EXG - EXG: Global Fund With An Options Strategy At A Deep Discount

2023-05-05 16:46:05 ET

Summary

• EXG has moved to an attractive discount since our prior update.
• The global tilt of the fund can be attractive as global valuations look tempting.
• The fund's distribution appears to be sustainable at this time.

Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on April 21st, 2023.

The last time we touched on Eaton Vance Tax-Managed Global Diversified Equity Income Fund ( EXG ) was back in August 2022. The fund, along with most of the rest of the equity since that time, hasn't performed too well. Despite a strong rebound from October 2022 lows, the market, as measured by the SPDR S&P 500 ( SPY ), had been about flat since the date of our prior update. However, during this time, EXG has managed to outperform on a total NAV return basis.

The SPY isn't necessarily an appropriate benchmark, but it can give us some context of what the rest of the market is doing. However, the main point is this is precisely what can provide an opportunity when investing in closed-end funds. When this happens, we know that the discount or premium has come down in the fund. In this case, EXG was trading at a bit of a premium when we last touched on it. That's why we favored its cousin, the Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund ( ETW ), when highlighting those two funds.

Today, both are trading at an attractive discount, but it is EXG that slightly beats out ETW in terms of being at the larger discount.

The Basics

• 1-Year Z-score: -1.63
• Discount: -9.89%
• Distribution Yield: 8.52%
• Expense Ratio: 1.07%
• Leverage: N/A
• Managed Assets: $2.6 billion
• Structure: Perpetual

EXG will "invest in a diversified portfolio of domestic and foreign common stocks with an emphasis on dividend-paying stocks and writes call options on one or more U.S. and foreign indices with respect to a portion of the value of its common stock portfolio to generate current cash flow from the options premium received." They last reported being overwritten by 48%, which regularly is the case as it was the exact same in our prior update.

They have a "tax-managed" focus, as the name would suggest. They do this by "evaluating returns on an after-tax basis and seeks to minimize and defer federal income taxes incurred by shareholders in connection with their investment in the fund."

By investing in this manner, they hope to achieve the fund's investment objectives. The primary objective here is "to provide current income and gains, with a secondary objective of capital appreciation."

The fund has no leverage in terms of borrowings, so that takes away one headache during this higher interest rate environment. The fund is rather large, which provides plenty of liquidity for most retail investors.

Performance - Discount Emerges

The fund has provided fairly attractive results historically.

Thanks to the fund's options strategy of writing calls on indexes, it saw reduced losses relative to SPY last year. The total NAV return for the fund was -15.71%, while SPY showed losses of over 18% on a total return basis. However, as I mentioned at the open, SPY isn't necessarily an appropriate benchmark because this fund utilizes an option strategy and has a global tilt.

If we tried comparing the long-term results in the last decade, we would see SPY handily outperforming. In a mostly bull market, option writing funds will tend to underperform. We also know that U.S. investments have considerably outperformed in the last decade. In fact, we were in a period where the U.S. outperformance had been quite extended, even relative to history, as highlighted by JPMorgan .

Should that reverse, as history suggests happens on occasion, we could see EXG's global sleeve perform a bit better. A catalyst to potentially make that happen would be that global investments are actually relatively cheaper than U.S. equities.

That could make EXG a better performer going forward compared to U.S. option writing peer funds. At the same time, with an options writing strategy, if we see a sideways market, we can still expect some returns via the option premium received too. That same option writing strategy that can act as a small hedge can hinder performance, too, if we experience a market that performs too strongly.

An additional catalyst for EXG right now is the deep discount the fund is providing. This came about, as we saw at the open because the total NAV return was positive, but the total share price return was negative. That's exactly how we want these types of opportunities to open up.

Distribution - Cut But Looking Better

A fund going from a large premium to a discount can happen on its own. However, in this case, the fund cut its distribution along with most of the other Eaton Vance equity funds last year. That seemed to be ultimately what spurred the declines. This is something fairly common we see; when distributions become extended, the valuation of the fund can run up to a premium. Then when it is cut, that quickly deflates. For EXG, they had hit an all-time high premium right before the cut.

This wasn't the first cut for the fund, though. While some of its U.S. peers have been able to maintain their distribution throughout the last decade, that lagging global performance caught up with the fund in the form of distribution trims.

As an equity fund, they will require capital gains to fund most of their distributions. Thus, underperforming in terms of capital appreciation on its underlying portfolio will see distribution cuts. The fund's net investment income did increase year-over-year, according to its last annual report .

Some of that increase was due to being at a premium. They were able to create new shares through the DRIP and the at-the-market offering. These things can be done at a premium and are accretive to the fund's NAV. Still, even on a per-share basis, the NII increased from $0.047 in the prior year to $0.067. Of course, that was still well below the amount they distributed to shareholders.

Despite the fund declining in 2022, we can see they realized enough gains in their underlying portfolio combined with the fund's NII to almost cover the distributions paid. The realized gains came in the form of embedded gains in the fund, but also its options writing strategy. The $48 million wasn't enough to cover the distributions on its own, and the fund relied heavily on gains from the underlying portfolio. However, the options written portion is something they can do even in a down or flat market.

Being able to generate gains from their options strategy in a flat or down market contributes to helping sustain the fund's current 7.75% NAV distribution rate.

EXG is a fund that generally distributes out a fair bit of return of capital, which again goes back to the fund's options writing strategy. In bull markets, the fund can see losses in its call-writing strategy since they write against indexes. However, 2022 saw very little in terms of ROC. Presumably, this was the case because, besides the written options, they realized a significant amount of gains in their underlying portfolio.

EXG's Portfolio

Despite being a global fund, they still put a fairly large allocation to companies in the U.S. Here is the geographic breakdown at the end of 2022; this is from their most recent available fact sheet, which we'll hopefully be getting an update soon.

For the fund's top ten, we see several usual suspects. Those are the mega-cap tech names we see in most Eaton Vance option-writing funds. Last year they reported a turnover rate of 27%, which was down from the prior 44% turnover reported in the prior year. It was the lowest in the last five years.

Since our last update, Nova Nordisk A/S ( NVO ) is the only new position to appear in the top ten, knocking out EOG Resources ( EOG ). NVO is a representation of one of its global holdings located in Denmark. While it made its way to the fund's top ten, it was previously a position in the fund. They held 301k shares at the end of October, but more recently, at the end of January 2023 , they held 371,538 shares.

Microsoft ( MSFT ) has retained its top spot, though its weighting did fall some from the 4.43% level prior. Alphabet ( GOOG ) even saw its weight drop, but that was a bit more substantially from the 4.29% level it had been at previously.

Conclusion

EXG has moved from what was an unusually high premium, touching a new all-time high premium, to trading at a deep discount. The catalyst for such a move appears to have stemmed from the fund's distribution cut. Many Eaton Vance equity funds have made similar moves, also losing their higher valuations. They require substantial capital gains to fund their distributions. During a bear market, equity funds cutting their distributions is natural in the CEF space as they pay out elevated distributions in the first place, and the capital gains become harder to come by.

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