MA - GDV: Distribution Might Be At Risk But Generally A Good Conservative Fund

Summary

• Gabelli Dividend & Income Trust invests in a portfolio of dividend-paying stocks in an effort to generate both capital gains and income for its shareholders.
• There are a few companies in the portfolio that do not make much sense for a dividend fund, but it is mostly blue-chip stocks.
• The closed-end fund is generally conservative and outperformed the S&P 500 in 2022.
• The distribution may not be sustainable due to the huge losses that the fund suffered in the first half of 2022.
• The fund is trading at a reasonably attractive valuation today.

It is little doubt that one of the biggest problems facing most Americans today is the incredibly high level of inflation that has been plaguing the economy. There has not been a single month over the past year in which the consumer price index did not increase by at least 6.5% compared to the previous year:

This has naturally had a devastating effect on the budgets of many households, particularly since real wage growth has now been negative for 21 straight months. As a result, many people have been forced to enter the gig economy or take on second jobs just to get the extra money that they need to make ends meet. In fact, a recent Prudential Pulse survey states that fully 77% of Millennials and 81% of Generation Z members have entered or are considering entering the gig economy just to keep their bills paid. We have also seen a surge in credit card balances and declining savings balances across the nation so it is quite obvious that people are struggling to get by and need more income.

Fortunately, as investors, we can put our money to work for us and do not have to resort to such extreme methods in order to boost our incomes. One of the best ways for us to do this is by purchasing shares of a closed-end fund that specializes in the generation of income. These funds are quite nice because they provide us with easy access to a portfolio of assets that is managed by a professional team with one easy trade. In addition, these funds are able to utilize certain strategies that have the effect of boosting their yields above those of any of the underlying assets.

In this article, we will discuss the Gabelli Dividend & Income Trust ( GDV ), which yields an impressive 5.98% at the current price. Admittedly, this is not nearly as attractive as some other funds boast but it is still far better than the 1.54% current yield of the S&P 500 Index (SP500). I have discussed this fund before, but as more than a year has passed since that report, a great many things have changed. As such, this article will focus specifically on those changes and provide an updated analysis of the fund’s finances. Therefore, let us investigate and see if this fund could prove to be a worthy addition to a portfolio today.

About The Fund

According to the fund’s webpage , the Gabelli Dividend & Income Trust has the stated objective of providing its investors with a high level of total return. This is not particularly surprising since the fund’s name implies that it is specifically seeking out dividend income. Dividends are typically paid by common stocks so that implies that this is an equity fund. That is, in fact, true as 95.58% of the fund’s portfolio is invested in common equities:

The fund’s webpage describes the strategy thusly,

“Under normal market conditions, the Fund invests at least 80% of its assets in dividend-paying or other income-producing securities. In addition, under normal market conditions, at least 50% of the Fund’s assets will consist of dividend-paying equity securities. In making stock selections, the Fund’s investment advisor looks for securities that have a superior yield and capital gains potential.”

Thus, the fund is investing in stocks with fairly high yields and growth prospects. At least, it claims it does. My experience is that many funds that claim to use this strategy actually include a number of the bubble stocks that offer no yield but generated large capital gains over the past decade due to the easy money policies of the Federal Reserve and other central banks. This is a strategy that has failed over the past year as tightening monetary policies have begun to put investors’ emphasis back on those companies that actually have cash-producing business models. Fortunately, this fund seems somewhat reasonable in this respect but it does still include a few stocks that have no real business being in a dividend-focused fund. Here are the largest positions as of the end of December:

The one holding that immediately jumps out at me is Alphabet ( GOOG ), which pays no dividends. Thus, the fund is certainly not abiding by its mandate of investing in income-producing common stocks by including this company in the portfolio. We also see Mastercard ( MA ) and Microsoft ( MSFT ), both of which have a yield so low that it hardly matters. The remainder of the stocks here are mostly low-growth blue chips, which is the sort of thing that we expect to find in a dividend-oriented fund. Overall, this portfolio is not really too bad as its exposure to low-yielding securities is not particularly significant and it mostly consists of the companies that a dividend growth investor would at least consider holding themselves.

Although many of the weightings have changed over the past year, there have been surprisingly few changes to the companies on this list. In fact, the only changes were the removal of PayPal ( PYPL ) and DuPont de Nemours ( DD ), which were replaced with Genuine Parts ( GPC ) and Mondelez International ( MDLZ ). The weightings changes could easily be explained by one company’s stocks outperforming another. For example, both Microsoft and Alphabet significantly underperformed the market last year so this could easily explain why their weightings are now lower in the portfolio than a year ago. The fact that so few stocks seem to have really changed may lead one to assume that the Gabelli Dividend & Income Trust has a fairly low annual turnover. This is indeed the case as the fund had an annual turnover of 12.00% last year, which is one of the lowest turnovers among all equity closed-end funds. The reason that this is nice is that it costs money to trade stocks or other assets, which are billed to the shareholders of the fund. This creates a drag on the fund’s performance and makes things more difficult for management. After all, the fund’s management needs to generate sufficient excess returns beyond those of the market to cover these costs and still manage to deliver superior returns to investors. This is a challenging task that few management teams have managed to accomplish on a consistent basis. This is the major reason why most actively-managed funds fail to beat comparable index funds. With that said, this fund has not really done very poorly. It did lag the S&P 500 over the past twelve months, though:

With that said, once you consider the fact that this fund has a much higher yield than the index, an investor in the Gabelli Dividend & Income Trust would actually come out pretty comparable to an investor in the S&P 500 Index. In fact, an investor that was reinvesting the distributions would actually have beaten the S&P 500 over the past twelve months. Admittedly though, the S&P 500 Index is not the best to use for a comparison benchmark for this fund.

The fund itself does not provide a benchmark, but we can clearly see that it delivered a higher total return than the market in 2022:

As we can see here, this fund did manage to beat the S&P 500 Index in terms of total return during 2022, although it lost to the Dow Jones. It also lost to both indices over longer periods of time. This is due to the fund’s focus on dividend stocks, which tend to hold up better during periods of market volatility than high-growth and speculative assets that tend to outperform during bull markets. As such, this fund may prove somewhat more attractive to an investor that does not want to lose sleep over unrealized losses during weak markets than a broader market index fund. The fact that it has a higher yield than index funds also make it a reasonable play for an investor that wants to preserve their capital and still generate a high yield.

A look at the largest positions in the fund would likely lead one to think that this is a global fund that purchases stocks issued by companies all around the world. After all, Swedish Match ( SWMAY ) and Sony ( SONY ) are both foreign companies. This is certainly the case, although the fund is very heavily weighted toward the United States. In fact, 79.87% of the company’s portfolio is invested in American companies:

The United States only accounts for a bit less than a quarter of the global gross domestic product so the fund is very overweighted to the country in comparison to its actual representation in the global economy. However, most global funds are overweighted to that nation as most have about 60% to 70% of their portfolios invested in the United States. Clearly, the Gabelli Dividend & Income Trust is well above that level. This is something to consider when constructing your portfolio as you will need to make sure that you have sufficient international exposure from other sources across your entire portfolio. This fund apparently does not work on its own to provide the global exposure that is necessary today.

Leverage

As stated earlier, closed-end funds have the ability to employ various strategies that provide them with higher effective yields than any of the underlying assets possess. One of these strategies is the use of leverage, which is employed by the Gabelli Dividend & Income Trust. Basically, the fund is borrowing money and using those borrowed funds to purchase dividend-paying common stocks. As long as the purchased assets deliver a higher total return than the interest rate that the fund needs to pay for the borrowed money, the strategy works pretty well to boost the overall yield of the portfolio. Since the fund is able to borrow money at institutional rates, which are substantially lower than retail rates, this will usually be the case.

Unfortunately, the use of leverage is a double-edged sword. This is because debt boosts both gains and losses. As a result, we need to ensure that the fund is not using too much leverage since that would expose us to too much risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for this reason. As of the time of writing, the Gabelli Dividend & Income Trust fulfills this requirement as its levered assets currently comprise only 13.32% of the portfolio. Thus, the fund appears to be running with a reasonable balance between risk and reward. In fact, the fund could likely take on a bit more leverage to boost its returns and still be acceptable in this respect. Overall, we have nothing to be overly concerned about regarding the fund’s use of leverage.

Distribution Analysis

As stated earlier in the article, the Gabelli Dividend & Income Trust has the stated objective of providing its investors with a high level of total return. In order to achieve this objective, the fund invests primarily in a portfolio of dividend-paying stocks and then applies leverage in order to boost the overall yield. Admittedly, given the low yields of most dividend-paying stocks, this is not a particularly impressive strategy for a yield-hunting investor. However, when we consider that this fund will also be paying out some of its capital gains to its shareholders, we can see that it will likely have a fairly high distribution yield. This is certainly true as the fund currently pays out a monthly distribution of $0.11 per share ($1.32 per share annually), which gives it a 5.98% yield at the current price. That is not particularly impressive for a closed-end fund, although it is still higher than many other things in the market today. The fund has fortunately been quite reliable with its distribution over the years as it has been steadily increasing it since 2009 and has not cut it since that time:

This is one of the better track records of any closed-end fund so it is likely to appeal to those investors that are seeking a steady and secure source of income to use to pay their expenses or finance their lifestyles. The fact that the fund’s distributions are entirely classified as dividend income as opposed to capital gains or return of capital will likely be a source of comfort to these same investors:

The reason why this may be comforting is that dividend income is generally the most sustainable way for a fund to make distributions. This is because it is financed entirely by the income that the fund receives from the stocks or other assets in its portfolio. In contrast, a return of capital distribution can be a sign that the fund is returning the investors’ own money back to them. That is obviously not sustainable over any sort of extended period. A capital gains distribution is paid out of the capital gains that the fund earns, which is fine by itself, but in order for it to be sustainable over a long period of time, the fund’s management must be able to continue to generate a certain level of capital gains. That may not always be possible. Thus, dividend distributions are generally the most sustainable. However, Gabelli funds have a tendency to state that a distribution is a dividend when it is actually not. I pointed this out in a previous article . As such, it is a good idea for us to investigate the fund’s finances in order to determine exactly how it is paying for its distribution and, by extension, how sustainable it is likely to be.

Unfortunately, we do not have an especially recent document that we can consult for that task. The fund’s most recent financial report corresponds to the six-month period that ended on June 30, 2022. As such, it will not include any information about the fund’s performance over the past seven months or so. With that said, much of the market volatility in 2022 started when the Federal Reserve started tightening monetary policy in March so we will still be able to see how the fund handled that even reflected in this report. During the six-month period, the Gabelli Dividend & Income Trust received a total of $23,270,449 in dividends and another $193,867 in interest from the investments in its portfolio. This gives the fund a total income of $23,464,316 during the period. It paid its expenses out of this amount, leaving it with $7,450,691 available for investors. That was nowhere close to enough to cover the $59,636,088 that the fund paid out in distributions. Thus, it does not appear that the fund’s distributions are actually dividend income as it is failing to cover its distributions out of net investment income.

However, this does not necessarily mean that the fund’s distributions are not sustainable. This is because it does have other ways to get the money that is used to pay for the distribution. One of these methods is through capital gains. The fund did generally fail at this, but the situation is not as bad as we may think. In aggregate, the fund reported net realized gains of $63,526,778 but this was offset by net unrealized losses of $581,279,235 during the period. That is concerning, although the fund did have sufficient net investment income and net realized gains to cover the distribution. The big reason for the concern is that it seems unlikely that the fund managed to generate comparable gains in the second half of 2022. That is because the fund may have gotten some of those gains by selling before the market decline that followed the Federal Reserve’s rate hikes. The steep unrealized losses also mean that the fund now has to generate higher percentage returns to match its performance during the first half of the year. Thus, management had a harder job during the second half of the year than during the first half. We will want to have a look at the fund’s full-year report once it is finally released, but there are some reasons to be concerned.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return on that asset. In the case of a closed-end fund like the Gabelli Dividend & Income Trust, the usual way to value it is by looking at the fund’s net asset value. The net asset value of a fund is the total current market value of all of the fund’s assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to purchase shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are acquiring the fund’s assets for less than they are actually worth. That is fortunately the case with this fund today. As of February 8, 2023 (the most recent date for which data is currently available), the Gabelli Dividend & Income Trust had a net asset value of $25.34 per share but the shares only traded for $22.07 per share. This gives the shares a 12.90% discount to the net asset value at the current price. This is not quite as good as the 13.81% discount that the shares have traded at on average over the past month but any fund trading at a double-digit discount has a reasonable price. Overall, this fund is not a bad value today.

Conclusion

In conclusion, the Gabelli Dividend & Income Trust is employing a dividend-investing strategy, which is generally a popular one among retail investors. This has the advantage of being a relatively conservative strategy that frequently outperforms during periods of market weakness. This is evident in the fact that this is one of the few closed-end funds that has outperformed the S&P 500 Index during 2022.

Unfortunately, there appear to be some questions as to whether or not Gabelli Dividend & Income Trust can sustain its distribution. As such, it will be a good idea to keep a cautious eye on the fund until it releases its full-year report. The current price does allow a margin for safety and overall investors could certainly do worse than this fund today.

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