but incorporate a passive investment approach, we can use the iShares Russell 1000 Value ETF (IWD) and iShares Convertible Bond ETF (ICVT) as an investable alternative where one could invest 75% in IWD and 25% in ICVT. Of course, as we noted last time, this is only a historical performance. That cannot tell us exactly what will happen going forward.
That said, the results still aren’t looking too impressive, but it has at least been a bit more competitive with ICVT’s results. Selling options here could be limiting the fund’s upside relative to IWD, along with security selection and higher expenses also being factors to consider.
At the same time, in our prior update, the fund’s discount was quite wide, so we can see that the total share price returns have slightly outpaced that of its otherwise flat total NAV return performance above. That means that while it was trading at a relatively larger discount compared to its historical level last time, some of that has been reduced.
Another consideration to NFJ could be its sister fund, the Virtus Equity & Convertible Income Fund (NIE). It takes a similar approach, but instead of focusing on value sectors, this fund will invest in growth sectors. Its largest holdings are the mega-cap growth names Microsoft (MSFT), Amazon (AMZN) and NVIDIA (NVDA). Names that have been powering the market higher, and that’s clearly been reflected in the performance comparison between NFJ and NIE.
NIE trades at a discount, but on a relative basis, is trading at a narrower discount than it historically has. NIE and NFJ both have Voya listed as the investment management team, but NFJ also comes with the NFJ Investment Group listed as well.
Further, despite some similarities, the differences between the portfolio of growth versus value means one would be transitioning into quite a different portfolio, potentially at the completely wrong time, too. Should one believe that the mega-cap growth names are losing steam and value may come in favor, then NFJ is still the better bet going forward.
Another consideration for NFJ could be that it looks like Saba Capital Management has recently taken a position in the fund. An activist group that frequently pushes funds to make moves to profit off of discounts. Currently, the stake works out to 5.34% of the fund.
Distribution Bump
On a bit of better news: since our prior update, the fund has seen its quarterly distribution increased in March. It took the quarterly payout from $0.245 to $0.28. That works out to an increase of 14.3%, while the NAV distribution rate remains reasonable at 7.94%. Thanks to the meaningful discount, the actual market distribution rate comes to 9.12%.
Similar to most closed-end funds that invest with a heavy component of equity positions, it will require capital gains to fund the payout to investors. With their last annual report, they were able to achieve that by realizing more than enough to cover the amount paid to investors.
The actual written options contributed to losses for the fund during the fiscal year, so all of the gains realized were from the underlying portfolio.
For tax purposes, 2023 saw the entire distribution classified as ordinary income, with only around 20.08% listed as being qualified dividends.
That’s quite unusual, given the makeup of the earnings for the year was largely driven by realizing massive gains from the underlying portfolio. It was also a big change from last year, where nearly two-thirds of the distribution was classified as long-term capital gains. Even further, over 50% was also considered to be qualified dividends of the ordinary income dividends bucket. This is a good reminder of how volatile and somewhat unpredictable the tax classifications can be for CEFs.
NFJ’s Portfolio
NFJ is quite an active fund, as its portfolio turnover rate would reflect, with the latest fiscal year 2024 showing a 102% turnover rate. That was up from 60% and 63% in each of the previous two years, and it makes it similar to 2021’s 104% turnover rate. Suffice it to say that the management is making a lot of moves. I suppose when you have seven managers listed, each one needs to try to justify themselves. Unfortunately, despite trading like mad, it really hasn’t been to the benefit of performance historically, as we explored more in our prior update.
The fund’s overall allocation hasn’t changed much either since our prior update. However, that is consistent with the fund’s investment policy of holding between 70 and 80% in equities and 20 to 30% in convertibles.
Additionally, the fund places a large allocation to financials, followed by real estate and healthcare. That’s also mostly in line with what we saw previously in the fund.
The real estate sector is quite noteworthy because that’s the only sector that is down YTD by a fairly large margin. Financials are performing much better more broadly, but clearly, real estate has been another headwind for NFJ. That can help explain further why YTD, the fund’s underlying portfolio, has been essentially flat.
Turning toward the fixed-income allocation, which is the convertible component of the fund, we can see that the sector allocations look quite different.
However, unlike the equity sectors, the underlying convertibles within these sectors haven’t seemed to benefit hardly at all. This can be reflected by ICVT, which is also allocated most heavily to the technology sector. Still, ICVT – along with NFJ – has been mostly flat this year, as indicated in the chart we provided earlier in the article. So, that seems to be another area that has kept NFJ from performing very well, which accounts for a rather meaningful sleeve of around 20% of its asset allocation.
Finally, despite the high turnover for the portfolio, the top ten hasn’t changed all that much either. There have been normal percentage allocation changes with natural gyrations of pricing, but otherwise, the top ten names remained rather consistent.
Edwards Lifesciences Corp (EW) is a new name, as well as Thermo Fisher Scientific (TMO). That saw Lululemon Athletica (LULU) and Ovintiv (OVV) evicted from the top ten. However, as of the fund’s last N-PORT filing, LULU and OVV still remain holdings in the fund, just the allocations are smaller now.
Conclusion
NFJ continues to trade at a fairly deep discount but is coming much closer to its longer-term average level. That means it might not be as much of a bargain as it was previously on a relative basis. Further, the fund’s track record of mediocre performance, unfortunately, seems to have continued since our last update. That doesn’t mean it will continue that way going forward. If the value sectors start performing better – particularly the real estate sector, which has been lackluster – then NFJ’s future could look a bit brighter. With Saba Capital getting involved, it’s also worth noting that they could attempt to push the fund toward a tender offer or some other means to profit off of the current discount.
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