This article will look at the Guggenheim Strategic Opportunities Fund (NYSE: GOF). I last watched GOF in March 2021. While the yield was attractive, I was concerned about the sustainability of distribution and erosion of net asset value. While the yield is even better now, the net asset value continues to erode and I’m still very concerned about the sustainability of the distribution. Let’s see why, despite a long history of declining NAV but not reducing the payout, I’m still worried about the payout.
What I look for in a closed-end (“CEF”) fund is a predictable income stream. To find such funds, I developed a method to determine if a specific CEF provided such an income stream. I developed my method starting with the process described in this article. I think rather than stock price or even net asset value, how the fund’s portfolio generates income from its assets and whether or not it builds or erodes its asset base are the determining factors distribution reliability.
I believe that the net asset value of the fund is the muscle it uses to generate cash. So while it may be bad if the fund erodes the net asset value (think muscle wasting), it is the fund’s ability to generate cash that is the true value.
Based on this perspective and my method of analysis, I determine whether the fund supported the distribution. Then, based on current holdings and past performance, I try to determine whether or not the fund will be able to support distribution in the future. You can read a full explanation of my method and get links to the other articles in the series (published before March 27, 2022) here.
Guggenheim Strategic Opportunities Fund
The first step in my evaluation process is to determine how a fund’s portfolio has performed over the past year. To do this, I look at the total return of the net asset value of the fund. This metric is important because portfolio returns cap what the fund can afford to pay its shareholders.
So how has GOF’s portfolio performed over the past 12 months?
It seems that the portfolio held by GOF has not performed so well over the past 12 months. While it may not be so bad that the portfolio, including dividends paid to fund shareholders, declined in value, it is certainly worse than if it had recorded gains. And a portfolio return that exceeds a 10% loss in just one year is a bad sign. So, while we don’t have to do the math to determine if the total return on the NAV exceeded the total return on the NAV (since the return was negative, it exceeds the positive return), let’s review the rest of the metrics and analysis just to see where the fund is.
How has the NAV performed (don’t expect a surprise increase here)?
And as expected, we see that the NAV (the market value per share of the GOF portfolio) has also fallen, by almost 22%. I don’t mean it’s automatically bad for the fund and its shareholders. Because falling NAV potentially presents opportunities that might not exist had NAV increased. But I think we can all agree that a drop here is worse than an increase. And while a decline in net asset value increases the chances that the fund will overpay its distribution, it’s not conclusive evidence that it is doing so.
So, in our quest to determine if the fund is covering its distribution, let’s look at the last 12 months of distributions and the sources from which they come.
I get a lot of CEF performance data from CEFData. Let’s look at the distributions.
The good news is that the distributions have not been reduced. However, we see that the source of part of the cast was the ROC. This means that the distribution exceeded the taxable income. If the NAV increased, that wouldn’t be a problem, but with the NAV falling, there is a potential problem here. Let’s take a look and see how the different benchmarks are doing. This will allow us to see if the drop in the GOF portfolio could be due to a general decline in asset prices.
Guggenheim does not provide a benchmark for GOF, but about a third of its portfolio is invested in high-yield bonds and another third is invested in senior loans. SPDR Bloomberg High Yield ETF (JNK) is a good benchmark for high yield bonds. Invesco Senior Loan ETF (BKLN) is a good benchmark for senior loans.
How has GOF’s portfolio fared so far this year against these benchmarks?
GOF performed significantly worse than BKLN and was comparable to JNK. This tells me that, at best, GOF is struggling to cover its distribution.
Luck and timing can always impact performance. But it’s not a good idea to rely on luck for you when projecting future performance. Over a single year, luck and timing can make a big difference, but over longer periods of time their impact diminishes. I like to look at 3 years, as I consider it strikes a good balance between being long enough to reduce the impact of atypical events and recent enough to reflect current management and conditions.
So how has GOF and its portfolio fared over the past 3 years?
Okay, GOF has done a lot better over the past 3 years than they did last year. Having a positive total NAV return means that we will have to do some calculations to determine the distribution coverage.
So how has NAV held up over the past 3 years?
Not so good. It has fallen by an average of 8.97% per year. This could mean that GOF was not covering its distribution. We’ll have to dig a little deeper into the data to figure that out.
Although the result is obvious, let’s do the math, so we can see how much of the distribution is out of line. Over the past 3 years, GOF has paid out $6.5556 in distributions. Based on the average net asset value over this period of $16.43, this represents a total return on net asset value (not an annualized number) of 39.90% or 13.30% on average per year. This exceeds the total return on NAV by 12.48% (for the entire 3 year period) or only 3.99% CAGR. The distribution has obviously not been covered for 3 years.
And as we can see, looking at the last 10 years of NAV history, a declining NAV is not new for GOF. The downward trend in net asset value started in 2015. The average annual decline was just over 3.5%.
Next, let’s see how distributions have changed over the years.
The only apparent drop in distributions (as of December 2010) was actually a special distribution. Looking at the distribution trend, I see evidence that in the past, GOF has been able to sustain and even increase its distribution anyway. It’s a good sign that even if he doesn’t cover it now, he might start doing it again.
However, the fund has not increased its distribution for some time. The last increase took place before the net asset value began to decline in 2014. So, looking ahead, we will be looking for signs that this trend has reversed.
Future Distribution Coverage
In recent years, GOF has not fully covered its distribution. But so far, this hasn’t resulted in a reduction in distribution. The question for income investors is is it able to maintain its distribution or will the erosion of its net asset value force a reduction in the distribution? So let’s take a look at the portfolio and see if we can identify a way to turn things around. I will pull data from the fund’s website.
Bank loans and high-yield bonds were both down about 600 basis points from a year ago. Leverage is also down and cash is up significantly. It looks like the fund has positioned itself for a down market and has cash (and leverage) to buy past the bottom. But just like last year, I don’t see anything that is a big change from the last 5 years. But that could change if they manage to catch the wave when the markets eventually turn around.
Currently, the NAV premium is well above its 10-year average of 8.9%.
There could be an argument that with a yield above 13% and no signs of a change in the distribution, this GOF could be a good buy. However, the distro is not fully supported and is therefore still at risk. And there is no certainty that we will receive advance warning of a distribution cut. So with the premium to NAV being more than twice the 10 year average, I just don’t see GOF being a good value here.