CPZ - CPZ: Fails To Deliver Better Alternatives Exist (Ratings Downgrade)

2023-11-21 00:56:37 ET

Summary

• Calamos Long/Short Equity & Dynamic Inc Trust is an equity closed-end fund that is net-long with a 14.2% exposure.
• The fund seeks to generate current income by buying undervalued stocks while shorting overvalued ones.
• CPZ has failed to deliver in 2023, with a mere 3.8% total return, while its 3-year standard deviation is at 17.5%.
• A retail investor would have been better off by being all in cash, for example, with BIL delivering a 4.3% total return so far this year.
• The appropriate comparison though is with other long-short equity funds, where again CPZ lags significantly. FTLS and QLEIX are up 13.5% and 25.3%, respectively, highlighting that long-short equity strategies can deliver in a market like today's.

Thesis

The Calamos L/S Equity & Dynamic Inc Trust ( CPZ ) is an equity closed-end fund. The vehicle comes from the Calamos fund family, manager which is best known for convertible securities CEFs such as the Calamos Dynamic Convertible and Income Fund ( CCD ) or Calamos Convertible Opportunities and Income Fund ( CHI ). We have covered this name before here , and are revisiting it after almost a year, during which long/short funds could have posted extremely robust returns given the bifurcation of the current market:

While the S&P 500 is up over 17%, the wider market as represented by the Invesco S&P 500 Equal Weight ETF ( RSP ) is barely in the green for the year, with many names having negative total returns. The S&P 500 has been driven by the ' Magnificent 7 ' this year, with a long position in these names having produced outstanding results.

In this article, we are going to analyze the CEF's performance, its risk factors, and articulate why we believe a retail investor is best served to divest from this name given the availability of better options in the market.

What does CPZ actually do?

CPZ is a CEF that mainly takes long and short positions in equities:

As per the latest fund data, the CEF is net long with a 14.2% exposure. A long/short strategy is more typical for hedge funds rather than market-traded instruments:

Long/short funds represent some similarities to hedge funds. They seek to offer investment strategies with greater risk and greater return potential over standard benchmarks. Most long/short funds feature higher liquidity than hedge funds, no lock-in periods, and lower fees. However, they still have higher fees and less liquidity than most mutual funds.

Source: Investopedia

CPZ buys certain equities while shorting others, thus seeking to profit from the relative performance of the two respective assets. From that angle, the fund is not necessarily driven by the beta to the market, but rather by the relative value between the long and short components. To put it simply, the market going up or down in a similar fashion for all names will not have an impact on CPZ's performance. Let us have a closer look:

The fund is long Amazon ( AMZN ) while short the S&P 500 for example. So if Amazon and the SPY move up or down in lockstep, then we will not have any impact on CPZ. However, Amazon has outperformed this year versus the index:

The fund's position, if held since the beginning of the year, would have netted +72.83% on the long side and -17.88% on the short side, for a net gain of 54.95%.

The United Airlines ( UAL ) position is a different story though. The fund is long UAL versus short the SPY:

If held since the beginning of the year, the position would have netted +5.46% on the long side and -17.88% on the short side, for a net loss of -12.42%.

A long/short strategy is ultimately benchmarked on its historic performance since its success depends on going long undervalued names while shorting overvalued ones. The net direction of the market as a risk factor is secondary when analyzing a long/short fund.

Has CPZ delivered? The answer is no.

As described above, the long/short strategy is a relative value one, rather than directional, so the proper way to benchmark CPZ is via its peers:

We are comparing the CEF to the First Trust Long/Short Equity ETF ( FTLS ) which we have covered here , and to an institutional product, namely the AQR Long-Short Equity Fund Inst ( QLEIX ). The AQR fund has outperformed this year, while FTLS has also posted very robust returns. CPZ is the laggard, with a total return that is barely in the green for the year.

Most of the CEF's return represents a true NAV move, with its discount to NAV fairly constant this year:

The CEF's discount to NAV has barely budged, being down only -1% during the year.

A long/short fund like CPZ needs to deliver, especially during a volatile year with segmentation like 2023. Its peers have produced very robust results, while CPZ has severely lagged. A retail investor would have been better served by sitting in cash in 2023 than having invested with CPZ.

The large discount to NAV for the CEF is symptomatic of the endemic lagging performance of the fund. The discount has hugged the -10% range for the past five years, and it will not narrow until the CEF starts posting consecutive years with robust total returns. To that end, the portfolio managers need to deliver on their research and positions. Given its history, we are hard-pressed to see such a shake-up any time soon.

Analytics

• AUM: $0.33 billion.
• Sharpe Ratio: 0.33 (3Y).
• Std. Deviation: 17.5 (3Y).
• Yield: 11.6%.
• Premium/Discount to NAV: -15%.
• Z-Stat: -1.06.
• Leverage Ratio: 39%.
• Effective Duration: n/a
• Composition: Long/Short Equity

A long/short fund is supposed to exhibit better analytics when compared to the index, especially in a bear market. Unfortunately not here. The CEF's standard deviation is equivalent to the one exhibited by the index, while its Sharpe ratio is lower. So the lack of returns here is not driven by less risk-taking (we would see lower volatility and higher Sharpe ratios) but by a poor selection of long/short relationships. Just for reference, below are FTLS's analytics:

Distribution coverage

Despite its overall disappointing performance, especially when compared to peers, the CEF nonetheless has posted a net positive total return, giving itself the capital gains necessary to cover its dividend:

The fund has a distribution of $0.14 per month, which comes overwhelmingly from its trading capital gains:

What alternatives does a retail investor have?

There are a number of alternatives that a retail investor can pursue in the long/short space. The most accessible one is via the First Trust Long/Short Equity ETF which we covered with a 'Buy' rating. FTLS is incorporated as an ETF and thus does not have any leverage or discount to NAV, but its total return performance in the past years has been impressive, with very robust risk analytics.

A second alternative is the AQR Long-Short Equity I Fund, but this vehicle is only accessible to institutions or extremely wealthy individual investors:

Currently, the minimum amount to access the AQR fund for an individual investor is $5 million, much above what a regular individual invests.

Conclusion

CPZ is an equity closed-end fund. The vehicle falls in the long/short equity space and aims to generate current income by buying undervalued stocks while shorting overvalued ones. 2023 should have been a tremendous year for the CEF, with a very clear-cut market segmentation, where the mega-tech names have posted astounding results, while the rest of the market is actually in the red.

CPZ has failed to deliver in 2023, with a mere 3.8% total return. A retail investor would have fared better by being all in cash for example, with BIL delivering a 4.3% total return so far this year. The appropriate comparison though is with other long/short equity funds, where again CPZ lags significantly. FTLS and QLEIX are up 13.5% and 25.3% respectively, highlighting that long/short equity strategies can deliver in a market like today's. We have covered FTLS with a 'Buy' rating, and are of the opinion that investors should sell out of CPZ and consider FTLS instead.

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