2023-07-18 14:47:59 ET
Summary
- BlackRock Enhanced Equity Dividend Fund is trading at a more attractive discount due to its portfolio outperforming market price results, presenting a potential opportunity for investors.
- The fund provides exposure to the value-oriented sectors rather than a tech-heavy weighting; it helped provide downside protection last year.
- The fund's lack of leverage and covered call strategy can help reduce volatility, which also means no worrying about rising borrowing costs for this fund as interest rates climb.
Written by Nick Ackerman, co-produced by Stanford Chemist.
BlackRock Enhanced Equity Dividend Fund ( BDJ ) is back trading at a more attractive discount than in our previous update. Previously, the fund was trading right near its net asset value per share. The discount widening out came about as the fund's underlying portfolio outperformed the market price results. That's why we see the performance has been essentially flat since our last update , as it reflects the market performance and not the NAV performance. This divergence potentially presents a better opportunity to open up a position in this fund.
BDJ Performance Since Prior Update (Seeking Alpha)
Though this isn't your usual tech-heavy fund that's blowing outperformance - even on a total NAV return basis, it is lagging behind the major indexes. Not only because it's a covered call writing fund in a rapidly rising market but it is a value-oriented fund. While that meant it held up significantly better last year, it has been more of the laggard this year.
A couple of months ago, the fund filed an N-2 . This is a file that is used to issue new shares through a dividend reinvestment plan, an at-the-market offering or even a rights offering. BlackRock doesn't often utilize rights offerings, but it also isn't unheard of. If a rights offering is triggered, it would likely cause the fund to drop to an even further discount. However, earlier this year, BDJ was trading at a premium; they could be implementing an ATM offering. These are done only when shares are trading above NAV and are accretive to the fund.
The Basics
- 1-Year Z-score: -1.80.
- Discount: -5.76%.
- Distribution Yield: 8.08%.
- Expense Ratio: 0.85%.
- Leverage: N/A.
- Managed Assets: $1.652 billion.
- Structure: Perpetual.
BDJ's primary objective is to "provide current income and current gains." The fund intends to achieve this by "investing in common stocks that pay dividends and have the potential for capital appreciation." They concentrate on dividend-paying stocks with "80% of its total assets in dividend-paying equities."
The fund doesn't utilize any leverage, and that can help make it relatively less volatile compared to other equity funds. The covered call strategy can also generate options premiums to help reduce volatility when markets are declining. It's not the most defensive strategy, but it is something. With rising interest rates, borrowing costs for other leveraged funds have also been soaring - that's another positive of not operating with any borrowings for BDJ as well.
The covered call strategy is against single stocks in the underlying portfolio. They often write against around half of their portfolio. The company is heavily weighted toward large-cap companies, with 91.01% of its portfolio invested in this area. The average market cap of the underlying holdings comes to a whopping $148.294 billion. So it's closer to mega-cap (which starts at $200 billion) than it is large-cap ($10 billion and above).
Performance - Discount Opens Up Presenting A Better Opportunity
The fund has provided fairly decent results over the long term. As I mentioned, it is a laggard if it's compared to the broader indexes that investors often use. The reasoning for this is pretty simple, it's a covered call fund, and it actually doesn't benchmark against the S&P 500 and Nasdaq Indexes, which have a growth tilt. Instead, the portfolio is designed closer to the Russell 1000 Value Index.
Then they also utilize the MSCI USA Value Call Overwrite Index to also provide some benchmarking for the covered call side of their portfolio. Against these benchmarks, the results have been more competitive. The results are compared in their last annual report, which is for the period ending December 31st, 2022.
BDJ Annualized Results Through Last Year Compared To Benchmark (BlackRock)
Results on a YTD basis have BDJ coming in quite close on a total NAV return basis with the iShares Russell 1000 Value ETF ( IWD ). Not a bad result considering the covered calls can potentially limit some upside on option writing funds.
However, we can see that on a total share price basis, these two diverged significantly in March, when BDJ started moving sideways as IWD started its recovery.
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This is precisely where the opportunity for BDJ has opened up more recently. That's pushed the fund to a discount as the fund's NAV has provided positive performance.
Admittedly, it isn't the largest discount, and it is still trading above the longer-term decade-long average of around an 8% discount. However, it's still at a place where an initial position could be considered.
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Distribution - Providing Monthly Payouts
The fund currently sports a distribution rate of 8.08%. With a discount to NAV, the fund's NAV distribution rate comes in a bit lower at 7.61%. That's the amount the portfolio has to generate to "cover" the distribution to investors. After cutting several times after the global financial crisis, the fund has been providing consistent monthly distributions.
In fact, it was increased twice since 2013, and in the last two years, we saw some larger year-end specials. These would have primarily been driven by strong performance for the fund in 2021. 2022's performance was also relatively strong compared to the broader indexes, with its -3.83% total NAV return declines.
That said, they also realized a substantial amount of gains in the 2022 year, even if the underlying portfolio generated significant unrealized losses. As a regulated investment company, they are required to distribute nearly all of their capital gains and income to investors or pay an excise tax. Thus, that's why the fund would have been paying out a significant year-end special even in a year where results on the broader level weren't fantastic. We can also see that options writing helped contribute to $14.771 million of those realized gains for 2022.
BDJ Realized/Unrealized Gains/Losses (BlackRock (highlights from author))
As an equity fund, capital gains are paramount to covering the payout to investors. Even though BDJ invests in mostly dividend-paying stocks, net investment income still only covers around 48% of the regular distribution to investors. That's actually quite high for an equity fund, and NII even rose a touch in the last year.
For tax purposes in 2022 , the fund's earnings are rather consistent with what we see for the tax classifications. That is primarily long-term capital gains and qualified dividends. That can make it more appropriate for a taxable account, given the tax-friendliness of these tax classifications.
BDJ Distribution Tax Classification (BlackRock (highlights from author))
BDJ's Portfolio
BDJ managers can be fairly active in terms of buying and selling in the underlying portfolio. 2022 saw a fairly large increase from prior years as the turnover rate came in at 81%. In the four previous years, the average turnover had been 40.5%.
Since our last update, the fund has shifted back into a heavier allocation of financials over healthcare.
This has traditionally been more of the case when looking at BDJ. Healthcare and financials flip around as the largest weightings due to how fairly close they are in weightings, to begin with. It was healthcare that had a larger weighting at the end of 2022, which was more of an anomaly. So overall, that doesn't make that much of a meaningful change from what we typically see.
One area that could be noted as making a fairly substantial move is the consumer staples' weight. It represents 9.65% and comes in as the third largest sector allocation. It had previously been a 7.2% weighting, so we aren't seeing a substantial shift.
It is a bit of a difference, though, because it had previously been tech coming in at 12.4%. Tech's weighting has now downshifted to 8.62%. I believe it's that shift that together makes for a more meaningful change in the fund. This weighting change could have been in an effort to return the portfolio to a more value-oriented approach. As tech has continued to be a winner in 2023, it could make sense that they also took profits.
That said, financials and healthcare dominate over 44% of the fund and will have the largest impact. Both of these sectors have had mediocre performance, relatively speaking. When comparing the performance of ( XLF ) and ( XLV ) on a total NAV return YTD, it's another way to provide some context of what we are seeing from BDJ in 2023 so far.
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BDJ has been able to overcome this by outperforming these sectors despite its overweight allocation. Portfolio positioning is clearly playing a role as the fund is exposed to a fairly diverse pool relative to these sector-specific ETFs. It could also be the fund's options writing strategy generating some option premiums to thwart some of the downward moves too.
Looking toward the top ten positions in the fund, we see several familiar names that we frequently see for BDJ. The top ten represent around 25% of the entire portfolio. The fund lists 87 total positions, so 77 other positions comprise the other three-quarters of the fund. Generally speaking, 87 holdings are going to provide plenty of diversification for an investor. So I wouldn't say it is too concentrated.
Wells Fargo ( WFC ) was previously the largest position or basically tied at a weighting of 2.9% with BP ( BP ). However, BP has been eliminated from the top ten holdings list. As of the end of March 31st, 2023, the N-PORT listed BP as a position at a 3.07% weighting. That said, the holdings above are as of May 31st, 2023. So we can't confirm if the position is eliminated entirely from BDJ or not until newer filings become available.
For WFC and Citigroup ( C ), the latest news is that both these banks passed the Fed stress tests (all banks actually passed this year.) WFC is going for a fairly large dividend increase , taking the quarterly payout from $0.30 to $0.35 for a potential increase of 16.67%. C will also be looking to bump up its quarterly payout at a smaller pace, going from $0.51 to $0.53 or around a 4% increase.
For WFC, this marks its recovery march back towards its pre-Covid level - though coming in a bit shy. For C, it would mean a higher dividend after it had been frozen at its current level since Covid. That's all good news for BDJ, as those dividend increases mean more income for the fund.
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Conclusion
BDJ presents a much better valuation for initiating or adding to one's position than when we looked at the fund. This came about as the fund's underlying portfolio has performed fairly strongly while the fund's market price has lagged.
For further details see:
BDJ: Discount Widens For This Attractive Covered Call Fund