Summary
- BCAT launched towards the end of 2020 and enjoyed some of the end of the bull market.
- Since around mid-2021, BCAT, along with most everything else, has been on a downward slide.
- BCAT's deep discount and multi-asset approach could make it a worthwhile addition for a long-term investor.
Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on September 6th, 2022.
BlackRock Capital Allocation Trust ( BCAT ) launched in September 2020. We are closing on two years the fund has been operating. When new closed-end funds launch, investors are typically skeptical and push them to some fairly deep discounts. With this next anniversary, perhaps it is time that investors should seriously consider BCAT's diversified approach to investing.
When the fund launched, it enjoyed the tail-end of the market rallying from the COVID crash. The overall market was pushing new highs, including BCAT pushing above its IPO price. The fund even enjoyed a sharp premium shortly after being launched. BCAT and the market would enjoy those new highs until around mid-2021. At this point, the market started to turn. First came the BCAT opening up to a wide discount that really became significant. Then the NAV began to slide.
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With the current discount on the fund and the overall depressed prices in the market, BCAT could be worth looking at for a longer-term investor. That isn't to say that we don't go down further from here, but if you invest in terms of years, investing in bear markets is generally a good bet. Especially considering this is a fund that provides diversified exposure. You aren't placing a bet on just one or two companies to survive.
The Basics
- 1-Year Z-score: -1.46
- Discount: -17.78%
- Distribution Yield: 8.54%
- Expense Ratio: 1.54%
- Leverage: 4.03%
- Managed Assets: $1.927 billion
- Structure: Term (anticipated liquidation date of September 25th, 2032)
BCAT's investment objective is "to provide total return and income through a combination of current income, current gains and long-term capital appreciation."
To meet their objective, they simply "invest in a portfolio of equity and debt securities." They add a bit more color with, "the Trust may emphasize either debt securities or equity securities." Along with this, they will "utilize an option writing strategy in an effort to generate gains from options premiums and to enhance the Trust's risk-adjusted returns."
BCAT is a genuine multi-asset approach offered by BLK. Currently, the percentage of the portfolio overwritten is 13.34%. This is up a bit from our previous update. Additionally, the leverage is down from our previous update substantially. It is only at a very mild ~4% leverage ratio with around $83 million borrowed. Borrowings at the end of 2021 were almost $688 million.
That leaves them with a ton of capacity when things start to turn around for capital that they can put to work. Another positive of the low utilization of leverage is that the fund pays a variable rate on leverage. It is currently based on the Overnight Bank Funding Rate plus 0.75%. As interest rates head higher, the borrowing costs would also increase. Lowering the amount of borrowings means reducing uncertainty from the variable expense.
That being said, BCAT managers are also still protecting against higher interest rates too. That comes from derivatives such as interest rate swaps, total return swaps, credit default swaps and swaptions, among their usual option writing strategies. These can all play a role in making the overall duration of the fund lower since they have a material allocation to fixed-income.
Though notably, the effective duration has increased to 1.94 years from the 0.53 years we noted previously . It would appear they are getting a bit more comfortable with extending duration with that latest change.
Performance - Deep Discount
In the opening chart, I showed how the fund performed on a price and NAV-only basis. That doesn't include any of the distributions the fund paid, which have been meaningful. One of the things I see consistently is that investors look at a price chart of a CEF in isolation and believe it is a poor performer.
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Here we can see just how big of an impact the distributions have on an investor's performance. Do note that total return does assume the reinvestment of distributions, too. From that, we can see that the actual portfolio has provided a relatively strong performance. The total NAV return performance would reflect that since the manager can't control the share price directly. We see a big difference from just the NAV return. Additionally, we can see how much the price and total price returns have been dragged down due to the significant discount that has opened up.
When compared against the SPDR S&P 500 ( SPY ), Vanguard Total Bond Market ( BND ), and iShares iBoxx $ High Yield Corporate Bond ( HYG ), we can see that BCAT has been holding its own. It has been the weakest performer, even regarding the total NAV return basis. However, the sheer difference in the actual price return is grabbing my attention here.
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The fund seems to have reached the depths of its discount at this point. It has been bouncing around the ~16-18% level for months. That even includes from May to June, when the market had remained volatile. The discount didn't substantially widen from there. That's why I view it as a fairly attractive point to consider adding this fund to an investor's portfolio. Further losses from further discount widening could always happen, but that risk seems minimal for any significant period of time.
Distribution - Income Generation Holding Steady
The fund has maintained its $0.1041 monthly payout since the fund launched. That works out to an 8.54% and, on a NAV basis, comes to a reasonable 7.14% distribution rate. At around 7%, it would seem that it is a fairly safe bet it could continue maintaining this rate for now.
The fund's latest report shows that the income generated has also stayed relatively flat. That's a good reminder that we haven't seen massive defaults or dividend slashing across the board, despite what the bear market would otherwise suggest should be happening.
The NII coverage here stands at 42.1%, only a slight decline from the 42.7% we saw in the previous fiscal year. That mirrors the relatively flat income the portfolio has been taking in. Of course, we do see some substantial unrealized depreciation on the portfolio. That's consistent with the declines we've seen in NAV for the year.
Looking at the net realized gains/losses in greater detail, we can see that their hedges have been playing out. In total, the derivatives generated realized gains of just over $82 million. That was simply offset by the realized losses that the managers decided to take in the portfolio. It also highlights how gains can be produced even in a bear market where gains are more difficult to come by with underlying positions.
At the end of March 31st, 2022, their N-PORT showed that borrowings stood at $201 million. That means they swiftly took down their higher amount of leverage earlier on in the reporting period ending June 30th, 2022. At the end of June 30th, they reported borrowings of $101 million, so it has been reduced even a bit further in the month of July. That's why it would be even more encouraging that they've maintained most of their NII anyway.
That being said, the reduction of taking down their borrowings further can have an impact. NII could see a bit of a hit as they have less capital being put to work, potentially generating a reduced amount of dividends and/or interest payments.
For tax purposes, we have seen destructive return of capital utilized to maintain the distribution. It would be considered destructive because the fund didn't generate enough NII and gains for the payout in 2021 .
BCAT's Portfolio
As one could have picked up by now, BCAT's portfolio is quite dynamic. That includes the utilization of increasing or decreasing borrowings, increasing or decreasing the portion of their portfolio overwritten or the various derivatives they have running. The portfolio has some serious flexibility. In the last year, turnover was reported at 90%. For this latest report, they show a portfolio turnover rate of 31%. That's for only a six-month report, so it could be substantially higher by the time this year is done.
At this time, the portfolio is most heavily weighted in fixed-income investments. We also see an allocation of cash at this time.
This is a bit different of a mix than we saw previously. At the end of March, the portfolio had around 57.5% in fixed income and nearly 45% in equities. Both of these allocations have come down, contributing to the cash equivalent pool that was previously a -2.52% weighting.
Geographically speaking, the fund is heavily weighted to North America. It would be assumed that it is primarily going to be U.S.-based positions. However, there is still some material exposure to different European countries. An area that is under more volatility thanks to Russia's invasion of Ukraine.
When looking at the sector weighting of the fund, the equity sleeve is fairly standard. They have a higher allocation to tech stocks. However, since it is a minority sleeve of the portfolio, it isn't an overly aggressive weighting.
The bulk of the fixed-income sleeve is allocated to "credit," but "securitized" is also a significant weighting. To a lesser degree, we see "sovereign" holdings. The credit holdings here would be referring to primarily high-yield bonds. Securitized assets are debt instruments that are pooled together, which can include MBS or CLOs as some examples.
For BCAT, it appears a meaningful allocation has been put into non-agency MBS. Only a very small weighting of CMO and MBS are listed under the agency classification.
Those agencies and U.S. holdings would be why we see some AAA rated holdings, as well as the U.S. Treasury obligations too. AAA makes up 2.95% of the portfolio, along with some weightings in AA, A and BBB rated credit.
Some of those Treasury positions even appear on the top ten holdings for the fixed-income side of the portfolio.
Interesting to note that the largest position is iShares iBoxx $ Investment Grade Corporate Bond ( LQD ), with HYG coming in as the third largest. These are both BlackRock offerings. We'd generally like no affiliated investments where a fund can gain fees on fees because that could create a conflict of interest. In this case, they aren't too material since the fund holdings are hundreds of positions. The weightings here just aren't meaningful enough to send up a red flag.
On the equity side, we see several mega-cap tech names that we've all become quite familiar with.
Of the MAMAA names, we have Microsoft ( MSFT ), Amazon ( AMZN ), and Alphabet ( GOOG ) ( GOOGL ). We would be missing the Meta ( META ) and Apple ( AAPL ) positions. AAPL is a position in the fund, but META does not appear, at least at the end of June 30th, 2022. Over the last six months, META had been the worst performing of the MAMAA names. So it hasn't been detrimental to BCAT not having it in there. However, none of these names provided a particularly strong performance.
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Conclusion
BCAT provides a highly diversified portfolio. That goes beyond being a multi-asset fund, but a multi-strategy fund with flexibility into various derivatives and actively managing leverage levels. They've taken down their leverage, but for the latest report, it hasn't meant a meaningful reduction in NII. That's encouraging to see, as they still have the flexibility to put that to work once again, generating potentially higher earnings. The fund's deep discount and the overall bear market provide a potential opportunity for investors to pick up shares of BCAT at this time.
For further details see:
BCAT: Deep Discount And Diversified Exposure