ECF - Ellsworth Fund: Conservatively Managed Convertibles Fund

Summary

• ECF is a convertibles-focused CEF.
• It pays a 5.9% forward distribution yield that appears well covered by historical fund returns.
• ECF appears conservatively managed with significantly lower volatility than peers. However, it can lose just as much when the convertibles asset class suffers like it did in 2022.

The Ellsworth Growth and Income Fund Ltd. ( ECF ) is a convertible-focused closed-end fund offered by Gabelli Asset Management. The ECF fund has decent long-term historical returns, but short-term returns have been marred by a poor 2022.

Comparing ECF to peers, the fund appears to be conservatively managed, with significantly lower volatility and lower peak year returns. However, as shown by ECF's poor performance in 2022, when the asset class suffers, ECF can lose just as much as peers.

ECF pays a 5.2% NAV distribution that appears well covered based on a 5Yr average annual return of 6.4%. I believe ECF may appeal to conservative investors who want some exposure to the convertible asset class.

Fund Overview

The Ellsworth Growth and Income Fund is a closed-end fund ("CEF") that primarily invests in convertible securities and common stock. ECF's goal is to provide income and capital appreciation over the long-term. ECF has a long history (inception in 1986) and currently has $192 million in net assets (Figure 1). ECF charges a reasonable 1.16% operating expense ratio.

Convertibles Can Provide Equity-Like Returns In The Right Environment

Convertible securities are hybrid securities that can change from its initial form (eg. a bond), into another form (eg. an equity) after some conditions are triggered. The most common types of convertible securities are convertible bonds and convertible preferred shares that can be converted into common stock at a given conversion price.

Convertible bonds typically carry lower interest yields than vanilla bonds because the 'option' to convert into common stock is valuable. For the issuer, this allows them to raise capital at a lower cost of capital. However, the tradeoff is potential share dilution. Investors are willing to accept lower interest rates on convertible bonds because they can participate in 'equity upside' if the company does well.

One way to model convertible bonds is to consider them as a traditional bond plus a call option on the company's stock. In bull markets when stocks do well, convertible bonds can perform exceptionally well compared to other fixed income securities because the option component provides upside convexity, and the convertible bond can trade like equity above the conversion price.

On the other hand, in bear markets, convertible bonds can perform very poorly as the option component can lose value very quickly. However, after a certain point below the conversion price, convertible bonds trade like traditional bonds, so there is a certain 'floor' to their valuation, unlike common equity.

Portfolio Holdings

Figure 2 shows the top sector allocations of the ECF fund as of December 31, 2022. Computer Software & Services is the largest sector weight at 14.1%, followed by Health Care at 13.0% and Energy & Utilities at 7.9%.

Figure 3 shows the top 10 holdings of the ECF fund, which account for 18.4% of the fund's assets.

Returns

Figure 4 shows ECF's historical returns. The ECF fund has decent long-term historical returns with 5/10/15Yr average annual returns of 6.4%/7.9%/6.4% respectively to January 31, 2023. Short and medium-term returns were negatively impacted by 2022's annus horribilis when the fund lost 26.6%.

Distribution & Yield

The ECF fund pays a quarterly distribution of $0.13, which works out to a 5.9% forward yield. On NAV of $10.01, the ECF fund pays a 5.2% yield. In good years, the ECF fund also pays special distributions. For example, in 2021, the ECF fund's fourth quarter distribution was $1.11 instead of the normal $0.13.

The ECF fund's distribution is paid out of net investment income ("NII") and realized gains (Figure 5).

Relative to the fund's long-term average annual returns, I believe ECF's 5.2% of NAV distribution is sustainable and appropriate.

ECF vs. Peer Funds

Recently, I reviewed the Virtus AllianzGI Diversified Income & Convertible Fund ( ACV ) and the Calamos Convertible Opportunities & Income Fund ( CHI ), both convertibles focused CEFs. How does ECF compare against these two peer funds?

Figure 6 compares ECF against ACV and CHI using my proprietary scorecard of key performance metrics. First, on costs, ECF is the cheapest of the 3 options, charging only a 1.00% expense ratio according to Seeking Alpha (although the fund's annual report states the fund charged 1.16% of operating expenses in fiscal 2022). It also has the lowest portfolio turnover of the funds analyzed.

In terms of total returns, the ECF fund lags behind ACV and CHI on the 3 and 5Yr time frames. This is primarily because ECF suffered a similar level of drawdown in 2022, but it significantly underperformed the two peer funds in 2020 (Figure 7). However, on a 10yr time frame, ECF has performed better than CHI while ACV does not have 10 years of performance history.

With respect to risk, ECF has significantly lower volatility than the two peers, however, with its lower returns, it lags behind in terms of Sharpe Ratios.

Finally, in terms of the fund's distribution, ECF pays the lowest distribution rate, at 5.2% of NAV. However, ECF's distribution is the most sustainable, since it is well covered by the fund's 5Yr average annual returns. On the other hand, CHI pays a 11.0% of NAV distribution while earning only 7.7% 5Yr annual returns, so there is a large gap between returns and distribution.

Overall, I would characterize ECF as a conservatively managed convertible securities fund that does not aim to 'shoot the lights out'. It pays a reasonable distribution that is well covered by the fund's return in most years. However, when the asset class suffers like it did in 2022, ECF can drawdown just as bad as peers.

Deeply Discounted Valuation

The ECF fund is currently trading at a historically wide 12.6% discount to NAV (Figure 8). However, investors should note that ECF's discount can persist, like it did in 2018 and 2019.

Conclusion

The ECF fund is a convertible-focused CEF offered by Gabelli Asset Management. The ECF fund has decent long-term historical returns, although short- and medium-term returns have been negatively impacted by a poor 2022. Comparing ECF to peers, the fund appears to be conservatively managed, with significantly lower volatility and lower peak returns. However, when the asset class suffers, ECF can decline just as much. ECF's 5.2% of NAV distribution appears well covered by the fund's 5Yr average annual returns of 6.4%.

I believe ECF may appeal to conservative investors who are seeking exposure to the convertible securities asset class.

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