AOD - AOD: This Dividend Income Fund Is A Lot Better Than The Market Thinks

2023-10-03 14:32:28 ET

Summary

• The abrdn Total Dynamic Dividend Fund offers a high level of income with a current yield of 9.20%, surpassing major indices and fixed-income options.
• The fund's performance has been underwhelming compared to the S&P 500 Index, but its distribution payments improve its overall returns.
• The fund's strategy of investing in dividend-paying common stocks may not generate sufficient income, but its leverage ratio is low and it provides diversification with unique holdings.
• The fund comes surprisingly close to covering the distribution out of net investment income, and it does not rely on leverage to accomplish this task.
• The fund has an incredibly large discount on NAV right now, which could be due to the legacy of the previous fund manager.

The abrdn Total Dynamic Dividend Fund ( AOD ) has long been a very popular closed-end fund, or CEF, among investors that are seeking to earn a high level of income from their portfolios. Indeed, the fund's current 9.20% yield stands as a testament to its qualifications in this area. This is far better than any of the major indices, and it is even well above most fixed-income options. When we consider that this is an equity fund and so has greater upside potential than most fixed-income investments, we can certainly see the appeal of this fund to anyone who is seeking to earn a very high level of income.

It has certainly been quite a while since we last discussed this fund. My previous article on this fund was published in early June 2021, which was obviously a very different market environment than what we have today. The fund has certainly not been a good performer since that time, as its shares are down 26.18% compared to the S&P 500 Index ( SP500 ), which has been fairly flat:

However, as is usually the case with closed-end funds, this one delivers a significant portion of its overall investment return in the form of direct payments to the shareholders. These payments are obviously not captured by simply looking at the price performance of the fund. The inclusion of these distribution payments into the fund's returns certainly makes its performance look a lot better, but it still underperformed the index by a considerable margin:

Thus, it seems somewhat unlikely that everyone will be rushing out to buy this fund, despite the attraction of the yield. However, for a while now, high-yielding assets have been performing better than low-duration non-dividend-paying assets so perhaps that will help the fund. This is a characteristic of the current interest rate environment since it makes no real sense to hold anything with a yield under 5% when you could just hold a money market fund instead. Fortunately, this fund is well above that yield level, so it might still make sense to buy it. Let us investigate and see just how good the opportunity is here.

About The Fund

According to the fund's webpage , the abrdn Global Dynamic Dividend Fund seeks to provide its investors with a very high level of current income. As the name of the fund implies, it seeks to accomplish this by investing in dividend-paying stocks. This is, admittedly, a very strange objective for a fund whose portfolio consists entirely of common stocks:

The reason for this is that the dividend yield on common equities is incredibly low despite the high-interest rate environment. As of the time of writing, the S&P 500 Index ( SPY ) yields 1.52%. That is not really competitive with money markets, let alone anything in the fixed-income sector. This is why most income-focused funds invest in fixed-income securities. After all, the current yield of the ICE Exchange-Traded Preferred & Hybrid Securities Index ( PFF ) is 7.11%, which is still lower than this fund. However, it is a simple matter to apply a bit of leverage to a portfolio of preferred stock, junk bonds, or even investment-grade corporate bonds to achieve an effective portfolio yield of over 9%. It is very difficult to see how that can be accomplished by investing in common stocks though, considering that the amount of leverage needed to accomplish such a task is far too risky.

Unfortunately, the spartan webpage and the fund's fact sheet provide little insight into how exactly the fund seeks to accomplish its goals. Indeed, the only thing that the fund sheet states about its strategy is:

The Fund's primary investment objective is to seek high current dividend income. The Fund also focuses on long-term growth of capital as a secondary investment objective.

This is quite literally the only insight into the fund's strategy that we get from either the website or the fund's fact sheet, which are the two sources that investors typically rely on to obtain information about a closed-end fund. The only thing that this description implies is that the fund will invest in dividend-paying common stocks, which are unlikely to produce anywhere near a sufficient level of income to support its distribution.

This is confirmed by looking at the largest positions in the portfolio. Here they are:

We can see a bit more emphasis on achieving a high level of dividend income here than we see in most other closed-end funds that employ a dividend investing strategy. However, the yields on these stocks are still far too low to satisfy anyone seeking to earn a significant amount of income from a portfolio.

This is certainly not a bad portfolio for a dividend income fund. In fact, it is better than the portfolios of most funds that claim to use a dividend investing strategy. However, as I have pointed out numerous times in the past, it makes no real sense to include Apple, Microsoft, or especially Alphabet in any fund that seeks a high level of dividend income. This is because the yields of all three of these companies are basically nothing. The reason for their inclusion is probably because these three companies have accounted for a significant portion of the total return of the S&P 500 Index over the past decade, so any fund that excludes them will lag behind the index to an unacceptable degree. To its credit, at least the weightings for them are not especially high.

The one thing that we note here is that with the exception of the three mega-cap technology companies, the remainder of the fund's largest positions are companies that we do not typically see in a fund. In particular, I cannot remember the last time that I saw Engie or Glencore among the top positions in any multi-sector fund. This is nice because it helps to limit concentration risk across an investor's portfolio. I defined concentration risk in several previous articles:

Concentration risk with respect to mutual funds or similar funds refers to the tendency of fund managers to invest in similar assets. For example, the largest positions in multiple funds are likely to be similar. As a result of this, an investor who holds multiple funds might believe that they have a diversified portfolio. However, this is not actually the case because all of the funds are invested in the same stocks.

The mega-cap technology companies are common holdings in just about every multi-sector fund, including international funds. We see those here as well. However, we do not see other companies that are frequently found among a fund's largest positions such as JPMorgan Chase ( JPM ), UnitedHealth Group ( UNH ), Visa ( V ), or MasterCard ( MA ) in this fund's largest positions. Thus, including this fund in a portfolio of other funds could help to reduce your overall risk by increasing the diversification of your entire portfolio. In particular, we see some mining and energy stocks here that are not typically found in most multi-sector funds. This is a nice advantage that this fund offers over some of its peers.

One thing that some readers may note by looking at the largest positions in the fund is that the abrdn Global Dynamic Dividend Fund includes companies from all over the world. This is certainly the case, as the fund explicitly points out in its name, and which is a hallmark of abrdn funds in general. Abrdn itself is headquartered in Edinburgh, Scotland, United Kingdom but it has operations all over the world. Foreign asset managers in general tend to be more internationally-focused than American ones, which is one of the reasons why this company's funds have become popular among investors who are seeking international exposure. However, the abrdn Global Dynamic Dividend Fund currently has a considerable amount of exposure to the United States. As we can see here, 62.1% of the fund's assets are currently invested in North America:

While a North American allocation technically means the United States and Canada, it almost always means a United States investment. One reason for this is that the American market is far larger than the Canadian one and many of Canada's largest companies are dual-listed on both the Canadian exchanges and the New York Stock Exchange. The fact sheet does not actually specify what the allocation is to each country, but CEF Connect puts the Canadian weighting at only 1.26% of the fund's assets as of August 31, 2023. Thus, the fund clearly has an outsized weighting to the United States considering that the United States only accounts for a bit less than a quarter of total global economic output, but it does account for 42.5% of total global market capitalization. Thus, the fund appears to be overallocated to the United States right now even on a market capitalization-weighted basis.

As such, this fund might not help investors achieve as much global diversification as they would like. In numerous previous articles, I have pointed out that one of the biggest risks that American investors tend to have with their portfolio is an overallocation to the domestic markets, and it does not appear that this fund will help as much in the goal of achieving international diversification as we would like. It will certainly help more than a domestic fund, though.

Leverage

As we just saw, the stocks that comprise the fund's portfolio are not paying dividend yields anywhere near high enough to allow the fund to boast the 9.20% yield that it currently pays. As such, the fund must be using some method to boost the effective yield of its overall portfolio. This is the case, as the fund uses leverage to boost its overall yield just like many other closed-end funds. I explained how this works in various previous articles, such as this one :

In short, the fund is borrowing money and using that borrowed money to purchase dividend-paying common equities of various companies from around the world. As long as the purchased assets deliver a higher total return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, this will usually be the case. However, it is important to note that this strategy is not as effective today with interest rates at 6% as it was two years ago when rates were at 0%.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. Thus, we want to ensure that the fund is not using too much leverage since that would expose us to too much risk. I generally do not like to see a fund's leverage exceed a third as a percentage of assets for that reason.

As of the time of writing, the abrdn Global Dynamic Dividend Fund has levered assets comprising 4.74% of its portfolio. Thus, the fund easily satisfies our requirement of less than a third of its portfolio being leveraged. In fact, this one has one of the lowest leverage ratios of any closed-end fund that actually employs debt as a means of boosting its yield. That is probably a good thing in the current environment considering this fund's strategy.

This is due to the low yields possessed by common stock. It is highly unlikely that the fund can borrow for less than 6% in today's environment. This means that it would need to earn at least a 6% yield for its leverage to make any sense. As we saw earlier in this article, that is certainly not the average level that this fund is managing to achieve. In fact, only two of its ten largest holdings have sufficient yields for this strategy to work well. While it is true that the fund could make up for a low yield through stock appreciation and capital gains, even that is becoming very difficult to obtain right now. Thus, we want the fund to have a very low level of leverage. It appears to be satisfying this requirement at present so there is probably not too much that we really need to worry about here.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the abrdn Global Dynamic Dividend Fund is to provide its investors with a very high level of current income. In order to accomplish this objective, the fund invests in a portfolio of common stocks, most of which pay dividends. While some of these common stocks pay dividends, this strategy alone will not produce a very high yield in today's market environment. This is due to the incredibly low yields offered by most common stocks that trade in developed markets. However, as is the case with most closed-end funds, the abrdn Global Dynamic Dividend Fund will sometimes realize capital gains from the assets in its portfolio. This can significantly boost the fund's income since the S&P 500 Index appreciates by about 9% to 11% annually on average. The fund collects the money from these two sources of income and then pays it out to the shareholders, net of expenses. The basic goal is for the fund to pay out all of its investment profits while maintaining a relatively stable portfolio valuation.

This generally allows closed-end funds to pay out higher yields than anything else in the market, and this fund is no exception to that. The abrdn Global Dynamic Dividend Fund currently pays a monthly distribution of $0.0575 per share ($0.69 per share annually), which gives it a 9.20% yield at the current share price. This fund has been surprisingly consistent with respect to its distribution over the years, as it has been flat or increasing since 2013, although the fund's history prior to that date was not particularly impressive:

The fund's general history in recent years is likely to appeal to those investors who are seeking a safe and secure source of income to use to pay their bills or finance their lifestyles. However, the series of cuts prior to 2013 seems unlikely to impress anyone. With that said though, the fund was using a different strategy under a different management company prior to 2018. That means a lot here since the previous management under Alpine was trying to use a dividend capture strategy, which does not always work particularly well. The new management under abrdn has generally been doing much better and for the most part, we should think of this fund's history prior to 2018 as being a completely different fund. As its distribution has been stable over its entire history with the current fund manager, we can probably draw some confidence from that.

However, it is still important to investigate the fund's finances in order to ensure that it can actually sustain the current payout. This may be especially important right now, since the stock market has not been performing very well for the past two years, apart from the bear market bounce during the first half of this year. This poor performance has undoubtedly had an adverse impact on the fund's portfolio, and we want to know the extent of that since many other funds that use a similar strategy have already had to cut their distributions.

Fortunately, we have a fairly recent document that we can consult for the purpose of our analysis. As of the time of writing, the fund's most recent financial report corresponds to the six-month period that ended on April 30, 2023. This is obviously a much more recent report than the one that we had available to us the last time that we discussed this fund, and the time period works pretty well too since it should give us a good idea of how well this fund was able to take advantage of the market optimism that existed during the first six months of this year. It also will include information about the fund's performance during the much more challenging market that existed over the course of 2022, which is also obviously very important.

During the six-month period, the abrdn Global Dynamic Dividend Fund received $36,979,904 in dividends and $16,095 in interest from the assets in its portfolio. This gives the fund a total investment income of $36,995,999 during the period. It paid its expenses out of this amount, which left it with $30,930,305 available to shareholders. Unfortunately, this was not nearly enough to cover the $36,373,695 that the fund paid out to its investors in the form of distributions. I will admit though that this fund got a lot closer than I expected to fully cover its distribution out of net investment income. The fund was only about 15% short, which is much better than most common equity funds manage to achieve. With that said though, it still may be concerning that the fund did not manage to completely cover its payout.

However, there are other means through which the fund can obtain the money that it needs to cover the distribution. For example, the fund might be able to sell appreciated stocks and realize some capital gains that can then be paid out to the investors. The fund had mixed success at this during the most recent six-month period. The abrdn Global Dynamic Dividend Fund reported net realized losses of $10,026,132 during the period but this was more than offset by $113,822,057 net unrealized gains.

Overall, the fund's net assets increased by $98,352,535 over the six-month period after accounting for all inflows and outflows. The fund thus did manage to cover its distribution during the period, which was a nice change from the previous full-year period. During the full-year period that ended on October 31, 2022, the fund failed to fully cover its distribution and its net assets declined by $249,483,706 after accounting for all inflows and outflows. During that period, the fund also got pretty close to covering its distribution out of net investment income.

It is questionable how sustainable the distribution is at the current level. The fund comes pretty close to covering its distribution solely with net investment income on a consistent basis. Its total investment income is actually larger than the distribution. Thus, if the fund sponsor reimburses the fund's expenses or something like that, it will be fine. This happens occasionally with open-ended mutual funds, but I have never seen it done with a closed-end fund. The worst-case scenario here is that the fund cuts its distribution by 15% to 20% and pays it completely out of net investment income. It is probably unlikely that this will happen though unless we have a sustained bear market that drops the S&P 500 Index by a lot more than the 6% or so that we have seen over the past month. That is possible, but unlikely in the near term. Overall, the fund's distribution is probably reasonably safe right now.

Valuation

As of October 2, 2023 (the most recent date for which data is available as of the time of writing), the abrdn Global Dynamic Dividend Fund has a net asset value of $8.71 per share but the shares only trade for $7.40 each. This gives the shares a 15.04% discount on net asset value at the current price. This is an incredibly large discount that is actually quite a bit better than the 13.46% discount that the shares have averaged over the past month. Thus, the current price looks like a very good entry point today.

Conclusion

In conclusion, the abrdn Global Dynamic Dividend Fund is actually a pretty good dividend income fund that seems to still have some bad blood from the investment community due to its previous management. We can see this quite simply in the size of the fund's discount, which is generally an unheard-of discount apart from energy infrastructure funds.

This is one of the few common equity funds that comes very close to covering its distribution out of net investment income and considering the current yield of 9.20%, that is certainly a feat. The biggest threat to this fund right now is a sustained bear market that limits its ability to earn capital gains. The fund's dividend income is still high enough, though, that even that is not a real threat. Overall, this fund is a lot better than the market seems to think.

For further details see: