HIE - HIE: Term Fund With A High Discount

2023-10-19 23:23:56 ET

Summary

• HIE seeks high current income by investing in high-yielding equities from various sectors.
• HIE has a specific termination date set for November 24, 2024, but it can be extended for one year to November 24, 2025, with approval from the Board of Trustees.
• The fund is currently trading at a discount of -7.9% to its net asset value, potentially making it an attractive investment due to the potential for gains upon liquidation.
• HIE's portfolio is highly concentrated with only 34 holdings, offering potential rewards but also concentration risk.

Thesis

The Miller/Howard High Income Equity ( HIE ) is an equity closed end fund. The vehicle seeks high current income by investing in high-yielding equities from multiple sectors. This CEF is very actively managed, with a high portfolio turnover:

What is particular about HIE is its term structure, with the fund set to mature next year:

The Fund will terminate on November 24, 2024, absent shareholder approval to extend such term. If the Fund’s Board of Trustees (“Board”) believes that under the current market conditions it is in the best interest of the Fund’s shareholders to do so, the Board may extend the termination date for one year, to November 24, 2025, without a shareholder vote upon the affirmative vote of three-quarters of the Board’s trustees then in office.

Source: Semi-Annual Report

As per its Semi-Annual Report, the CEF has the ability to extend the termination date for one year, both by shareholder vote or Board of Trustees vote.

The proximity of a termination date for a CEF prompts us to look at the fund discount, which currently sits at -7.9% to net asset value. As a reminder, upon a CEF liquidation, a shareholder realizes NAV, thus CEFs trading at large discounts close to their termination date are very attractive investments.

HIE has done very well in the past 3 years outperforming its peer group. The fund takes concentrated positions, with only 34 names in the portfolio currently. All assets are liquid, exchange traded equities, and the vehicle is overweight energy names currently. We like this allocation since we are bullish energy into the year end.

A retail investor looking at HIE is buying into a management team's trading acumen as reflected by its track record, a large discount to NAV which is going to narrow upon termination, and an energy heavy allocation.

Analytics

• AUM: $0.18 billion.
• Sharpe Ratio: 0.89 (3Y).
• Std. Deviation: 22.5 (3Y).
• Yield: 6.2%.
• Premium/Discount to NAV: -7.9%.
• Z-Stat: -0.7.
• Leverage Ratio: 24%.
• Composition: High Yielding Equities

Performance

The fund has done well to outperform peers in the ETF space in the past years:

When compared to the Invesco High Yield Equity Dividend Achievers ETF ( PEY ) and the Vanguard Dividend Appreciation ETF ( VIG ), HIE outperforms on a 3-year lookback. In 2023 the CEF is in the middle of the cohort from a performance standpoint:

On a total return basis HIE is flat on the year, while VIG is the only one outperforming. It has been a tough year so far for high yielding stocks due to the rise in rates, with REITs specifically having another negative yearly performance.

Holdings

The fund is currently overweight energy names, an allocation we like a lot:

The vehicle is long some of the best known MLPs in the market, namely Energy Transfer and Enterprise Products:

This CEF is very concentrated, with only 34 holdings in its portfolio. There is significant concentration risk in this CEF. We like energy into the year for several reason, and we have recently penned a number of articles around our view on the sector. With political tension high again in the Middle East, another risk factor is contributing to oil moving higher on the year.

While REITs have been pummeled this year by higher rates, energy equities, and especially MLPs are in a different category from a performance standpoint. Alerian MLP ETF ( AMLP ), a large ETF that contains MLP equities, is up over +14% this year. Energy equities have been able to capitalize on higher revenues to fix their balance sheets and utilize the free cash flows generated to repurchase shares. The sector is now a leader in terms of returning capital to shareholders, and the equity performance in the sector is reflective of that.

Premium/Discount to NAV

The CEF moved to a discount to net asset value during Covid, and never recovered:

HIE's discount to NAV has been very stable around the -8% mark in the past years. This structural feature is very important for HIE since an investor can realize a risk-free 8% gain as the fund moves towards its maturity date.

Upon maturity, a CEF liquidates its assets at market prices and pays out investors on NAV. Any discount to market prices is thus closed out. The fund's collateral is extremely liquid, with all securities being Level 1 assets:

Publicly traded companies must classify all of their assets based on GAAP valuation metrics, with the most liquid class being the Level 1:

Level 1 assets include listed stocks, bonds, funds, or any assets that have a regular mark-to-market mechanism for setting a fair market value. These assets are considered to have a readily observable, transparent prices, and therefore a reliable fair market value.

If a fund contains a high percentage of Level 2 or Level 3 assets, a retail investor must be very careful with NAV valuations since exit prices might differ quite a lot. As a simple example, a fund trying to sell a $10 million level 3 security might get a much lower price if trying to liquidate $50 million of the same issue. So the more illiquid an asset, the larger the potential gap-down upon liquidation.

Conclusion

HIE is an equities closed end fund. The vehicle takes a very active approach in terms of its portfolio, with a high turnover rate. The fund however has managed to significantly outperform ETFs in the space on a 3-year lookback.

The fund is currently overweight Energy and specifically MLP names, a sector which is up this year despite the interest rate headwinds. We like energy into year end, and we expect it to continue to perform.

HIE is a term fund with a termination date scheduled for November 2024. As we close in on the maturity date, the fund will continue to narrow its -8% discount to NAV. We like this name from a composition and structural perspective, and are a Buy here.

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