IAE - IAE: Distribution Still Unsustainable Even After Cuts

2023-08-16 03:03:01 ET

Summary

• The Voya Asia Pacific High Dividend Equity Income Fund aims to deliver high current income and capital appreciation from a portfolio of Asia Pacific equities.
• The IAE fund exhibits classic signs of being an amortizing 'return of principal' fund, with a high distribution yield that appears unsupported by the fund's total returns.
• Investors are encouraged to avoid 'return of principal' funds as long-term investments in these funds may lead to loss of both principal and income.

I came across the Voya Asia Pacific High Dividend Equity Income Fund ( IAE ) while screening for high yielding funds.

Although the IAE fund pays a very attractive 10.6% distribution yield, the distribution does not appear to be supported by the fund's earnings power, with 5 and 10Yr average annual returns of only 1.8% and 2.9% respectively. In effect, investors in the IAE fund are getting paid back their own principal in the form of the distribution.

Fund Overview

The Voya Asia Pacific High Dividend Equity Income Fund is a closed-end fund ("CEF") that aims to deliver current income and capital appreciation from a portfolio of Asia Pacific companies. The IAE fund may also write call options on 0-50% of the notional of the portfolio on select Asia Pacific indices and/or specific stocks and/or ETFs to generate additional income.

The IAE fund has $82 million in net assets and pays a 1.2% net expense ratio.

Portfolio Holdings

Figure 1 shows the geographical allocation of the IAE fund, with 28% invested in Chinese equities, 16% in Australia, 15% in Taiwan, 13% in India, and 12% in South Korea.

The large weight in Taiwan and South Korean equities leads to Technology being the largest sector weight at 23%. This is followed by Financials at 22%, and Consumer Cyclicals at 11% (Figure 2). The IAE fund is not very diversified as technology and financial stocks contribute almost half of the portfolio.

Figure 3 shows the top 10 holdings of the IAE fund, with TSMC being the largest holding at 6.5%. The top 10 holdings account for 25.2% of the portfolio.

Returns

the IAE fund has delivered modest historical returns, with 3/5/10/15Yr average annual returns of 4.1%/1.8%/2.9%/2.9% respectively to July 31, 2023 (Figure 4).

A large part of the fund's poor returns can be attributed to its large weight in Chinese equities that have done poorly in the past few years.

For example, the iShares MSCI All Country Asia ex Japan ETF ( AAXJ ), a passive ETF? which has geographical allocation similar to the IAE fund (Figure 5, with the notable exclusion of Australian equities), have done as poorly as the IAE, with 3/5/10Yr average annual returns of -0.3%/1.3%/4.2% respectively to July 31, 2023 (Figure 6).

Distribution & Yield

However, despite its history of poor total returns, the IAE fund pays a very high distribution yield, currently set at $0.16 / quarter or a forward yield of 10.6% (Figure 7). On NAV, the IAE fund is paying a 9.1% distribution yield.

In fact, IAE's distribution was even higher prior to being cut at the beginning of 2023, paying $0.215 / quarter for a few years (Figure 8).

Unfortunately, with distribution yield still outstripping the total return of the fund, the IAE fund appears to be a classic 'return of principal' fund as outlined in Eaton Vance's whitepaper, ' Return of Capital Distributions Demystified '.

'Return of principal' funds cannot earn their distributions and must resort to liquidating NAV in order to sustain the high payouts. This causes NAV and market price (which typically tracks NAV) to decline over time. The IAE fund's NAV shows the classic amortizing pattern characteristic of 'return of principal' funds (Figure 9).

Furthermore, as NAV declines, there are less income earning assets to support future distributions, which eventually leads to distribution cuts, as we have seen repeatedly with the IAE fund. The IAE fund has cut its annual distribution from $1.992 in 2008 to $0.64 annualized on a forward basis (Figure 10).

Investors are highly encouraged to avoid 'return of principal' funds as long-term investment in these funds often lead to a loss of both principal (market price follows decline in NAV) and income.

Conclusion

The Voya Asia Pacific High Dividend Equity Income Fund aims to provide high current income and capital appreciation from a portfolio of Asia Pacific equities. Although the IAE fund has delivered only modest historical returns, the returns appear to be inline with the Asia Pacific equities asset class and is not too problematic.

However, my main issue with the IAE fund and many high yielding CEFs in general is that despite weak returns, they continue to maintain a distribution yield that far outstrips their total returns. In effect, unitholders are paid back their own principal, like an annuity.

While some may find this 'feature' attractive, I believe most investors should avoid amortizing 'return of principal' funds like the IAE, as long-term investments in these funds may lead to a loss of both principal and income.

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