PAYX - BOE: A Solid Income Fund But Appears To Be Struggling To Sustain The Distribution

2023-07-04 10:19:02 ET

Summary

• Investors today are desperate for additional sources of income to maintain their lifestyles in the face of the rapidly rising cost of living.
• BOE invests in a portfolio of dividend-paying stocks issued by companies around the world and then writes options against them in order to generate a high level of income.
• The fund tends to outperform during bear markets and underperforms during bull markets. This is exactly what we would expect given its strategy.
• The fund's assets declined over the past two years, so it might be stretching to maintain its distribution.
• The fund is currently trading at a very attractive discount to net asset value.

There can be little doubt that one of the biggest problems affecting the average American household today is the rapidly rising cost of living. The fact that prices are rising is probably apparent to anyone that has been out shopping for groceries recently, and it is also evidenced by the consumer price index. This index claims to measure the cost of a basket of goods that is regularly purchased by the average consumer and as we can see here, it has increased by at least 4% year-over-year during each of the past twelve months:

As I mentioned in a previous article , the fact that inflation seems to be cooling down seems to be somewhat misleading because it is almost entirely caused by the fact that energy prices are lower than they were at this time last year. If we look at the core consumer price index, which excludes volatile food and energy prices, we can clearly see that inflation is not really getting any better:

As a result of this situation, real wage growth has been negative for 26 straight months. It should be pretty obvious how that would stress the budgets of the average American, especially since approximately 64% of the nation's citizens are living paycheck to paycheck . It would not be surprising if much of the strength that we have seen in recent employment numbers is caused by people taking on second jobs to obtain the extra money that they need to maintain their lifestyles. There have been some surveys that support this conclusion.

As investors, we are certainly not immune to this. After all, we need to eat and keep our homes at a comfortable temperature just like anyone else. However, we do have some additional options available to us to obtain this extra income besides taking on second jobs. After all, we have the ability to put our money to work for us in this capacity. One of the best ways to accomplish this is to purchase shares of a closed-end fund that specializes in the generation of income. Unfortunately, these funds are not often discussed in the investment media and most financial advisors are unfamiliar with them, so it can be difficult to obtain the information that we would really like to have to make an informed investment decision. This is a shame as these funds offer a number of advantages over exchange-traded or open-ended mutual funds. In particular, a closed-end fund is able to employ certain strategies that have the effect of boosting its effective yields well beyond that of any of the underlying assets or anything else in the market.

In this article, we will discuss the BlackRock Enhanced Global Dividend Trust ( BOE ), which is one fund that can be purchased by investors that are seeking a high level of income. As of the time of writing, the fund yields 7.51% so it is one of the few things that actually has a positive real yield in today's highly inflationary environment. I have discussed this fund on this site before, but several months have passed since that time so naturally a great many things have changed. This article will focus specifically on these changes as well as provide an updated analysis of the fund's finances. Therefore, let us investigate and see if this fund could be a good addition to your portfolio today.

About The Fund

According to the fund's webpage , the BlackRock Enhanced Global Dividend Trust has the objective of providing its investors with current income and current gains. This is not particularly surprising considering that this is a common equity fund. As we can see here, the fund's portfolio currently consists of 98.25% common equity with the remainder in cash:

The reason that the fund's focus on current income and current gains is not particularly surprising considering this is that these are the main goal of most investors in common equity. After all, anyone that purchases a common stock typically does it with the goal of receiving income from the dividends that the company pays out as well as benefiting from rising stock valuations as the company grows and prospers. The difference between this fund and most other stock funds is that this one is not particularly targeting long-term capital appreciation. In this case, the fund only has a secondary focus on the long-term performance of its portfolio. From the webpage:

BlackRock Enhanced Global Dividend Trust's primary investment objective is current income and current gains, with a secondary objective of long-term capital appreciation.

The reason why the long-term is only a secondary focus is because of the "enhanced" descriptor in the fund's name. Anytime we see this in a fund's name, it is a sure sign that the fund is going to be using some sort of options strategy to change the return profile of its portfolio. In this case, the fund is using a covered call writing strategy. The BlackRock Enhanced Global Dividend Trust purchases common stocks in a variety of companies and then writes call options against them. This provides the fund with an upfront payment from the option sale, which acts much like a synthetic dividend. This allows the fund to generate a higher level of income from its portfolio than it could simply by collecting dividends. However, the strategy also forces it to sacrifice some of the capital gains that it could earn. This is because the option forces the fund to sell the stock if the option buyer wishes to exercise the option, which will almost certainly be done if the market price goes above the strike price of the option. Thus, the fund sacrifices some of the upside potential of the stocks in its portfolio, which is almost certainly the reason why long-term capital appreciation is only a secondary objective.

The fact that this fund employs an options strategy might be concerning to some risk-averse investors. After all, we have all heard of how options can cause enormous losses fairly easily. However, that is not really true with the covered call strategy. This is because the fund already owns the stock that it would have to sell if the option is exercised against it. It will not have to go out and potentially pay any price to obtain the stock to sell, as it would if a naked option was exercised. Thus, the worst-case scenario here is that the fund might have to sell a stock for less than it could get by selling that same stock in the open market. It might still end up getting a capital gain on the stock though, depending on the price that it paid to get the stock in the first place. Thus, there is not much risk with the fund's strategy.

The fund's webpage claims that the BlackRock Enhanced Global Dividend Trust insists at least 80% of its assets into dividend-paying common stocks. This certainly appears to be the case, as we can see by looking at the largest positions in the portfolio:

Every one of these stocks pays a dividend to its shareholders, although both Microsoft ( MSFT ) and Apple ( AAPL ) have such low yields that their dividends are rather meaningless. This is certainly much better than some of Eaton Vance's enhanced dividend funds that are heavily weighted to non-dividend paying stocks like Amazon ( AMZN ) or Alphabet ( GOOG ) (GOOGL). The nice thing about the fact that this fund's portfolio consists mostly of dividend-paying stocks means that it does not need to depend as much on option sales to maintain a certain level of income. The stocks in the portfolio provide the fund with income that it is then able to increase with the options strategy.

There have been numerous changes to this fund's portfolio in the past eight months since we last discussed it. In particular, Intuit ( INTU ), UnitedHealth Group ( UNH ), Industria de Diseno Textil ( IDEXY ), M&T Bank ( MTB ), Telus ( TU ), and AbbVie ( ABBV ) have all been removed from the fund's largest positions. In their place are Taiwan Semiconductor ( TSM ), Accenture ( ACN ), Apple, Paychex ( PAYX ), Philip Morris International ( PM ), and Diageo ( DEO ). In addition to these changes, the weightings of the remaining companies have changed, but this could simply be a sign of one stock outperforming another in the market. As I mentioned in a recent blog post , all of the returns of the S&P 500 Index ( SPY ) this year have been caused by seven stocks including Microsoft and Apple, so this performance differential is a very real possibility for some of these stocks. With that said though, we still see that the fund appears to be consciously making changes on a regular basis, although it only has a 44.00% annual turnover. That is not a particularly high turnover for an equity closed-end fund.

The reason that this matters is that it costs money to trade stocks or other assets, which is billed directly to the fund's shareholders. This creates a drag on the fund's performance and makes management's job more difficult. After all, the fund's managers need to generate sufficient returns to cover the added expenses and have enough left over to appropriately reward the shareholders. This is a task that few management teams are able to accomplish on a regular basis, which is one reason that actively managed funds often fail to outperform their benchmark indices. With that said, this one does not do too badly. We can see that here:

Here are the comparable returns for the iShares Core S&P 500 ETF ( IVV ):

The biggest thing that we see here is that the fund generally underperformed the index in 2019, 2020, and 2021 but substantially outperformed in 2022. This will normally be the case, as the options strategy limits the fund's upside during strong bull markets. However, the same strategy will prevent the fund from declining as much during bear markets because the premium income from the options strategy offsets some of the losses from the stock portfolio. Thus, this fund is overall less volatile than the broader market but still provides some upside exposure along with a considerably higher yield. That will probably appeal to a certain type of investor.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the BlackRock Enhanced Global Dividend Trust is to provide its investors with current income and current gains. In order to achieve this objective, the fund purchases shares of dividend-paying stocks and then writes call options against them to synthetically boost their dividend yields. As call premiums can be fairly high, this works quite well to convert the stocks into high-yielding assets. The fund then pays out its investment profits to the shareholders. As such, we can assume that the fund itself will boast a very high dividend yield. This is certainly the case as it currently pays out a monthly distribution of $0.0630 per share ($0.756 per share annually), which gives it a 7.51% yield at the current price. Unfortunately, the fund has not been entirely reliable with its distribution, as it has steadily declined over the years even when we account for the fund converting from a quarterly to a monthly distribution:

The fund has been very reliable with its distribution since 2018 though, which is a good track record compared to many other funds. Overall, this fund certainly could appeal to an investor that is looking for a safe and secure source of income to use to pay their bills and finance their lifestyles. However, we still want to make sure that the fund can actually afford the distributions that it pays out. After all, we do not want to be the victims of a distribution cut since that would reduce our incomes and almost certainly cause the fund's share price to decline.

Unfortunately, we do not have an especially recent document that we can consult for that purpose. The fund's most recent financial report corresponds to the full-year period that ended on December 31, 2022. As such, it will not include any information about the fund's performance during the first half of this year. However, it is still a more recent document than we had available the last time that we discussed this fund so it still should work to provide a good update of the fund's financial condition. During the full-year period, the BlackRock Enhanced Global Dividend Trust received $20,255,105 in dividends along with $5,863 in income from other sources. Once we net out the withholding taxes that the fund had to pay, it had a total investment income of $19,327,299 during the period. The fund paid its expenses out of this amount, which left it with $12,760,469 available for the shareholders. As might be expected, this was nowhere close to enough to cover the $48,104,066 that the fund actually paid out in distributions. At first glance, this could be concerning as the fund's net investment income was nowhere close to enough to cover the amount that it paid out.

However, the fund does have other methods to obtain money that is not included in net investment income but can still be paid out to the shareholders. For example, the income that the fund generates from its options strategy might be considered either capital gains or return of capital depending on the situation. The fund might also have capital gains from simple stock trading activity. During the full-year period, it had net realized gains of $15,653,551 but this was offset by net unrealized losses of $137,096,032. Overall, the fund's total assets declined by $169,256,726 after accounting for all inflows and outflows during the period, so clearly the fund failed to cover its distributions during the period. Unfortunately, it failed to cover them over the trailing two-year period too. The fund had total assets of $786,230,002 at the start of 2021 but this was down to $688,463,885 at the start of 2023. This is concerning and could indicate that the fund will have to cut its distribution if it does not manage to correct this problem in the near future. We will want to keep a close eye on its next financial report, which will probably be released sometime in August.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the BlackRock Enhanced Global Dividend Trust, the usual way to value it is by looking at the net asset value. The net asset value is the total current market value of all the fund's assets minus any outstanding debt. This amount is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to purchase shares of a fund when we can acquire them at a price that is less than the net asset value. This is because such a scenario implies that we are purchasing the fund's assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of June 30, 2023 (the most recent date for which data is currently available), the BlackRock Enhanced Global Dividend Trust had a net asset value of $11.59 per share but its shares currently trade for $10.09 each. This gives the fund's shares a discount of 12.94% per share. This is a very large discount, although it is not as good as the 13.65% discount that the shares have had on average over the past month. Overall, the price looks acceptable here as a double-digit discount is generally a reasonable price to pay for a fund. The big question is how much the shares will decline if the fund is forced to cut the distribution, so it might be worth waiting to see if it holds it steady.

Conclusion

In conclusion, the BlackRock Enhanced Global Dividend Trust appears to be a reasonable way to earn a high level of income and still have some upside exposure to the stock market, albeit not as much as would be present in the absence of the options strategy. The fund's strategy does reduce volatility though, which can be nice. The big problem here is that the fund appears to be struggling to sustain its distribution and may have to cut it in the near future. The price is quite acceptable though, so it might be worth considering for your portfolio.

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