2023-10-12 03:32:06 ET
Summary
- Cornerstone Total Return Fund has delivered total returns of 24% compared to the S&P's 15% in 2023.
- The U.S. economy showed resilience in the face of concerns over rising interest rates and inflation but shows signs of weakness ahead.
- CRF's long-term performance has consistently lagged behind the S&P 500, with higher volatility and an alarmingly high expense ratio.
Introduction
Cornerstone Total Return Fund, Inc. ( CRF ) has had a notable start to the year delivering total returns of 24% compared to the S&P 500’s 15% ( SPY ), as we move into Q4 of 2023, it's essential to examine its performance so we can plan for the years to come.
In this article, we delve into CRF's semi-annual report , revealing key insights into its net asset value ((NAV)), market performance, distribution policy, and the economic landscape it navigated. Let's take a peek under the hood to examine how CRF has fared and what the best course forward is for investors.
Economic and Market Overview
It’s well known that many economists predicted a possible recession early in 2023, citing concerns over rising interest rates and inflation. However, CRF's report indicates that the U.S. economy showed resilience. Anecdotally, I am seeing in my own personal life in the services sector as restaurants and airplanes still seem to be jam-packed.
In the second quarter, the annual GDP growth rate stood at 2.1%, surpassing the 2.0% seen in the first quarter. CRF’s investment team says that they believe this solid growth hints at a potential "gentle landing" as inflation approaches the Federal Reserve's 2% target without triggering a recession. Despite a slowdown in job creation, the labor market remained strong, and wage growth remains sticky, with the unemployment rate hovering near record lows.
While the financial sector faced concerns due to a series of bank failures, these concerns were largely dismissed by investors who deemed systemic risk as contained. Recently though, rates on the long end of the yield curve have begun to jump with the US 10-year standing at 4.5% compared to 4.3% just a month back.
Manager’s Outlook
The fund's managers note that economists forecasted a possible slowdown in the U.S. economy in the second half of 2023 due to the effects of the Federal Reserve's interest rate hikes, consumer savings depletion, and the resumption of student loan repayments. However, positive macroeconomic indicators like unemployment, wage growth, and moderating inflation introduce uncertainty into these predictions.
Legislation, namely the "IRA" passed in the early years of the Biden administration which the fund manager expects to stimulate the economy, with infrastructure spending, subsidies for electric vehicles and renewable energy, and increased expenditure on manufacturing facilities.
However, balancing those tailwinds is the fact that rising interest rates on the long end of the curve increase default risk in companies that are heavily indebted. This refinancing risk may pose as a headwind going into late 2023 and 2024 as real estate companies, utilities, and other indebted industries look to refinance.
Dividend Distribution Policy
As a closed-end fund, CRF maintains its policy of regular distributions to stockholders, a policy well-received by cash-flow-starved investors, particularly retirees. These distributions aren't tied to the Fund's investment income and capital gains and don't represent yield or investment return on the Fund's portfolio. Instead, regular monthly distributions aim to enhance stockholder value by increasing liquidity for individual investors and providing greater flexibility in managing their investments. Stockholders then have the option of taking their distributions in cash or reinvesting them in CRF shares.
One unique feature of the fund is its dividend reinvestment plan which can offer significant benefits to investors who opt in Under the plan, the method for determining the number of newly issued shares received when distributions are reinvested is calculated by dividing the distribution amount by either CRF's last reported NAV or by a price equal to the average closing price over the five trading days preceding the distribution's payment date, whichever is lower. This means that whenever CRF trades at a premium to its NAV, stockholders would be able to get a significant discount compared to the public market.
Pros and Cons of Closed-End Funds
Investing in closed-end funds (CEFs) has its upsides and downsides. Closed-end funds can be enticing due to their potential for generous yields, diversification, and the chance to buy assets below their net asset value. They're also professionally managed, bringing in expertise and active asset management. However, it's important to bear in mind that CEFs tend to have higher expense ratios, they can face liquidity challenges because of their trading on secondary markets, and some employ leverage, which amplifies risk.
Additionally, the market for CEFs may be relatively illiquid, making it less convenient to buy or sell shares quickly, and this may sometimes lead to price differences compared to the fund's net asset value. That said, if a CEF distributes income regularly and at a high rate (like CRF does), it can help address liquidity concerns for investors.
Speaking of cons, here's a big one , CRF's expense ratio of 1.84% is substantially higher than that of the majority of other passive funds, serving as a substantial and concerning drag on performance. Compare the expense ratio of this fund to SPY’s (0.09%) and it's clear that this fund is incredibly pricey. This elevated cost structure significantly erodes potential returns for investors, casting a shadow over the fund's overall appeal.
Total Returns
Though this year CRF has shown strong performance, outpacing the S&P 500 by nearly 10 percentage points, over the long term the fund has lagged. Over the last five years, CRF has lagged behind the S&P 500 by a significant margin, trailing the index by 15%. Furthermore, it has exhibited greater volatility, implying higher risk. Despite being classified as a total return fund, CRF has yet to consistently demonstrate the ability to generate alpha sustainably, highlighting the importance of balancing short-term momentum compared to its historical performance.
When it comes to comparing the total returns of closed-end funds against the S&P 500, it's quite common to find that most other well-known closed-end funds tend to fall behind the overall market. However, in the case of CRF, it lags the market by a smaller margin when compared to many of its counterparts. For example, the John Hancock Tax Advantaged Dividend Fund has lagged the market by roughly 20% since mid-2021.
For me, it's hard to be proud of the sort of lackluster these funds have historically delivered, especially in light of the high fees.
Holdings
CRF's portfolio comprises rather generic holdings, primarily consisting of mega-cap tech giants such as Apple, Microsoft, and Amazon, alongside passive tech ETFs like Invesco's ( QQQ ) and the SPDR Tech ETF ( XLK ). These holdings are straightforward and unsurprising, explaining why the fund's returns have closely mirrored the overall market's performance. The focus on such widely recognized tech leaders and broad tech ETFs contributes to the fund's performance that broadly tracks market trends. All of this further reinforces my growing belief that this fund will not generate alpha for its investors above and beyond what could be attained by simply investing in QQQ or XLK or the fund's individual holdings.
Conclusion
Despite a robust performance this year, where CRF outperformed the S&P 500 by nearly 10 percentage points, its long-term track record tells a different story. Over the past five years, CRF has consistently lagged the S&P 500 by a significant 15%, accompanied by higher volatility... That's not a winning combination.
The fund's alarmingly high expense ratio of 1.84% dwarfs that of most passive funds, severely undermining potential returns. What's more, CRF's holdings, primarily comprising familiar mega-cap tech giants and passive tech ETFs, have led to returns that closely mimic the broader market.
Based on all of the above, I rate CRF a "Strong Sell". It's my view that recent outperformance has created an opportunity to sell, investors are likely better off with a simple tech fund or the S&P.
For further details see:
CRF: The Time To Sell Is Now