FFA - FFA: Unloved Buy-Write CEF 8% Yield

Summary

• FFA is an equity buy-write fund from a lesser known asset manager, namely First Trust.
• FFA's NAV outperforms on a 5-year time-frame when compared to better known names such as ETV and SPXX.
• The CEF however does not exhibit the same interest from the investor community as its peers, trading at persistent discounts to NAV, even in 2022.
• The fund has a managed dividend policy, and pays distributions quarterly rather than monthly.
• This article covers CEFs from our suite of products - we focus on macro portfolio allocation, CEFs, and yield-generating options strategies, targeting overall yearly portfolio returns of 9%+.

Thesis

The First Trust Enhanced Equity Income Fund ( FFA ) is a buy-write CEF. The vehicle comes from a lesser known asset manager, namely First Trust. As per its literature:

The Fund's investment objective is to provide a high level of current income and, to a lesser extent, capital appreciation. The Fund seeks to achieve its investment objective by investing in a diversified portfolio of equity and writing call options on at least 80% of the Funds managed assets. Under normal market conditions, the Fund will pursue an integrated investment strategy in which the Fund will invest substantially all of its managed assets in a diversified portfolio of common stock of US corporations and US dollar-denominated equity securities of foreign issuers, and on an ongoing and consistent basis, write covered call options on at least 80% of the Funds managed assets. Effective on 19-Nov-07; the fund will no longer be required to write call options on at least 80% of its managed assets Effective from 08-Jan-08, the fund manager will be prohibited from investing 25% or more of the Funds total assets in securities of issuers in any single industry.

The fund takes some very concentrated positions in Microsoft and Apple, with each name representing more than 8% of the portfolio. Overall the CEF contains 79 names in its portfolio. As we can see from the above literature extract, the vehicle's mandate gives it a bit of latitude in the amount of calls to be written on the portfolio. We believe its concentrated positioning and lack of a systematic approach to its written calls policy are the main culprits for its persistent discounts to NAV. Investors like systematic strategies because they provide transparency in an otherwise "black-box" type of investing style (i.e. what tenors are to be used for the options, how much of the portfolio is overwritten, etc). Systematic strategies are quantifiable and therefore provide appeal to the investor community.

FFA has a very robust long term performance that has seen its NAV outperform the better known names ETV and SPXX on a 5-year time-frame:

We can see how the CEF's NAV has managed to beat its peers. However, fundamental performance is not the only driver behind a fund's market price. Investors' perceptions, transparency and consistency are other aspects to be considered. Coming from large fund families is also a plus. FFA does not deliver on any of those fronts.

FFA is a fundamentally sound buy-write CEF that has posted robust historic results. The vehicle has single-name concentration issues and a wide, non-systematic buy-write mandate. These factors combined with a lack of investor marketing have resulted in this CEF being one of the few vehicles not trading at premiums to NAV in 2022 in the buy-write space.

Holdings

The fund holds a portfolio of mainly large cap equities:

We can see the vehicle is overweight the largest capitalization stocks, which can be observed from its top 10 names as well:

The CEF is overweight technology stocks:

Currently the CEF has single name and index call options covering around 82% of the portfolio:

The fund uses both single name and index call options:

Performance

The fund has a very robust long term performance:

We can see how FFA displays a 5-year total return that exceeds ETV's and SPXX's, with a significant outperformance in the 2020-2022 period. However, FFA is underperforming in 2022:

The fund is underperforming by quite a high amount this year, especially when benchmarked against SPXX. The reason for this underperformance? The fund's premium to NAV:

While ETV and SPXX have seen their premiums to NAV grow in 2022 as investors flocked to short volatility strategies, FFA has seen its premium move to a discount !

What are the drivers for a fund's premium? It is mainly investor perception. Investor perception regarding long term results, transparency around strategy and continuous execution and marketing. FFA seems to be able to post robust long term results but is unable to highlight to the investor community its strategy and benefits, the same way the EV and Nuveen funds do.

From a pure NAV performance, FFA is clearly the outperformer when looking back 5 years:

However, a robust fundamental performance has not translated into a commensurate premium to NAV.

Premium / Discount to NAV

The fund has historically traded at discounts to NAV:

We can see that on average the fund has traded with discounts to NAV ranging from -5% to -10%.

Distributions

As per its literature, the fund has a managed distribution policy:

The Fund's managed distribution policy (the "Plan") permits the Fund to make periodic distributions of long-term capital gains as frequently as quarterly each tax year. The plan has no impact on the Fund's investment strategy and may reduce the Fund's NAV. However, the Advisor believes the policy helps maintain the Fund's competitiveness and may benefit the Fund's market price and premium/discount to the Fund's NAV. Under the Plan, the Fund currently intends to continue to pay a recurring quarterly distribution in the amount of $0.315 per Common Share that reflects the distributable cash flow of the Fund. The Fund maintained its regular quarterly Common Share distribution of $0.315 per share for the six month period ended June 30, 2022. Based on the $0.315 per share quarterly Common Share distribution, the annualized distribution rate as of June 30, 2022 was 7.49% at NAV and 7.71% at market price. The final determination of the source and tax status of all 2022 distributions will be made after the end of 2022 and will be provided on Form 1099-DIV. The foregoing is not to be construed as tax advice. Please consult your tax advisor for further information regarding tax matters.

The fund has tried to have a fairly stable distribution payout throughout time:

Conclusion

FFA is an equities buy-write CEF from First Trust. The CEF has robust long term results but has underperformed in 2022 on the back of a widening discount to NAV. The CEF has single name concentration issues, with Microsoft and Apple accounting for over 8% of the portfolio each. The fund also has a basis between the holdings and the written options, with the fund mainly writing index calls. Currently the fund writes calls on 82% of its portfolio. The lack of a systematic approach to its written calls, coupled with a quarterly dividend and single name concentration issues are the factors that are driving a persistent discount to NAV. FFA has not acted the same way to other buy-write CEFs in 2022, being down more than the S&P 500. Expect the discount to NAV to persist for this CEF and do not trade it as the other systematic buy-write equity CEFs.

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