FAX - FAX: Asian Bond Fund With A Shrinking NAV/Distribution Problem
2023-03-08 12:32:59 ET
Summary
- Aberdeen Asia-Pacific Income Fund, Inc. primarily invests in Asian bonds to fund its high distribution yield.
- The FAX closed-end fund currently pays a $0.275/month distribution for a 12.0% forward yield.
- However, with poor investment returns, FAX investors are simply having their own principal returned to them through the distribution.
The Aberdeen Asia-Pacific Income Fund, Inc. ( FAX ) primarily invests in Asian bonds to maintain a high level of distribution. The fund is currently paying $0.275/month for a 12.0% distribution yield. However, I am worried that the FAX's fund is not earning its distribution, as the FAX fund has had negative 3/5/10Yr average annual returns. This means the FAX fund must liquidate NAV to fund its distribution, creating a negative shrinking NAV/distribution spiral.
Fund Overview
The Aberdeen Asia-Pacific Income Fund, Inc. is a closed-end fund ("CEF") that seeks to provide high current income through primarily investing in Asian debt securities. The FAX fund has $781 million in net assets as of February 28, 2023 and charged a 2.87% net expense ratio (Figure 1).
Portfolio Holdings
Figure 2 shows the FAX fund's geographical and currency exposure as of December 31, 2022. The fund's five largest country exposures are India (25.4%), Indonesia (20.6%), China (18.3%), Australia (10.3%), and Malaysia (8.8%).
Figure 2 - FAX country and currency exposure (FAX December 2022 factsheet)
In terms of currency exposure, 30.1% of the fund is exposed to U.S. dollar-denominated bonds, 13.7% in Indian Rupee, 12.6% in Indonesian Rupiah, 7.7% in Chinese RMB, and 7.6% in Malaysian Ringgit.
Figure 3 shows FAX's credit quality allocation and maturity allocation. Through leverage, 108.4% of the fund is invested in investment grade securities rated BBB or above. 33.6% of the portfolio is rated non-investment grade ("junk"), with the biggest weights in BB (20.0%) and B (8.6%) credits.
Figure 3 - FAX credit quality and maturity allocation (FAX December 2022 factsheet)
The fund's investments are predominantly under 10 years of maturity, with the portfolio having an overall effective duration of 6.7 years.
Figure 4 shows FAX's sector allocation. The FAX fund has a 59.8% allocation to government debt and a 17.8% allocation to quasi-sovereign debt. Financials make up 21.9% of the portfolio.
Figure 4 - FAX sector allocation (FAX December 2022 factsheet)
Returns
Figure 5 shows the FAX fund's historical and annual returns. Overall, FAX's returns have been poor, with 3/5/10/15Yr average annual returns of -5.5%/-2.4%/-1.3%/2.0% to February 28, 2023.
However, investors should note that much of the poor performance can be attributed to a tough asset class, as the FAX fund has generally been a 2nd quartile fund compared against the Morningstar category Emerging Markets Bond .
Distribution & Yield
Against poor historical returns, we find that the FAX fund pays a very high monthly distribution of $0.0275/share, or a forward yield of 12.0%. On NAV, FAX is yielding 10.4%. FAX's current distribution rate has been maintained since 2020.
While FAX's distribution looks attractive, investors should note that the fund has not "earned" its distribution. In fact, looking through the fund's annual report, we can see the vast majority of the fund's annual distribution has been funded through return of capital ("ROC") (Figure 6).
Figure 6 - FAX distribution funded through ROC (FAX 2022 annual report)
Funds that cannot earn the distributions are called " return of principal" funds because their distributions are funded through liquidating NAV and "returning" investors' own principal to them. These funds are characterized by a long-term amortizing NAV, like FAX (Figure 7).
Figure 7 - FAX exhibits a classical long-term amortizing NAV (morningstar.com)
"Return of principal" funds are problematic because every distribution payment requires a portion of NAV to be liquidated. Over the long run, this practice depletes income-earning assets, making future distributions even more unsustainable.
Eventually, unsustainable distribution rates must be cut. This leads to investors losing both principal (since market price often tracks NAV) and income. Historically, we can see the FAX fund has reduced its distribution rate from an annual $0.54 in the early 2000s to $0.33 in recent years (Figure 8).
FAX Fund Trades At A Significant Discount
The only upside to FAX's high distribution rate is that the fund is currently trading at a significant 13.6% discount to NAV (Figure 9). When a fund is trading at a steep discount, returning capital through high distributions can help investors capture some of that discount.
Figure 9 - FAX is trading at a steep discount (cefconnect.com)
However, I think the FAX fund's steep discount to NAV is a reflection of the fund's poor long-term performance and is not something to be celebrated by investors.
Conclusion
In summary, although the Aberdeen Asia-Pacific Income Fund, Inc. pays an attractive 12.0% distribution yield from a portfolio of Asian bonds, I believe the high yield is simply a mirage, as the vast majority of the fund's monthly distribution is funded through the return of investors' own principal. Over the past decade, the Aberdeen Asia-Pacific Income Fund, Inc. has been consistently paying out more in distribution than it earns, shrinking its income-earning asset base for future years. This creates a long-term negative spiral of shrinking NAV and shrinking distributions.
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FAX: Asian Bond Fund With A Shrinking NAV/Distribution Problem