This research report was jointly produced with High Dividend Opportunities co-author Philip Mause.
Liberty All-Star Equity Fund (USA) is an equity closed-end fund which traded recently at $5.86. The CEF’s investment strategy is rather unusual; This is a multi-managed CEF which allocates its portfolio assets among several independent investment management organizations that follow different investment styles. How is this done? USA has a board of trustees and is managed by Alps Advisors. The manager, in turn, allocates its funds in 5 equal shares to 5 separate fund managers – these are:
- Macquarie Investment Management (value oriented).
- Pzena Investment Management (value oriented).
- Sustainable Growth Advisors (predictable growth orientation).
- TCW Investment Management (sales growth oriented).
- Aristotle Capital Management (value with catalysts).
As we can note from the above, USA’s portfolio of 5 equal shares have 3 of them following a “value-style” investment strategy, and 2 following a “growth-style” investment strategy.
The fund managers selected to demonstrate a consistent investment philosophy, decision-making process, continuity of key people and above-average long-term results compared to managers with similar styles.
When the investment manager combines the variety of styles, there is a tendency for the overall return on the melded portfolio to closely mimic overall index fund returns.
There are several advantages in investing into USA rather than index funds:
- USA trades at a deep discount to NAV whereas index funds usually trade right at their “Net Asset Value”.
- USA pays lofty quarterly distributions to investors who are looking for income. Note, however, that the quarterly income could change -increase or decrease – in the future should market conditions change.
- USA has catalysts that could result in investors achieving capital gains as we will discuss in later in this report.
The dividends of USA were just hiked by 25%! – After the market closed last week on Monday, September 18, 2017, USA announced that it would increase its dividend by 25%. The dividend was hiked to 10% of net asset value (or “NAV”) from 8% of NAV so that the new dividend will be 2.5% of Net Asset Value (or “NAV”) per quarter. USA trades at a 11% discount to NAV (currently, $6.52). As a result, the new dividend will be 11.1% of current market price.
Possible Catalyst – There are two catalysts that can result in a higher price for the CEF:
- First, the recent dividend hike is likely to attract investors’ attention.
- Before this years shareholders’ meeting on August 24, there was a shareholder proposal in the proxy statement calling for USA to tender to shareholders for their shares. If investors decide to tender over 50% of the shares, USA would be required to convert to an ETF or an open-end fund or to liquidate its assets and distribute the proceeds. All of this is aimed at capturing the 11% discount to NAV. The company has not yet announced the results of the shareholder vote at the meeting. Even if the proposal was not adopted, it is likely that there will be recurring efforts to achieve this result and that management may begin to take actions (such as share repurchases) to close the gap between the price and the NAV in order to reduce activist pressure in this regard. USA has not always traded at a big discount to NAV. In the years 1992-1994 and in 2001-2005 time period, USA actually traded at a premium to NAV. However, since the Panic of 2008-09, USA has traded at a double-digit discount to NAV. It is not an unreasonable expectation that, regardless of the results of the vote on the shareholder proposal, there will be efforts to reduce the discount due to shareholder pressure.
Dividend Policy – Investors should be aware of USA’s distribution/dividend policy. USA is not restricted to dividends received and capital gains realized as sources of its dividends to investors. Instead, USA’s policy is to pay a dividend to investors which is consistent with long-term historical market returns. With the current market in a strong bull mode, it is not surprising that USA has hiked its dividen- by 25%. However, investors should note that it is possible that at some times the payment of dividends could eat into NAV in case USA does not generate its target of 10% returns per year.
Long-Term Perspective – USA is an old “Closed-End Fund” with a long history. USA got started in the late 1980’s and has been through a couple of market cycles. It paid dividends of over a dollar in the 90’s peaking out at $1.42 in 2000 with its stock trading in double digits. Its stock price has never recovered to those levels.
Since inception, USA has paid out $24.58 a share in dividends. Its annual report indicates that an investor who invested $10,000 in 1987 and reinvested dividends and took advantage of rights offerings would have $220,765 by the end of 2016. Without rights offerings, that number would be $151,839 and without dividend reinvestment, it would be $50,500. Therefore, the fact that the dividend policy tends to limit NAV appreciation does not necessarily mean that investing in USA will not pay off in the long run.
Funds Holdings and Other Information – The overall expense ratio is 1.07% for the year ending 12/31/16 which is reasonable. The turnover rate was 46% for a total of 151 separate holdings. Unfortunately, the USA leadership does not have a great deal of “skin in the game.” Officers and directors, in aggregate, own some 119 thousand shares which are roughly $600 thousand or less than one-tenth of 1% of market cap. We would have liked to see more insider ownership into USA. However, institutional investors’ ownership is more important, with 133 institutions owning 32% of total outstanding shares. Among institutional investors, shareholder activist RiverNorth owns roughly 2.7% of shares outstanding.
USA does not use a “covered call” strategy. Not using a covered call strategy can help maximize the returns of the fund during periods of a strong bull market such as the one we are currently seeing.
Portfolio – USA has assets of $1.1 billion and uses no leverage. The fund is more than 99% invested. Despite the fact that 3 out of the 5 managers are “value” oriented, it has what would appear to be a growth-oriented portfolio. Its largest 5 holdings are Alphabet Class C (2.2%). Facebook (2.2%), Visa (2.0%), Salesforce (2.0%) and Adobe (1.8%). Below is a list of its top 20 holdings as for August 31, 2017:
Its sector allocation includes largest five sectors of:
Only 17% of the overall portfolio is concentrated in the top ten holdings. USA does not disclose which investment advisor selected which stock in which percentage but it is interesting that the overall portfolio is not tremendously dissimilar in make up to an index portfolio. USA definitely does have a smaller percentage of Apple (AAPL) that would be reflected in an index fund. USA does indicate portfolio averages and its portfolio has an average dividend yield of 1.8% (somewhat lower than the S&P 500). It also has an average market cap of $95 billion, which is quite a bit lower than the S&P 500 average market cap of $148 billion. Recent performance has been slightly below index levels which is not unusual in a world in which virtually all financial advisors have struggled mightily to match index results; The total returns with reinvested dividends as compared to the S&P 500 index were as follows:
|Period||USA Returns||S&P 500 Index returns|
|Past 12 months||27.1%||19.4%|
|Past 3 Years||28.5%||32.3%|
|Past 5 Years||77.7%||89.6%|
However recent history is not an indication of future results; We believe that interest in value stocks (or stocks with lower valuations) are starting to attract investor interest which could help USA achieve better results than the broad indexes going forward.
Risks – USA usually trades in line with the general equities. Should we see a significant market pullback, USA’s price is likely to decline. Furthermore, investors should be aware of the dividend policy; Should the equity markets underperform their historic averages, and investors do not reinvest dividends, the shares of USA could see a long-term decline in market value. Furthermore, if markets underperform, the high dividends could result in “Return of Capital” and declines in the fund’s “Net Asset Value”.
Conclusion – We remain bullish on equities, and we believe that USA is well positioned to deliver solid returns over the next 2 years at least. When baking in the discount to NAV and the expense ratio with a melded strategy, USA will probably perform in a reasonable relationship with major indices. In addition, USA has the potential for a catalyst in the form of shareholder action leading to a closing of the price/NAV gap and an immediate double*digit gain; Investors should not count on this but there is some likelihood that management may take actions to reduce the gap and thereby reduce shareholder pressure. The recent dividend hike could also help increase the price of USA and reduce the discount to NAV. We believe that USA can be a good addition to a diversified high-yield portfolio aimed at achieving or slightly exceeding overall market performance.
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Disclosure: I am/we are long USA.
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.