JCE - JCE: Valuation Stays Around Fair Value

2024-01-19 16:46:31 ET

Summary

• Nuveen Core Equity Alpha Fund provides exposure to large-cap companies and uses a call-writing strategy to generate options premiums for distributions and potentially dampen volatility.
• The JCE closed-end fund's discount/premium seems to have somewhat stabilized, but it's around the longer-term average, making it appear fairly valued.
• The JCE fund offers a relatively high distribution rate, but the distribution is largely covered by capital gains, which can come under pressure in a down market.

Written by Nick Ackerman, co-produced by Stanford Chemist.

Nuveen Core Equity Alpha Fund ( JCE ) provides investors with exposure to a basket of primarily large-cap equity investments that mirror the S&P 500 Index (SP500). They then write calls to generate options premiums to provide a higher distribution and dampen volatility slightly. When the market is raging higher, a call-writing strategy will limit overall results, but collecting some option premium during a slightly down market can help offset a bit of losses. Additionally, in a flat market - which doesn't happen very often - it can still produce some returns for investors.

The last time we covered the fund was at the beginning of November 2023. That was right in time to catch the rapid rebound when the broader equity markets hit correction territory briefly.

During this period, the fund underperformed, and some of that was the discount widening a touch further. That means during this time, the fund's underlying portfolio actually performed a bit better, but that wasn't reflected in the fund's share price results.

JCE Basics

• 1-Year Z-score: -0.37
• Discount: -2.49%
• Distribution Yield: 9.89%
• Expense Ratio: 1.02%
• Leverage: N/A
• Managed Assets: $213.669 million
• Structure: Perpetual.

JCE's investment objective is "to provide an attractive level of total return, primarily through long-term capital appreciation and secondarily through income and gains."

To achieve this, the fund will invest

"in a portfolio of actively managed large-capitalization common stocks, using a proprietary quantitative process designed to provide the potential for long-term outperformance."

They will additionally:

"sell call options with a notional value of up to 50% of the Fund's equity portfolio in seeking to enhance risk-adjusted performance relative to an all-equity portfolio."

The fund doesn't incorporate any leverage in the form of borrowings. That could be a positive for investors looking to avoid high amounts of leverage while we are in a higher-rate environment. That said, this fund is also quite small in terms of total managed assets, and that can generally limit liquidity. A larger investor could find it difficult to get in and out of a large position in a short period of time.

Still Around Fair Value

In our previous coverage, we were actually looking at a revisit of the fund in terms of how it performed against a couple of call-writing peers previously covered . This was because JCE was looking a bit richly valued, and it had actually been fairly volatile in terms of discounts/premiums for the last couple of years. The alternatives were the First Trust Enhanced Equity Income Fund ( FFA ) and Voya Global Advantage and Premium Opportunity Fund ( IGA ).

FFA far exceeded the performance relative to JCE, and IGA came in line with total share price results. IGA was able to do that despite the underlying portfolio underperformance, thanks to JCE's premium coming down. In fact, during that time, IGA even saw its discount widen a bit further.

For JCE's discount/premium, we now seem to have hit a period of somewhat calmer times. However, the fund did actually recently touch a premium again on a few occasions in the last few months. It just wasn't as anything extreme as what we saw in 2022 when it was running to a 20%+ premium valuation.

As of today, the fund appears to be trading around its decade-long average level and even its 1- year average level. That's where the 1-year z-score reflects only a -0.37 figure.

Overall, I believe that JCE still appears to be a "Hold" today based on its trading around fair value based on its discount. Investors in this fund can still earn a decent return going forward, but there really isn't too much upside in terms of premium valuation. That is, unless they believe the fund can return to its former premium levels.

Distribution Looks Enticing

One of the appeals of JCE is the relatively higher distribution rate it pays out to investors. Given the shallow discount, the NAV rate of 9.65% is quite similar to the market rate of 9.89%.

That said, as is the case with nearly all closed-end fund, or CEF, equity funds, the distribution will largely be covered via capital gains. In a down market, that can definitely pressure the fund as it can erode the NAV if they continue to pay the same level.

For JCE, it appears that the management has no problem adjusting the distribution when necessary. Some investors don't enjoy that and instead want a level distribution policy for years at a time. That could keep JCE from becoming a candidate for such an investor.

As of the fund's last semi-annual report, we can see that net investment income ("NII") took a hit this year. Even if we were to annualize the six-month figure, it has slipped from the prior year. That is even as the fund was able to issue some new shares thanks to its premium trading level and the dividend reinvestment policy.

On a per-share basis, the fund's NII came to $0.03 compared to $0.10 for the prior year. Again, this simply reflects that the distribution will largely be funded - if it is covered - through capital gains the portfolio may be able to produce.

However, instead of just squeezing some capital gains from the fund's underlying portfolio, the fund's option writing strategy can also contribute to the capital gains pool. In the last semi-annual report, the options written contributed positively to the realized gains pool.

Overall, the largest contributor to seeing a strong first-half reporting period was the sizeable unrealized appreciation of the underlying portfolio. Additionally, on an unrealized basis, the fund's options writing contributed to losses. Of course, that reduced the fund's overall net results. This is where we can start to see the negative drag that options writing can have on call writing funds in a rising market.

The official breakdown for 2023 tax distribution classifications has not been released yet from Nuveen. That said, the 2022 results showed us that a large majority was actually non-qualified dividend income. Long-term capital gains and some return of capital also made the breakdown.

That was a bit surprising and quite a drastic change from the prior year. In 2021 , the significant majority of 83.43% was classified as long-term capital gains. Generally speaking, the LTCG classification is rather shareholder-friendly in terms of tax consequences. LTCG is also what I would generally expect to contribute to the largest classification of the distribution, as is often the case with most of its peers.

JCE's Portfolio

Turnover for this fund was last reported at 51%, but that was in the fund's semi-annual report, which would bring the annualized figure to just over 100%. That puts it in line with the turnover rate of the prior couple of years. Indicating that this fund is quite active in terms of shifting its portfolio around. It invests primarily in names that strongly reflect the S&P 500 (SP500) tilt. That is, the names you see, such as the Magnificent 7 in the S&P 500, appear as top names here.

That said, the portfolio is listed as only 126 holdings, so they mirror the index in a meaningfully lower quantity of names.

This is something that is particularly important for JCE, though. That's because this fund doesn't write covered calls, but it writes calls against the S&P 500 Index itself primarily. If their portfolio was significantly different than the results of the S&P 500, that could create a situation where the fund's options writing is losing money, and at the same time, so is its underlying portfolio.

An index can't be owned directly. Index options are cash-settled; therefore, in theory, the strategy can generate unlimited losses. So, this is essentially "covering" by owning the index by mirroring the holdings with the most significant impact on the index.

In general, writing call options can limit the upside. Sometimes, funds leave a little bit of room to move higher before hitting the ceiling, but that sacrifices options premiums that can be generated.

For JCE, they have essentially no upside potential on the amount of the portfolio that is overwritten. This is because they are writing options that appear to be right at-the-money. Where they do leave themselves some wiggle room is in terms of the amount of the portfolio being overwritten. Their strategy simply stipulates "up to 50%." They came in at a 24% overwrite as of the latest information available.

Conclusion

Nuveen Core Equity Alpha Fund is continuing to trade at what would appear to be around its fair value discount level, in my opinion. While the fund enjoyed a spike to a 20% premium, that was a bit of an anomaly. For the most part, the fund has averaged trading at a discount, and I'd like to see that move to a wider level before getting too excited about this name. That said, for investors already holding, the current distribution rate certainly is solid, and that can definitely make it easier to hold at this time.

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