CHW - CHW: This 10.27%-Yielding CEF Provides Much Needed Foreign Exposure

2023-08-22 10:15:13 ET

Summary

• The rapidly rising cost of living is a major problem for the average American, with prices increasing dramatically.
• The Calamos Global Dynamic Income Fund offers a 10.27% yield, providing a high level of income for investors.
• The fund's focus on both domestic and international assets helps diversify portfolios and reduce exposure to the United States.
• The distribution was cut late last year, but the fund has had some investment success since then and so should be able to sustain the payout for a while.
• The fund is currently trading at a reasonably attractive discount on net asset value. As such, the price looks right today.

As I have discussed in various previous articles, such as this one , there can be little doubt that one of the biggest problems facing the average American today is the rapidly rising cost of living. Over the past two or three years, it certainly seems that the cost of everything that we regularly purchase has increased fairly dramatically. This is certainly the case, which we can clearly see by looking at the consumer price index. The consumer price index claims to measure the price of a basket of goods that is regularly purchased by an average American household. It is certainly not perfect in this respect and has occasionally come under criticism about its underweighting of certain expensive items, such as healthcare costs, but it is still the definitive measurement used by economists. This chart shows the annual change of the consumer price index during every month over the past 25 years:

As is clearly visible, the consumer price index began to increase at a much more rapid rate than normal following the outbreak of the COVID-19 pandemic and the economic lockdowns that were imposed by most governments throughout the nation and internationally. The reason for this is that the United States Federal Government and the Federal Reserve increased the money supply by approximately 40% in order to finance all of the various stimulus and economic support programs that were created during that period. When the economy reopened, consumers began to spend the money that they saved up while stuck at home and all of this money drove up prices. After all, the productive capacity of the economy certainly did not increase by 40% due to these stimulus programs. That resulted in more units of currency, attempting to purchase every given unit of economic output, which is the very definition of inflation.

Unfortunately, for many people, wages did not increase nearly as much as prices have been. As of right now, median usual weekly real wages stand at $365 (measured in 1982-1984 constant dollars), which is lower than the $377 that they stood at right at the start of 2021:

As many Americans live paycheck-to-paycheck, this means that people are able to purchase less than they could only two short years ago. That has strained the budgets of many households, pushing many people to desperate measures such as dumpster diving, pawning possessions, or taking on second jobs. In short, people need additional sources of income in order to simply maintain their standard of living in the current environment.

As investors, we are certainly not immune to this. After all, we want and need to purchase various things too. Thus, we are looking for additional sources of income just like everyone else. There are various ways through which this can be accomplished, although one of the best is purchasing shares of a closed-end fund that specializes in the generation of income.

In this article, we will discuss the Calamos Global Dynamic Income Fund ( CHW ), which is one fund that investors can use to earn an income today. As of the time of writing, the fund boasts a 10.27% yield, which is certainly sufficient to appeal to anyone that is seeking a high level of income from their portfolios. The fund also has the advantage of helping American investors diversify their assets internationally, which is a big problem faced by many in the nation. Let us investigate and see if this fund could be a reasonable addition to your portfolio today.

About The Fund

According to the fund's webpage , the Calamos Global Dynamic Income Fund has the primary objective of providing its investors with a high level of current income. This makes a great deal of sense considering that the fund's name specifically mentions income. The portfolio is a bit strange for an income-focused fund, however, as it focuses mostly on common stock:

As I have pointed out numerous times in the past, common stock is generally a pretty poor vehicle for anyone seeking income. This is especially true today considering that money market funds are yielding around 5%. Unless an investor is purchasing the common equity of a midstream corporation, master limited partnership, a handful of telecommunications companies, or something similar, they will not receive a yield that is greater than a money market fund. Indeed, even utilities are not generally yielding 5%. As such, bonds are generally the primary investment for just about any fund that is seeking to generate a high level of income for its investors.

The fund's webpage states that at least 40% of its assets will be invested in foreign assets. This could improve the fund's income credentials since foreign stocks, in many cases, have higher dividend yields than domestic ones. This is partly due to the fact that most foreign markets have underperformed the United States over the past decade. As of the time of writing, the MSCI World Index ( URTH ) yields 1.69% compared to 1.49% for the S&P 500 Index ( SPY ), so this verifies that income opportunities from common stocks are indeed more common internationally than within the United States. This could make it easier for the fund to achieve its primary objective of the provision of income from a mostly common stock portfolio. However, there is another method through which the fund can possibly achieve this goal. That is by selling appreciated stock. Common stocks deliver the majority of their total return via capital gains, but there is nothing stopping an investor from selling some of their appreciated stock and taking the cash. For example, if you buy $1,000 worth of Apple ( AAPL ) stock that then goes up 10%, you could sell $100 worth of your position. That would leave you with your $1,000 worth of stock and $100 cash, which is the same result that you would have if the stock simply stayed flat and gave you a 10% dividend yield. Closed-end funds such as the Calamos Global Dynamic Income Fund tend to do this with their portfolios, then distribute the profits to shareholders. In short, the fund attempts to keep the portfolio relatively stable and pay out most of its investment gains via its distribution.

As just mentioned, the fund's website claims that it will invest between 40% and 100% of its assets in non-American securities. It is currently fulfilling this requirement, as shown here:

As we can see, only 52.6% of the fund's assets are currently invested in American securities. The remaining 47.4% are invested abroad. This is admittedly a lower allocation to foreign markets than I might really want, but it does satisfy the fund's stated mandate. The United States only accounts for a bit less than 25% of global gross domestic product though, so the fund is still overweighted to the United States based on its actual representation in the global economy. The MSCI World Index is actually 69.38%-weighted to the United States right now though, so this fund does a better job at achieving international diversification than the broader index. The reason that this is important is due to the protection that it provides us against regime risk. Regime risk is the risk that some government or other authority will take an action that has an adverse impact on a company in which we are invested. The only realistic way to protect yourself against this risk is by ensuring that only a relatively small percentage of your assets are exposed to any individual company. This fund is certainly doing that to a degree and better than many other global funds that have a 60% to 70% weighting to the United States.

The need to diversify away from the United States is perhaps more important for American investors than foreign ones. This is because Americans work in the country, so their incomes are at least somewhat dependent on the economic fortunes of the United States. Thus, a domestic economic crisis, an adverse action by the United States Federal Government, or anything else that affects the American economy could wipe out an American's income and savings. A person that lives in another nation and has assets in the United States may be able to avoid losing both their income and their assets. The same thing would apply to an American that is well-diversified internationally. However, because the American stock market has generally outperformed foreign ones over the past decade, many Americans are now significantly overweighted to the United States. Indeed, the only ones that are not would be those investors that actively rebalanced their portfolios on a regular basis. The fact that this fund does include a reasonable amount of foreign exposure could thus allow it to reduce your overall portfolio's exposure to the United States.

Today might be a good time to reduce your exposure to the United States, particularly for long-term investors. This is due to the rather poor budget outlook of the United States Federal Government. According to a study by the World Bank , a country whose debt-to-GDP ratio exceeds 77% for any prolonged period of time experiences a reduction in its growth rate. Notably, every percentage point by which the ratio exceeds the 77% level reduces the country's economic growth by 0.017% annually. The effect is cumulative, so the higher the national debt goes, the slower economic growth. As of right now, the debt-to-GDP ratio for the United States is 119.13%:

There have been no credible proposals from anyone currently in a leadership position in Washington, D.C. on how to reduce this. Indeed, the Congressional Budget Office states that the national debt will pass $50 trillion by 2033. There is no possible way that the gross domestic product will grow at a similar rate. Thus, American economic growth will almost certainly be stunted going forward. This is particularly true when compared to numerous emerging market nations that are in much better financial shape. This further adds to the argument that we want to have a respectable amount of foreign exposure in our portfolios. The Calamos Global Dynamic Income Fund appears to offer this, especially as it can go to 100% abroad if it appears likely that the American market will underperform (as could be the case as government spending consumes an ever-greater amount of the country's domestic output).

One interesting thing that we see in the fund's asset allocation chart above is that the Calamos Global Dynamic Income Fund has 24.39% of its assets invested in convertible securities. In some ways, these securities offer the best of both worlds, as they offer substantially higher yields than common stocks but can be converted into common stock in order to grab the capital gains that accompany equity securities. Thus, they can be thought of as a way to get the upside potential of stocks but with the safety and income of bonds. While the yields are a little lower than a bond from the same company that lacks the conversion feature, they are still an excellent investment for anyone seeking to generate income from their portfolio without sacrificing the upside potential of common stocks.

Leverage

In a previous article on income-focused funds, I stated that closed-end funds like the Calamos Global Dynamic Income Fund have the ability to employ certain strategies that allow them to have higher effective yields than any of the underlying assets. I provided a more specific explanation of how exactly this works:

One of these strategies is the use of leverage. In short, the fund borrows money and then uses that money to purchase stocks, convertible securities, and bonds from issuers that are located all over the world. As long as the purchased asset delivers 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. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, this scenario will usually be the case. It is important to note though that this strategy is much less effective today with rates at 6% than it was eighteen months ago when rates were basically 0%. This is because the difference between the rate that the fund has to pay on the borrowed money and the return that it can get from the purchased security is much narrower than it once was.

Unfortunately, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage because that would expose us to an excessive amount of risk. I generally do not like a fund's leverage to exceed a third as a percentage of its assets for this reason.

Fortunately, this fund appears to satisfy this requirement. As of the time of writing, the Calamos Global Dynamic Income Fund had levered assets comprising 26.46% of its total portfolio. Thus, it appears that this fund is striking a reasonable balance between risk and reward today.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the Calamos Global Dynamic Income Fund is to provide its investors with a high level of current income. In order to accomplish this goal, the fund invests in a blended portfolio of common stocks, bonds, and convertible securities from issuers around the world. In the case of bonds and convertible securities, the fund receives direct payments that constitute income. However, with common stocks, it will have to rely on realizing capital gains in order to convert stock appreciation to income. When we consider that common stocks can enjoy fairly high gains in a given year though, this can allow the fund to essentially realize a high yield. It then pays out the majority of its net investment gains to the shareholders. All things considered, we can assume that this process will allow the fund to have a fairly high yield itself, particularly since it is using leverage to boost its effective returns. This is certainly the case as the Calamos Global Dynamic Income Fund pays a monthly distribution of $0.05 per share ($0.60 per share annually), which gives it a 10.27% yield at the current stock price. Unfortunately, the fund has not been especially consistent with its payout over the years. Indeed, the distribution has varied quite a bit and the fund cut its distribution late last year:

This is likely to be something of a turn-off for those investors that are seeking a safe and secure source of income to use to pay their bills or finance their lifestyles. However, it is important to keep in mind that this fund's portfolio consists primarily of common stocks, and common stocks tend to have variable returns. After all, just a simple look at the S&P 500 Index's annual returns over time would show figures that are all over the place. As such, it is very unrealistic to expect the fund's returns to exhibit the perfect stability that is needed to keep its distributions flat over time. This fund has managed to show a great deal of stability over time, but that was probably caused by it either under-distributing or over-distributing during any given year with the hopes that it would balance out with time. The real disappointment here was the distribution cut late last year, but considering the weak performance of both stocks and bonds as central banks all over the world started tightening it does make a great deal of sense.

However, the fund's past is not really the most important thing for our purposes. After all, anyone buying shares of the fund today will receive the current distribution at the current yield. They will not be affected by actions that the fund has taken in the past. Thus, the most important thing is to determine how well the fund can sustain its current distribution going forward.

Fortunately, we have a relatively recent document that we can use for the purposes 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 a newer report than many other closed-end funds have made available so far, which is nice due to the recent bias of it. This report will give us a good idea of how well the fund performed in the first few months of this year, which we want to know because the first half of this year was much stronger than in 2022 in terms of market performance. That likely gave this fund an opportunity to earn some capital gains that can be paid out.

During the six-month period, the Calamos Global Dynamic Income Fund received $3,669,337 in interest and $3,523,022 in dividends from the assets in its portfolio. However, some of this interest was considered return of principal, so it is not considered to be income for tax purposes. As such, the fund reported a total investment income of $4,768,806 during the six-month period. It paid its expenses out of this amount, which left it with a net investment loss of $2,351,266. This is unfortunate, as this fund's expenses surpassed its investment income. This is also concerning for the distribution since it explicitly states that the fund did not have enough income to sustain its distribution. For its part, the fund paid out $19,159,316 in distributions to the shareholders.

However, the fund does have other methods that can be used to obtain the money that it needs to cover the distribution. For example, capital gains are not included in net investment income, so if the fund managed to generate sufficient capital gains to cover both the net investment loss and the distribution, then it is just fine financially. This was the case during the six-month period. The Calamos Global Dynamic Income Fund reported net realized losses of $3,688,410 but that was more than offset by $53,689,645 net unrealized capital gains. Overall, the fund's assets increased by $28,490,653 after accounting for all inflows and outflows during the period. Clearly, it did manage to cover its distributions, although not in the way that one might think. Still, if the fund were to actually realize all of those distributions, it would have enough to sustain its current distribution for quite a while. Overall, we probably do not have to worry here unless the fund has taken large losses ever since the market turned downward around the start of August.

Valuation

As I explained in numerous previous articles:

It is always critical that we do not overpay for any assets 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 Calamos Global Dynamic Income Fund, the usual way to value it is by looking at the fund's net asset value. The net asset value of a fund is the total current market value of all the fund's assets minus any outstanding debt. It 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 obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are acquiring the fund's assets for less than they are actually worth.

Fortunately, this fund appears to be presenting a fairly good purchase price today. As of August 17, 2023 (the most recent date for which data is available as of the time of writing), the Calamos Global Dynamic Income Fund has a net asset value of $6.50 per share but the shares only trade for $5.84 each. That gives the fund's shares a 10.15% discount on net asset value at the current price. This is relatively in line with the 10.68% discount that the fund's shares have averaged over the past month, so the price appears to be quite reasonable right now.

Conclusion

In conclusion, two problems facing American investors today are a need for income and overexposure to the United States. The Calamos Global Dynamic Income Fund provides a method to solve both problems at once as it invests its assets both in the United States and abroad in an attempt to provide a high level of income for its investors. Unfortunately, the fund currently has more than half of its assets invested domestically, but that may change as a rising debt load seems almost certain to make several foreign markets grow much more rapidly than the United States over the next few decades. The fund's 10.27% yield is quite attractive and appears sustainable, and it trades at a discount to the net asset value. Overall, this fund might be worth considering today.

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