FGB - AOD: Moving To Hold Watch Out For The Merger (Rating Upgrade)

2023-11-01 22:35:28 ET

Summary

• abrdn Total Dynamic Dividend Fund is set to benefit from a potential year-end rally in equities, after being down more than -13% since our Sell rating.
• AOD is moving from a Sell to Hold rating due to its potential for positive momentum and attractive seasonality factors, with the original factors driving the Sell rating now dissipated.
• AOD is set to merge with First Trust Special Finance and Financial Opportunities Fund, creating a larger fund with increased assets under management.
• The usual merger arbitrage rules do not apply in this case, given the potential for a move wider in the FGB discount.

Thesis

abrdn Total Dynamic Dividend Fund ( AOD ) is an equities closed-end fund. We covered this name before here when we were of the opinion it was time to Sell the name on the back of market euphoria and fund composition. Our call was timely and robust:

The CEF lost almost 2x the value of the S&P 500 on a price basis since our rating. Today's markets are not easy, and are more favorable to active investors rather than regular buy-and-hold folks. While many people do not actively adjust their portfolios, they should be more proactive during this cycle since they can significantly boost their return profile, or conversely as in AOD's case, avoid significant drawdowns.

AOD is now back trading at the bottom of its price range on a 5-year lookback and is set to benefit from a potential year-end rally in risk. From a seasonality and statistics perspective, risk factors are looking attractive for equities heading into the year-end:

Looking back historically for periods of time when the market experienced three consecutive negative months in August, September, and October we get an overwhelmingly positive net total return for the remaining months in the year. We can see the average return for the final two months of the year comes out to 4.5% historically, while the median return comes out to 5.3%.

A Sell rating should be interpreted as reducing exposure or eliminating it outright. At this juncture, we are comfortable with AOD at the current price point and feel the CEF is set to benefit from a rally in risk into year-end, thus creating a positive momentum. We are therefore moving from Sell to Hold (Neutral).

Merger on the way

Please note that as part of a larger merger, AOD is set to incorporate the First Trust Special Finance and Financial Opportunities Fund ( FGB ):

PHILADELPHIA, PA / ACCESSWIRE / October 23, 2023 / The Board of Trustees of each of the Acquiring Funds, listed below, announces the proposed reorganization of several closed-end investment companies advised by First Trust Advisors, L.P. into the respective Acquiring Funds ("Reorganizations"). The proposed Reorganizations are subject to the receipt of necessary shareholder approvals:

The combination of the merging funds will help ensure the viability of certain Funds, increasing scale, liquidity and marketability changes that may lead to a tighter discount or a premium to NAV over time. Following the Reorganizations, shareholders of each Acquiring Fund will experience an increase in the assets under management. There are no proposed changes to the current objectives or policies of the Acquiring Funds as a result of these Reorganizations. Shareholders of ASGI and AOD are not required to vote on the issuance of shares in connection with the respective Reorganizations.

What is fairly unusual regarding this merger is the fairly different collateral pools for the two funds. While AOD contains international large capitalization equities, FGB is a BDC CEF:

We are not quite sure how the new entity will deal with the BDC equity, because BDCs run significant credit risk as compared to the names in the AOD fund. However, FGB is very small with only $53 million in assets:

While some of the equities in FGB will fit within the AOD mandate, we feel a number of them will not. We surmise the new entity will retain just a small slice of BDC exposure, generally the largest names.

FGB is also currently trading at a much larger discount to NAV when compared to AOD:

Technically there is the potential for a merger arbitrage opportunity here via the difference in discounts, but since the exposures are a bit different, we are hard-pressed to see BDC investors jump on the FGB wagon to buy into a fund for large capitalization international equities. In fact, we would expect FGB to move to even a higher discount to NAV since many investors might be tempted to jump into true BDC alternatives. The discounts for the two names are to be watched closely since there might be an extremely attractive opportunity down the line, where we could see a 10-point divergence here.

FGB shareholders will have to approve the merger, and following the reorganization, they will receive shares in AOD with an aggregate net asset value equal to the NAV held currently. This is the standard for CEF mergers.

As in the past, expect a roughly six-month period until all the approvals are obtained and the merger is consummated.

Analytics

• AUM: $0.76 billion.
• Sharpe Ratio: 0.31 (3Y).
• Std. Deviation: 17 (3Y).
• Yield: 9.5%.
• Premium/Discount to NAV: -15%.
• Z-Stat: -1.55.
• Leverage Ratio: 4%.
• Effective Duration: n/a
• Composition: International Large Cap Equities

Holdings

The CEF contains a portfolio of large-cap equities, with a concentration on North American names:

North America and Europe represent the largest geographic concentrations, followed by Asia Pacific. To note the CEF is holding many of the well-known tech mega-caps which compose the top ten holdings in the fund:

Apple ( AAPL ), Microsoft ( MSFT ), and Alphabet ( GOOG ) make up roughly 9% of the CEF, with the percent of the portfolio in the top ten names coming out to 20%.

Conclusion

AOD is an equities closed-end fund. The vehicle focuses on multinational names and has a close correlation to the wider equity risk appetite. We covered this name in July when we put a Sell rating on the CEF, warning investors regarding the exuberance prevalent in the large capitalization stocks making up the collateral tape here. The fund is down 2x the S&P 500 performance since, with a significant adjustment of roughly -13%. Going into year-end seasonality factors will help AOD, with the last two months of the year statistically set for average period returns of 4.5%. We are therefore upgrading the AOD rating to Hold.

To note that AOD is also part of the latest abrdn merger announcement, with the CEF set to absorb FGB. This merger is still subject to approvals, but it is a bit of an odd one since FGB contains BDC equity mostly. The usual merger arbitrage opportunities do not apply in this case in our humble opinion because a different dynamic might take place in the interim where the FGB discount to NAV might widen out even more.

For further details see: