Within the equity closed-end fund market, several funds exist with a primary objective of generating income and capital appreciation. While some believe this type of investment does not have a place in a traditional growth-oriented equity portfolio, there is an investment case for such strategies. In fact, this segment of the market can provide great value to the patient equity investor at the right times. The Allianz NFJ Dividend Interest & Premium Strategy Fund (NFJ) is such a fund that currently trades a 12% discount to its net asset value (NAV) and offers an attractive opportunity for investors. Its current discount to NAV is significantly lower than its average discount of 7% over the last five years, and for several months in 2014, NFJ traded at NAV. NFJ pays a quarterly dividend and currently yields 9.3%. The market capitalization is slightly over $1.2 billion.
NFJ invests about 75% of the fund in common stocks. Typical holdings include large-cap dividend-payers like JP Morgan, Travelers Insurance and Citigroup, among the larger names. Based on the dividend focus, the fund has a value tilt which had been out of favor until last year. The fund also writes index-based covered calls on about 50% of the equity holdings. This provides an additional earnings stream and helps dampen the overall volatility of the fund. The remaining 25% of the fund is invested in convertible bond and preferred stocks. The convertibles also provide income and upside if their underlying common stock performs well. All of this leads to a fund that likely has less downside than the overall equity market and an attractive income stream. It likely will not keep up in a bull market but should outperform in a flat or down market.
Investors are often hesitant to buy a fund that may underperform in a strong equity market, but there remains a strong case for funds like NFJ. The added return resides in the ‘reversion to the mean.’ If NFJ could just get back to its 5-year average discount of 7%, that would add close to 6% to our return. At NAV, the holder would have realized an added almost 14% if purchased today at a 12% discount. This, of course, is in addition to or subtraction of the actual performance of the underlying holdings. My firm originally bought NFJ at a 17% discount in the wake of the global financial crisis in 2009 and exited the fund at a 3% to 5% discount in 2011.
So how did NFJ end up at a double-digit discount after trading at NAV less than three years ago? As mentioned above, NFJ has a value tilt. Value was out of favor in 2015 when the discount expanded. Value stocks did poorly compared to the overall market, and NFJ was no exception as its NAV dropped 9.2% while the S&P 500 was up 1.4%. Investors left the fund and new investors could only be enticed by a deep discount, and ultimately the turn in NFJ’s performance last year. NFJ’s NAV was up 11% vs. 12% for the S&P 500. This can be considered a very strong return when accounting for the convertibles and call writing in the portfolio.
I do believe that history can repeat itself, and NFJ will see brighter days as investors seek yield and value within equity closed-end funds.Read more posts from Maury on Forbes.com