ADX - ADX: A Good Fund For Income Seeking Investors

2023-08-17 11:42:16 ET

Summary

• Adams Diversified Equity Fund aims to match or beat the performance of the S&P 500 index while delivering a dividend yield of 6-7% annually.
• The fund has a long history of paying dividends for 85 years straight and has seen strong results, especially since 2010.
• The fund often trades at a discount to its NAV, providing potential for slightly higher gains compared to the S&P 500 index under right conditions.

Adams Diversified Equity Fund ( ADX ) is an actively managed closed-end fund that aims to match or beat the performance of S&P 500 index while delivering a dividend yield around 7-8% annually. The fund has been around for decades and delivered some solid results but keep in mind that most of the fund's good results came after 2010. From the early 1990s all the way to 2009, the fund had hardly any positive returns, whereas it had very strong results since then, as you can see in the chart below.

As a matter of fact, the fund has been around in one shape or another since 1929, and it's been paying dividends for 85 years straight. When we look at the fund's holdings, we mostly see the usual suspects such as Apple ( AAPL ), Microsoft ( MSFT ), Nvidia ( NVDA ) and Amazon ( AMZN ) who are mostly responsible for pushing indices higher year after year even in years where the rest of the market might be lagging in performance. Since the fund's top holdings are very similar to top holdings of the S&P 500 index, the fund's long term performance will also be very close to the performance of the index.

There is one difference though. The fund often trades at a NAV discount of 12-15% which means when investors buy and hold this fund, they might beat the performance of S&P 500 slightly even if the fund itself barely matches the performance of the index. How? Let's say in a given year, S&P 500 index rose 10% and so did this fund's NAV. If you invested $1000 into the index in the beginning of the year, you've made $100 as a result of this climb. If you invested the same amount into ADX, you bought $1,150 worth of shares for the price of $1,000 since it trades at a discount, so your 10% gain will be actually $115 instead of the $100 you would have gotten from the index. There is a problem with this approach, though. If a fund is trading at a discount permanently, it's not really a discount because sooner or later the discount would have to disappear for investors to realize those extra gains. In the above example, your $1,000 grows into $115 only assuming that the fund will someday trade at a full value before you sell your shares and exit your position. If you sell while the discount is still there, the gain is only $100.

This fund has been trading at a discount for such a long time that we might as well say that the discount is now part of the price. One benefit of this type of discount to investors is dividends. If a fund trades at a 15% discount against its NAV, and it receives a dividend of 2% from its holdings, investors are actually receiving 2.3% from it because of the discount for as long as that discount stays in place. When we look at this fund's overall performance as compared to the S&P 500 index, we see that it's slightly underperforming in 1 and 3-year periods but slightly outperforming in 5 and 10-year periods in total annual returns, which includes reinvestment of dividends.

Since the overall market tends to rise at an average rate of 8-9% and this fund pays a dividend yield of 6-7%, the fund is able to reinvest some of its gains into its NAV and grow its dividend payments over time. As a matter of fact, this is what we've been seeing over the years. Here is an interesting fact: if you had bought $10k worth of ADX in 1990 and reinvested your dividends and held until today, your annual dividend income would be $15k per year, representing an annual dividend yield of 150% on your original investment.

Unlike many other CEFs, this fund doesn't utilize leverage. It collects dividends from its holdings and adds long-term capital gains to it on order to create a tax-advantaged dividend which will be taxed at the lowest possible rate because it counts as a qualified dividend. The fund has a goal of delivering at least 6% yield each year, and its actual yield ranged from 6.3% to 15.7% in the last decade. The fund pays quarterly dividends, but not all quarters pay equally. Typically, the last quarter contains the biggest dividend because the fund sells some positions at the end of each year to create a large bulk of these dividends.

One possible issue with this fund is that its overweight in big technology firms (so is the S&P 500 index). Currently, close to 30% of the fund's weight comes from companies like Apple, Microsoft and Nvidia. These companies already had very strong rallies this year, and they are already pretty much overextended and enjoying historically high valuations, with their P/Es ranging from 30 (Apple) to 150 (Nvidia). Being long in this fund exposes you to big tech, which is great when these stocks rally strongly, but also carry the risk when these stocks are already up so much. If you are a long term investor with decades long time horizon, this might not be a big deal though because valuations tend to iron themselves out over time.

The fund mostly relies on capital gains for its dividends, but that doesn't mean it will not be able to pay dividends if the market has a down year. The fund has been holding most of its positions for many years, and it likely bought most of its positions at much lower prices and sitting on unrealized gains. Even if the market were to drop -10% from here, the fund could liquidate some stocks it bought years ago at a pretty large capital gain and easily fund its dividends. For example, in 2018 when the overall stock market was down, ADX was able to pay a dividend yield of 12.9% as you can see in the table above.

Overall, this is a good fund that seems to match the performance of S&P 500 index over time and if investors are feeling bullish about stocks overall, they can invest into this fund. Alternatively, they can also invest in an index fund and liquidate about 6% of their position every year in order to create their own dividends. This way they won't have to pay the 0.59% fee this fund comes with. If investors don't feel comfortable with this approach, 0.59% isn't too high of a price to pay for an actively managed fund with a strong history of delivering good results over several decades.

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