GLO - GLO: High Leverage And Expenses Make This A Fund To Avoid

2023-04-05 11:24:04 ET

Summary

• American investors are almost always overly exposed to the United States, which creates risks that can be avoided.
• Clough Global Opportunities Fund invests in a portfolio of assets from around the world, although it is heavily weighted to the United States.
• The closed-end fund employs a substantial amount of leverage that significantly increases its investment risk.
• The GLO fund is failing to generate a positive NII due to excessive expenses and its asset base fell substantially over the past year.
• The fund is trading at a reasonable valuation, but it is not really suitable for anything except for a raging bull market.

One of the biggest problems with the portfolios of most American investors is that they are overly exposed to the United States. This is certainly understandable, particularly as the United States has outperformed most other major countries over the past decade. Thus, even a portfolio that was properly diversified internationally a decade ago might no longer be without constant rebalancing. This is something called "home country bias," and it affects investors in most nations. Unfortunately, it does expose an investor to many risks as macroeconomic problems at home could cause both a reduction in income and wipe out your savings. Thus, it is important to ensure that you have sufficient international diversification across your portfolio to protect you against problems that affect only one individual country.

One of the best ways to achieve this international diversification is to invest in a closed-end fund, or CEF, that invests its assets in securities from around the world. In some ways, these funds are better than ordinary mutual funds because they are able to use certain strategies that enhance their yield and total return, which are unavailable to open-ended funds. Unfortunately, they are not particularly well-followed in the financial media and many investment advisors are unaware of them, so it can be difficult to find the necessary information on them.

In this article, we will discuss the Clough Global Opportunities Fund ( GLO ), which is one fund that invests in securities from issuers all around the world. This fund boasts a remarkable 11.80% yield at the current price, which is certainly an attractive return but unfortunately might also be a sign that the market expects a distribution cut. I have discussed this fund before, but well over a year has passed since that time so obviously, a great many things have changed. This article will therefore focus specifically on those changes as well as provide an updated analysis of the fund's finances. Let us investigate and see if this fund could be a reasonable addition to a portfolio today.

About The Fund

According to the fund's webpage , the Clough Global Opportunities Fund has the stated objective of providing its investors with a high level of total return. This is certainly not surprising for an equity fund, since common equities are a total return vehicle. After all, investors purchase these securities in order to receive income from the dividends that they pay out as well as benefit from capital appreciation as the issuing company grows and prospers. However, the Clough Global Opportunities Fund is not exclusively a common equity fund. In fact, its portfolio is comprised of a mix of common stock and fixed-income securities such as bonds:

This is something that could prove to be an advantage to the fund's investors due to the fact that fixed-income securities and common equities have different risk profiles and characteristics. For example, common stock offers much greater potential for capital appreciation than bonds because bonds have no inherent link with the growth and prosperity of the issuing company. However, bonds are much safer than common stock because the bondholders must be paid first during bankruptcy or liquidation proceedings. In addition, the purchaser of a bond is guaranteed to receive the face value of a bond at maturity, but the owner of common equity has no guarantee that they will ever recover their original investment. Meanwhile, bonds usually have a higher yield than common stock so the presence of the bonds in the fund's portfolio results in it having a higher income than it would with an all-stock portfolio.

The fund has no specific rules with respect to the mix of stocks and bonds in its portfolio. From the webpage:

"The Fund's investment objective is to provide a high level of total return. The Fund seeks to achieve this objective by applying a fundamental research-driven investment process and will invest in equity and equity-related securities as well as fixed-income securities, including both corporate and sovereign debt. The Clough Global Opportunities Fund will invest in both U.S. and non-U.S. markets."

Thus, the fund appears to have the ability to alter the mix of stocks and bonds in its portfolio in response to changes in the market environment. This is something that is quite nice as historically stocks and bonds have moved opposite of each other. For example, in an overheating economy, the Federal Reserve will raise interest rates in order to prevent inflation and thus drive down bond prices. However, stocks will be increasing in price because of the powerful economic growth. This was not the case in either 2018 or 2022, as both years saw stock prices fall when the central bank raised rates. This is mostly because the economy never properly recovered from the financial crisis fifteen years ago and the central bank left rates too low for too long, resulting in an enormous asset bubble and an economy that is completely dependent on and addicted to cheap credit. Eventually, this will probably resolve itself, but it will be like a drug addict and take some time and pain to properly heal. Regardless, the ability to diversify its asset mix between stocks and bonds should prove to be an advantage in any economic conditions. In theory, this could also help the fund maintain a stable share price, but that was not the case over the past year. In fact, the Clough Global Opportunities Fund is down a whopping 48.11% over the past twelve months:

This is at least partly due to the risks that I highlighted in my previous article on this fund. In short, this fund uses a tremendous amount of leverage that causes it to decline much more than the market during bear environments. As both stocks and bonds broadly fell over the past year, this fund got obliterated. Thus, the fact that this is a mixed fund did not protect its investors like it theoretically should have back over the past year.

One of the nice things about the Clough Global Opportunities Fund is that the portfolio looks very different from most other closed-end funds. Here are the largest positions:

This portfolio looks very different from the last time that we looked at the fund. In fact, only two of the companies that are currently on the list were on it the last time that we looked at the fund. These two core positions are Microsoft Corporation ( MSFT ) and Royal Caribbean Cruises Ltd. ( RCL ). All of the remaining positions are new:

Although well over a year has passed since we last looked at this fund, this is still a substantial number of positions to have been traded. This implies that the Clough Global Opportunities Fund has a very high turnover rate. This is confirmed by the fund's 212.00% annual turnover in 2022, which is the highest level that I have ever seen a closed-end fund possess. The reason that this is important is that it costs money to trade stocks and bonds, and these expenses are billed directly to the fund's investors. This creates a drag on the overall performance of the portfolio and makes the job of management much more difficult. After all, the fund's managers will need to earn a sufficiently high return to cover the extra expenses and still earn a sufficiently high return to satisfy the investors. That is something that very few management teams have achieved sufficiently, which is one reason why most actively-managed funds fail to beat their benchmark indices. Obviously, this one is no exception since the Clough Global Opportunities Fund underperformed every major broad-based domestic and foreign stock index in 2022.

A look at the largest positions in the fund reveals a surprisingly large number of American companies versus foreign ones. In fact, this is a problem with this fund that I pointed out the last time that we looked at it. This is that fully 65.76% of the fund is invested in American securities:

The United States only accounts for a bit less than 25% of the global gross domestic product. Thus, this fund is substantially overweighted to this country based on its actual representation in the global economy. However, this is not completely out of line with what other global funds have so we cannot really complain about it in that respect. However, the fund's very high weighting to this country does mean that our thoughts of using this fund as a way to diversify our assets internationally and reduce home country risk are effectively invalid. We do still have some protection against regime risk as 34.24% of the fund is not invested in the United States, but we will still want to supplement this fund with an international fund (that does not include American securities) in our portfolios in order to achieve true international diversification.

Leverage

As mentioned earlier in the article, the Clough Global Opportunities Fund employs leverage as part of its strategy. This is one of the methods by which closed-end funds can deliver much higher yields and returns than their open-end fund cousins. In short, the fund borrows money and then uses that borrowed money to purchase stocks and bonds. As long as the purchased assets deliver a higher return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the overall yield and total return of the portfolio. As this fund is capable of borrowing money at institutional rates, which are significantly lower than retail rates, this will usually be the case.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As stated earlier, this is almost certainly one reason why the fund fell much more than any of the broad-based market indices over the past year. Due to this problem, we want to ensure that the fund does not have too much leverage because that would expose us to too much risk. I do not usually like to see a fund's leverage exceed a third as a percentage of its assets for this reason. The Clough Global Opportunities Fund currently has levered assets comprising 53.66% of its portfolio, which is not only well above the level that we want to see but also the highest level that I have ever seen. This fund is thus running a very high-risk, high-reward strategy that could potentially work during raging bull markets but also results in very steep losses during a bear market. It may be best to avoid this fund due to the risks inherent in this leverage unless you are truly willing to risk losing your money.

Distribution Analysis

As mentioned earlier in this article, the Clough Global Opportunities Fund has the stated objective of providing its investors with a high level of total return. In order to achieve this objective, the fund invests in common equities and debt from around the world. While this alone is not necessarily conducive to a high yield, the fund then applies a significant amount of leverage to boost the total returns on its assets. As is the case with most closed-end funds, it aims to distribute all of its investment income and capital gains to its investors via direct payments. Overall, we can expect that this fund will boast a very high distribution yield. This is certainly the case as the fund pays out a monthly distribution of $0.0483 per share ($0.5796 per share annually), which gives the fund an 11.80% yield at the current share price. Unfortunately, the fund's distribution has not been especially consistent over the years. In fact, it has exhibited considerable variation over time:

This variable distribution is likely to be somewhat off-putting for those investors that are seeking a safe and secure source of income to use to pay their bills. This is especially the case recently, as the fund cut its monthly distribution by 48.8% back in January of this year. This cut brought its distribution down to its lowest level in history. It is not really surprising that the fund had to reduce its distribution considering the poor performance that the fund delivered over the course of 2022. However, as I have pointed out numerous times in the past, the fund's distribution history is not exactly the most important thing for anyone buying shares today. This is because a new investor will receive the current distribution at the current yield and will not really suffer any significant adverse consequences from its disappointing past performance. As such, we want to investigate how well the fund can maintain its current distribution.

Unfortunately, we do not have an especially recent document that we can consult for this purpose. The fund's most recent financial report corresponds to the full-year period that ended on October 31, 2022. As such, it will not include any information about the fund's performance over the past few months. However, the worst of the market turbulence was in the first half of last year, and that time period will be reflected in this report. Thus, it should be able to provide us with a good idea of how well this fund weathered the challenging market conditions. During the full-year period, the Clough Global Opportunities Fund received $4,209,712 in dividends and $4,492,899 in interest from the investments in its portfolio. When we combine this with a small amount of income from other sources, the fund had a total income of $8,943,610 over the period. This amount was not enough to cover the fund's expenses, which is very concerning. The fund reported a net investment loss of $7,552,691 over the course of the year. That is obviously not enough to pay any distribution, but the fund actually paid $26,322,087 in distributions to its shareholders. At first glance, this is very concerning as the fund did not have sufficient net investment income to cover its distributions. The fact that the fund's expenses are incredibly high is also a bit of a concern.

Fortunately, the fund does have other methods that can allow it to earn the money that it needs to cover the distribution. For example, the fund might have significant capital gains. As is probably expected from the volatile market of 2022 though, this fund failed miserably at that. The Clough Global Opportunities Fund had net realized losses of $49,490,363 and suffered $54,718,133 net unrealized losses. Despite the fact that the fund did a secondary offering that raised $14,074,176, its assets still declined by $119,805,080 over the course of the year. This certainly explains the distribution cut earlier this year as the fund cannot sustain losses of this magnitude for very long. The fact that the market has been stronger this year could help things somewhat, but the fact that the fund's expenses exceed its net investment income by a factor of two means that it is going to need to generate pretty strong capital gains just to cover its expenses, let alone distribute any money. I recommend avoiding this fund for that reason.

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 Clough Global Opportunities Fund, 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 the fund's assets minus any outstanding debt. This 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 acquire them at a price that is less than the net asset value. This is because such a scenario implies that we are buying the fund's assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of April 4, 2023 (the most recent date for which data is currently available), the Clough Global Opportunities Fund had a net asset value of $5.73 per share but the shares currently trade for $4.92 per share. That gives the fund's shares a 14.14% discount to net asset value at the current price. This is a reasonable price that is better than the 12.52% discount that the shares have averaged over the past month, but I am still hesitant to recommend buying this fund because of the aforementioned high risks.

Conclusion

In conclusion, the Clough Global Opportunities Fund does not really appear to be a great way for investors to improve the international diversity of its portfolio, although it does have a vastly different portfolio than most global funds. The biggest problem here is that the fund has tremendously high leverage and expenses that lead to it performing poorly in anything but a raging bull market. The fund should be able to perform reasonably well in that environment though since the high leverage will boost its gains sufficiently to cover the high expenses. However, it does not seem like a raging bull market is likely to occur in the near term, so it is probably best to avoid the Clough Global Opportunities Fund for now.

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