AOD - AOD: Time To Take Some Profits On This CEF

2023-07-20 02:31:44 ET

Summary

• abrdn Total Dynamic Dividend Fund is an equities closed-end fund that aims to convert global equities returns into monthly dividends.
• Despite being up 12% this year, the fund has lagged behind its ETF counterpart, the Vanguard Total World Stock ETF, by roughly 476 basis points.
• The fund has a -13% discount to NAV, but the discount has a low beta to overall market moves, translating into a return profile mostly driven by equity market vectors.

Thesis

abrdn Total Dynamic Dividend Fund ( AOD ) is an equities closed-end fund. The vehicle aims to transform global equities returns into monthly dividends. The fund falls in the Large Cap - Blended Morningstar box and has a portfolio with a global build. We last covered this CEF in February. It is up 12% this year:

During any 'regular' year 12% would have been an extremely attractive return already, however the fund has lagged its plain vanilla ETF counterpart the Vanguard Total World Stock ETF by roughly 476 bps. Please note the above figures are 'Total Return' levels, meaning that the AOD dividends have been incorporated into the calculations. That is the appropriate metric to use for CEFs since they aim to disburse equity gains via the dividend structural feature.

The CEF has a low beta on its discount when correlated to risk-on / risk-off markets, hence most of its total returns will come from the equity sleeve returns. We have had an enormous run-up this year that nobody expected, driven mostly so far by tech mega-caps. The rally is however showing signs of extending into other corners of the market, questioning the bear market rally thesis.

State of the global equities markets

This year has seen a massive rally in U.S. and European equities (the largest exposures in this fund):

The move is even more surprising given the history of interest rate increases this year. We have seen 'peak inflation' in many jurisdictions, and many market participants are now pricing in a soft landing, hence the buoyancy in equities.

In the U.S., the S&P 500 has now surpassed its level from when the Fed started raising rates. Mind you, we have gone up by 500 bps in cost of capital yet nobody seems to think it will have an impact on earnings or profitability. We are of the opinion it takes time for the monetary policy to really sink in, and eventually later this year we will get another correction.

Let us go through a simple example on how the percolating impact works. Let us say company A, an investment grade corporation, had placed bonds that are maturing in August 2023. When the company issued the bonds, rates were low, with three year treasuries trading at 2%. The company had placed its debt at 100 bps over Treasuries, thus recording an all in cost of capital of 3%. With the debt now due, the company wants to re-finance. Currently 3-year treasuries are at 4.4%, and when you add 100 bps you get 5.4% as an all-in cost of capital. That difference of (5.4% - 3%) = 2.4% will come directly from the company's profitability, with interest expense now higher. Did the company suffer immediately when the Fed raised rates? No. Will higher rates eventually impact the company? You bet.

Some market participants see a new structural bull market, despite the fact that the equity rally this year has been fueled by higher P/E ratios rather than EPS. You need solid, expanding fundamentals to call a new structural bull in our opinion. Expanding P/E ratios has more to do with perception and allocation rather than improving profitability. The jury is still out on this topic, but we will find out by the end of the year what the correct answer is.

Holdings

The fund has the U.S. as the highest weighted jurisdiction:

The top names in the portfolio are well recognized global multi-nationals:

This fund is a predominantly large-cap fund, with most of the name falling in the 'Blended' category.

Premium / Discount to NAV

The fund has a very low beta to risk-on / risk-off moves:

We can see the CEF's discount to NAV navigating a very narrow range of -12% to -14% in the past year. This is unusual when compared to other equity CEFs, signaling the market is fairly comfortable with what the fund is trying to achieve long term. A low beta for the discount translates into lower long term volatility, but also into lower total returns when buying at the bottom.

Conclusion

AOD is a global equities CEF. The fund has a robust historic performance that does reflects what it is structured to do - convert global equities returns into monthly dividends. The fund has a -13% discount to NAV, but the discount has a low beta to overall market moves. This translates into a return profile that is mostly driven by equity market vectors. The CEF has had a very nice 12% total return this year on the back of the global equities buoyancy.

An investor needs to see AOD in the context of global equities. We feel the market moves this year are now overstretched, with higher rates across the jurisdictions. Irrespective of a bear market rally or a new bull, we are overdue for a healthy pull-back here. AOD will follow that market move. We are not saying an investor should short this name, but we are of the opinion that 12% is a nice return to have for the year here, and crystalizing some of the gains is a prudent move. A Sell therefore for AOD at these levels, with a targeted re-entry -7% lower.

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