A few months ago I covered Cornerstone Strategic Value Fund (NYSE:CLM) in an article titled CLM Only Works If It Can Maintain Its NAV Premium where I argued that the fund's advantage comes from its ability to maintain a high NAV premium because investors like the idea of being able to reinvest dividends at NAV which gave them immediate gains. Looks like the fund's NAV premium has been eroding since then with the stock dropping significantly lately. I maintain my position that this fund will only be good if it can maintain its NAV premium.
Here is how NAV premium works in this fund's favor if you are able to reinvest dividends at NAV. Let's say you have a fund that trades at a 20% premium to its NAV. The fund's NAV is $10 and its share price is $12. Let's say this fund is paying a dividend distribution of 20% which is $2.40 per share per year. When an investor receives a dividend of $2.40, this amount gets deducted from the fund's NAV because the fund has to reduce its assets or cash by that amount in order to pay the dividend. If the investor is simply collecting a dividend of $2.40 while his share price drops by the same amount, he didn't make any money in total returns. But what if he reinvested this dividend at NAV price which is $10 and immediately sold his newly acquired shares? Now he spent $2.40 to buy 0.24 shares of this fund and sold them immediately for $2.88 to book a quick profit of 48 cents per share (minus taxes). This is where this fund's advantage came from.
Historically, there had been periods where the fund traded at huge premiums, sometimes as large as 60%, which made it very profitable to reinvest distributions at NAV and immediately sell those newly acquired shares at full price and book the profit. Some investors also chose to keep reinvesting without booking any profits and growing their portfolio over time. When I first covered CLM a few months ago it had a rich NAV premium of 19% but now the premium has shrank to 10% in a matter of months, making it less desirable.
That's the irony with this fund. When it comes to most CEFs you want to buy them when they are trading at a deep discount so that you get more return for your original investment but CLM trades in such a way that you want to reinvest more when it is enjoying a higher premium. Buying it at a discount still has advantages as with every fund but the advantage of reinvesting is a lot bigger when the NAV premium is rich.
I have also heard some commentors saying that certain brokers aren't allowing reinvesting dividends at NAV anymore. You can find such discussion at the bottom of this article. I don't know if this is due to a technical issue or a policy change but this might have caused some investors to liquidate their positions which might have contributed to the shrinking NAV premium we've been seeing lately. If people aren't allowed to reinvest their dividends at NAV most of the fund's appeal would disappear and I wouldn't blame them for selling or moving their accounts to other brokers who might allow them to reinvest at NAV.
In the last 3 years, the fund's total return NAV is up 27% while its actual NAV is down -35%. This is because the fund has a distribution policy where it distributes a huge portion of its NAV (around 20%) to investors so its actual NAV will keep shrinking unless its stock holdings climb 20% or more in a year.
This is expected and by design for the most part and investors know that this fund's NAV will keep shrinking in the long run unless the stock market decides to climb 20% or more every year. The true value of the fund comes from reinvesting dividends. This is why investors who own this stock will want to be able to invest their dividends at NAV and they will prefer NAV premium to be as high as possible so that they can get more bang for their buck.
When we look at this fund's holdings, it's mostly holding the top 150 stocks in S&P 500 index (SPY) and these stocks account for the majority of the weight of the index so you can expect this fund's real performance to track the S&P 500's performance very closely in the absence of dividends or NAV premium. It would be basically like buying and holding S&P 500 and selling 20% of your portfolio holdings every year for income which would cause a significant amount of shrinkage in your portfolio over time unless the S&P 500 is rising 20% every year which is extremely unlikely. Historically the S&P 500 rises about 8% per year or close to 10% in the long run if you include dividends. Your portfolio might be sustainable if you sell about 4-6% of your holdings each year for income but anything passing 8% will be dangerous - let alone 20%.
Interestingly enough, this year has been one of those years where the S&P 500 actually rose by 20% YoY (from October 2022 to October 2023) but CLM's total return lagged behind as it's only up 10.5% including dividends. This is not because CLM's holdings performed badly but because its NAV premium shrank significantly. Earlier this summer the fund was outperforming significantly when its total return was up close to 30% but it's all gone now due to its NAV premium disappearing.
Investors should watch this fund's NAV premium closely and make sure that the fund's long term structure meets their long term goals. Investors should also check their brokerage accounts to make sure that their dividends are actually reinvesting at NAV value because we've heard of cases where this is not happening. You might need to call your brokerage to have them enable reinvestments at NAV if it's not already enabled in your account.
Also many investors may be better off in an index fund like SPY if they are not comfortable with this kind of fund structure.
Diesel
I own separate portfolios for separate goals. I have one portfolio where I have nothing but income plays, another portfolio where I have nothing but growth stocks. I also have another portfolio where I run my options plays. I try not to mix different portfolios because they all have different goals and purposes. Sometimes one of my portfolios outperform other times other do. I am a big believer of diversification of not only assets but also methods and investment philosophies. Diversification is not simply buying 20 different stocks, it is applying different methods to different goals that fit to serve an investor's short term and long term targets.I am a "long only" investor and stay away from shorting companies. I will also do a lot of delta-neutral options plays where I will try to benefit from a stock or funds lack of movement. Also a huge fan of options plays and strategies including but not limited to covered calls, iron condors, butterflies, calendar spreads, call-put spreads. I've probably tried every options play there is, sometimes with success, sometimes with failure.At Seeking Alpha, I mostly analyze and write about stocks and funds that I own or I plan on owning. I rarely ever write about a stock or fund I at least don't have intention of owning some day.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SPY, CLM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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