USA - USA: Discount To NAV Presents Attractive Buy Opportunity

2023-09-24 09:54:58 ET

Summary

• Liberty All-Star Equity Fund provides a juicy 10.7% yield.
• USA is a multi-managed fund, offering stability and capital preservation by avoiding leverage.
• With a rare discount to NAV, this may be a good opportunity to start a position.

I believe that if you are the type of investor that hopes to one day live off the passive income your portfolio produces, it's essential to throw in some high yielding funds to help you get there quicker. Closed-end funds can provide enhanced diversification, attractive yields, and opportunities for capital appreciation, making them valuable additions to an investor's portfolio. I believe this holds true for any investor, young or old.

Granted, there are plenty more downsides for a younger investor to be heavily invested in funds such as CEFs, but that is not what I am suggesting. Rather, I simply believe that having a bit of exposure to funds such as USA is extremely beneficial for investors that put a focus on income generation. USA is a great tool to boost income while also capturing a total return that is similar to major indexes.

Overview

The Liberty All-Star Equity ( USA ) fund employs a unique investment approach among closed end funds by distributing its assets among five institutional managers who cover both "value" and "growth" style mandates. This strategy enhances diversification while combining various areas of expertise. One of the fund's key attractions is it's juicy 10% yield, distributed quarterly based on the fund's NAV (net asset value). Since the distribution is correlated to the NAV, the distributions can vary over time.

USA is a "multi-managed fund," with separate firms responsible for managing roughly equal portions of its assets. Of the five current investment managers, three follow a value-style mandate, while two are focused on growth.

Portfolio & Strategy

I really enjoy USA's top holdings as a lot of the larger positions are tied to growthier companies. Among its top holdings, Microsoft Corp. ( MSFT ) holds the largest position in the USA fund, accounting for 3.4% of its portfolio, followed by NVIDIA ( NVDA ), and lastly Amazon ( AMZN ). USA maintains a portfolio of 145 holdings. Nevertheless, its holdings are selected with a more selective approach, resulting in less concentration among the top positions.

USA takes a deliberate approach by not incorporating leverage into its investment strategy. While leverage can potentially enhance returns in bullish market environments, it simultaneously elevates risk levels. Leverage can easily make investments more susceptible to losses during market downturns. This strategy is especially reassuring during market volatility like what we are currently experiencing.

By avoiding leverage, the fund aims to provide a more stable experience. This approach prioritizes capital preservation and mitigates the potential for significant losses. I think this strategy reflects a commitment to maintaining the fund's long-term sustainability and protecting investors' capital.

Total Return

USA has traditionally provided an appealing blend of both growth potential and income, thanks to its effective management. While it may exhibit occasional volatility on a day-to-day basis, its long-term stability is maintained due to its absence of leverage. Over a 10 year period, the total return of 177% isn't too far off from the S&P 500's ( SPY ) total return of 200%. This isn't at all surprising but it is important to figure out if you are okay with the underperformance in total return in exchange for income. I personally value having my portfolio produce income so it's a tradeoff I accept.

Speaking of income, let's take a look at how your income would have grown over the last decade with an investment in USA. Using portfolio visualizer , we can see that your total income would have grown by 3x with an initial investment of $10,000 from 2013 to present day. During the same time period, you would have earned an annualized return of 11.6%.

Dividend

The CEF last declared a quarterly cash dividend of $0.16 per share which brings USA's current distribution is 10.7%. USA's official policy is to distribute four installments of 2.5% of the fund's net asset value per quarter. Historically, this distribution has been achieved through a combination of capital gains and a small portion classified as a return of capital. The sustainability of the payout is contingent on the fund's net asset value, with the per-share amount varying each quarter.

As a quick note, ROC (return of capital) is merely an accounting classification for the distribution when coming from a Closed End Fund. The confusion comes in from the name itself; the general confusion is that it seems like it means you are simply being returned your principal back. This is not true. I like how analyst, David Van Knapp describes it:

Return of capital is any portion of a CEF distribution that does not come from dividends, interest, or net realized capital gains.

ROC can be a confusing concept but I really like David's insightful article about return on capital and recommend a read through.

NAV-Price Relationship

Over the last 3 year period, the price traded at a premium to NAV of 1.4%. At the current price level, USA is trading at a slight discount to NAV of roughly 3%. USA has the potential to justify a higher premium once again if market sentiment becomes more positive. Although, I do think that this may present an attractive buy opportunity to start a position at these levels.

As time passes and the market starts to stabilize, I do think we will see some price appreciation happen. In the meantime, I feel comfortable starting a position here and collecting some nice passive income while we wait out the market's dramatic reactions.

Conclusion

In my opinion, incorporating closed-end funds like the Liberty All-Star Equity Fund ((USA)) into your investment strategy can fast-track your journey to passive income and financial independence. These funds offer diversified portfolios, appealing yields, and potential capital appreciation.

While closed-end funds like USA prioritize income generation, they come with unique considerations. USA's non-leveraged approach, although slightly affecting total returns, aligns with its focus on stability and capital preservation, which is crucial in volatile markets.

Over the past decade, USA has consistently grown income, offering a 10.7% distribution yield tied to its net asset value. Currently trading at a slight discount to NAV, USA presents an enticing opportunity for investors to initiate or expand positions.

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