RIV - RIV: A Unique CEF To Boost Your Income

2023-05-22 06:25:53 ET

Summary

• Investors are desperate for new sources of income to maintain their lifestyles in the face of a rapidly-rising cost of living.
• RIV invests in SPACs, BDCs, and CEFs, which allows it to add a great deal of diversification to an ordinary stock and bond portfolio.
• The fund's share price has delivered disappointing performance over the past year, but its underlying portfolio has performed much better than the shares.
• The fund currently yields 13.87%, and this is probably sustainable going forward.
• The fund is currently trading at a fairly attractive discount to the net asset value.

Without a doubt, one of the biggest problems facing the average American today is the rapidly rising cost of living. This is evidenced by the consumer price index, which claims to measure the price level of a basket of goods that is regularly purchased by an average consumer. As we can see here, over the past twelve months, there have only been two months in which the consumer price index did not rise at least 6% year-over-year:

While the consumer price index is showing that inflation has been slowing down over the past few months, this may be misleading. As I pointed out in a recent blog post , the reported decline has been entirely driven by declining energy prices. The International Energy Agency recently released data that shows that the energy price weakness may soon be about to reverse, which will rapidly undo all of the progress against inflation that the above chart displays. In addition to this, inflation still remains much higher than the 2% year-over-year target of the Federal Reserve. Thus, it remains very uncertain what the future may bring as far as the cost of living is concerned.

Regardless, the high inflation has already strained the budgets of many ordinary people. As I have pointed out in numerous previous articles, many Americans have been forced to draw down the savings that they accumulated during the pandemic just to make ends meet. Just recently, outstanding consumer debt set a new record, clearly indicating that people are struggling to remain above water financially. In short, many people are in desperate need of additional sources of income.

As investors, we are certainly not immune to this since we are also consumers and have seen the prices of the goods and services that we purchase increase over the past year. However, we do have the ability to put our money to work for us to earn additional income. One of the best ways to do this is to purchase shares of a closed-end fund that specializes in the generation of income. These funds are unfortunately not very well followed in the investment media, so it can be difficult to obtain the information that we would like to have to make an informed decision. This is a shame as these funds have a number of advantages over ordinary open-ended and exchange-traded funds. In particular, they have the ability to employ certain strategies that can boost their yields far beyond anything else in the market.

In this article, we will discuss the RiverNorth Opportunities Fund ( RIV ), which currently boasts a very appetizing 13.87% yield at the current price. This yield is certainly high enough to get the attention of any income-focused investor, but anything that has a yield this high is surrounded by concerns that the payout is unsustainable. We will want to pay specific attention to that over the course of this article. I have discussed this fund before, but a few months have passed since that time so naturally a few things have changed. This article will therefore focus specifically on these changes, as well as provide an updated analysis of the fund's finances.

About The Fund

According to the fund's webpage, the RiverNorth Opportunities Fund has the stated objective of providing its investors with a high level of total return. That is not especially surprising since this is a hybrid fund that invests in both fixed-income and common equity securities:

As we can clearly see, the fund's largest position is in fixed-income securities such as bonds and preferred stock. However, it also has significant exposure to common equity securities issued by special purpose acquisition companies, business development companies, and similar entities. This is in line with the fund's description of its strategy from the webpage:

The fund employs a tactical allocation strategy primarily comprised of closed-end funds, exchange-traded funds, special purpose acquisition companies, and business development companies.

This is something that separates it from most other closed-end funds. Most funds invest in either common stock or fixed-income securities exclusively. There are very few that invest in business development companies or other closed-end funds. That is certainly not a problem though, as it provides investors with access to asset classes that might be hard to include in a portfolio otherwise. Business development companies in particular can add a great deal of diversity to a portfolio because they generally invest in private companies. Business development companies, therefore, provide one of the only ways for non-accredited investors to gain exposure to these opportunities, which is nice because private investments can substantially outperform anything in the public markets. This is one of the reasons why companies such as Brookfield Asset Management ( BAM ) and Apollo Global Management ( APO ) have seen growing assets under management in recent years. Business development companies also typically have very high yields. For example, Ares Capital ( ARCC ), which is the largest business development company in the United States, currently has a yield of 10.26%, and FS KKR Capital ( FSK ), another large business development company, yields 13.31% at the current price.

Special purpose investment companies, which comprise the largest weighting of this fund other than fixed-income, also provide a way for non-accredited investors to gain access to private investments. These entities basically attempt to raise a substantial amount of money from investors and then purchase a private company. In short, they offer a way to take a private company public without needing to conduct an initial public offering. These entities were popular during the post-pandemic market bubble, but have admittedly lost some of their previous shine as the Federal Reserve has tightened up market liquidity significantly. However, they can still provide substantial returns if the special purpose acquisition company purchases the right private company. The fact that the RiverNorth Opportunities Fund employs a professional management team could be useful here as it may be able to separate the good opportunities from the bad ones in this space.

Unfortunately, the rather unique nature of the fund's assets and the skills of its management team were not able to prevent its shares from handing shareholders a loss over the past year. Over the trailing twelve-month period, the fund's share price declined 19.97%:

As I have pointed out in various previous articles though, the share price of a closed-end fund is not necessarily indicative of the return that shareholders receive nor does it directly correlate with the return of the fund's underlying portfolio. After all, anyone that held this fund over the one-year period would have received a significant amount of distributions that would offset some of the market price declines. In fact, as of April 30, 2023, the fund's portfolio delivered a positive total return over the trailing one-year period despite the fact that its shares delivered a -12.57% return:

This is, admittedly, one of the biggest differences between a fund's portfolio and market performances that I have ever seen. The reason for this is probably a combination of repricing of risk as well as a reduction in market liquidity. Back in April 2022, when this started, most money market funds were yielding next to nothing but today the money market is yielding 4.50% to 5.00% with almost no more risk than a bank account. Thus, people no longer want to take on the risk of investing in a fund like this just to obtain some sort of yield. In addition, the M2 money supply has dropped for the first time since the United States went off of the gold standard:

Thus, there is less money in the system that is trying to find some kind of yield for its investors. Investors that are hungry for yield thus no longer have as much of a desire to take on risk to get it. This has affected everything in the market regardless of the actual performance or fundamentals as we have seen the share prices of most income-focused closed-end funds underperform more than their portfolios. This one has just been greater than most other funds due to the unique nature of the assets that it holds. For example, the fact that special purpose acquisition companies are no longer dominating financial headlines as they did back in 2021 has caused investor appetite to sour. As we will see later in this article though, this may have created an opportunity for investors to acquire the fund's assets for less than they are actually worth.

Leverage

As I stated in the introduction to this article, closed-end funds like the RiverNorth Opportunities Fund have the ability to employ certain strategies that can boost the yield of its portfolio above that of the underlying assets. One of these strategies is the use of leverage. In short, the fund borrows money and then uses that borrowed money to purchase shares of closed-end funds, special purpose acquisition companies, and business development companies. As long as the purchased assets have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing money at institutional rates, which are considerably 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 such, we want to ensure that the fund is not employing too much leverage as 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 assets for this reason. This is doubly true for this fund since many of the assets that it invests in will employ leverage themselves. Unfortunately, this fund exceeds my leverage target as its levered assets currently comprise 35.51% of the portfolio. When we consider that half of the fund's assets are invested in closed-end funds that are probably using similar levels of leverage, we can see that this fund is almost certainly going to be much more volatile than the market. That may make it too risky for some investors.

Distribution Analysis

The primary investment objective of the RiverNorth Opportunities Fund is to provide its investors with a high level of total return. The fund specifically states that it will accomplish this by investing in assets that should provide income and the potential for capital gains. The fact that it invests in closed-end funds and business development companies reinforces this as these entities typically have some of the highest yields in the market. This fund then applies a layer of leverage in an effort to boost its effective yield beyond these levels. As such, we might assume that the fund boasts a very high yield itself. That is certainly true as the RiverNorth Opportunities Fund pays a monthly distribution of $0.1278 per share ($1.5336 per share annually), which gives it a 13.87% yield at the current price. This fund has been reasonably consistent with its distribution over the years, although it has not been perfect:

We can see that the fund has made an effort to be consistent, although it has varied the distribution from time to time. Most recently, the fund cut its distribution back in January of this year. That was not unexpected, as the fund took a beating when the Federal Reserve started hiking interest rates and traditional yield vehicles like business development companies and special purpose acquisition companies lost some of their appeal. We discussed this a few minutes ago. This is likely to reduce the fund's appeal in the eyes of those investors that are seeking a safe and secure source of income to use to pay their bills or finance their lifestyles. However, it is important to note that anyone purchasing shares of this fund today will receive the current distribution at the current yield so does not have to worry about the fund's past. The most important thing for a buyer today is the fund's ability to sustain its distribution at the current level. Let us investigate this.

Fortunately, we have a very recent document that we can consult for this task. As of the time of writing, the fund's most recent financial report corresponds to the six-month period that ended on January 31, 2023. This is a much newer report than we had available the last time that we looked at this fund, which is nice as it should be able to provide us with better insight into the items that led to the distribution cut as well as a more clear picture into the fund's performance during one of the more challenging market years in the past decade. During the six-month period, the RiverNorth Opportunities Fund received $9,875,118 in dividends and $1,461,809 in interest from the assets in its portfolio. That gives the fund a total investment income of $11,336,927 during the period. The fund paid its expenses out of this amount, which left it with $8,555,452 available for the shareholders. That was nowhere close to enough to cover the $19,528,379 that the fund actually paid out over the period, which was somewhat expected given the distribution cut. This is something that may be concerning as the fund clearly did not have enough net investment income to cover the distributions.

However, the fund does have other methods through which it can obtain the money that it needs to cover its payouts. For example, it might have capital gains. It is also common for closed-end funds to make return of capital distributions, which would result in the RiverNorth Opportunities Fund receiving some money that is not included in net investment income. However, the fund actually had mixed results here. During the six-month period, it reported net realized losses of $8,163,443 but this was offset by net unrealized gains of $9,259,939. The fund still failed to cover its distributions solely through its portfolio performance, however. During the period, the fund issued new shares totaling $38,034,976, which was sufficient to fully cover the distributions with a substantial amount of money left over. Overall, the fund's assets went up by $26,062,677 over the period but this increase was only due to the new money that came in. This certainly explains the distribution cut as the fund relied on outside money to make its distributions during the period, which is not sustainable over the long term. The question is whether or not the payout will be sustainable at the new level, which is questionable. The market has been relatively flat so far this year (apart from the strong performance of a handful of technology stocks), but the assets in this fund's portfolio will have been paying out dividends and distributions that provide some sort of investment return. Thus, we will have to wait for a few more months to see how well the fund is covering its new lower distribution, but I am cautiously optimistic right now.

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 earn a suboptimal return on that asset. In the case of a closed-end fund like the RiverNorth 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 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. I referenced this scenario earlier in this article. Fortunately, this is the case with this fund today. As of May 18, 2023 (the most recent date for which data is available as of the time of writing), the RiverNorth Opportunities Fund had a net asset value of $12.11 per share but the shares only trade for $11.06 each. This gives the shares an 8.67% discount to the net asset value at the current price. That is slightly better than the 7.90% discount that the shares have had on average over the past month. Thus, the price certainly looks to be reasonable today.

Conclusion

In conclusion, the RiverNorth Opportunities Fund is a rather unique closed-end fund that provides investors with a way to increase the diversification of their portfolios. This is something that could certainly be appealing, especially as the S&P 500 Index ( SP500 ) has become increasingly concentrated in only a few technology names over the past few weeks. The assets that this fund invests in provide access to private companies, which can deliver outsized returns that are not correlated with other assets. The fund's finances have improved considerably since we last reviewed it, which is nice as that is important for the sustainability of the distribution. The fund is also trading at a very nice discount to the net asset value, so it might be worth buying today.

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