Summary
- Cornerstone Total Return Fund has been a contentious fund to discuss.
- The fund has a huge following for its generous payouts.
- We discuss how this remains one of the final signposts of the ZIRP bubble and how we think this ends within a year.
Cornerstone Total Return Fund ( CRF ) has been a unique fund where investors have focused on a rather unusual characteristic. The fund's relatively high distribution levels. Now, normally a fund which maintains an unwieldy distribution would have to wind down. CRF has managed to go around that by multiple distribution cuts and multiple reverse splits. This has been done while maintaining a managed distribution payout with a high yield relative to the current NAV. Of course, when you look at the plain share price since this policy began, it looks like this.
The distributions adjusted for the splits are similar. You can see the linked site for the whole history , but we are posting a short snippet here from where things began and where they are now. 2007 to 2009 saw the $1.424 monthly distribution get cut by more than half.
Dividend Channel-CRF
Today we are 11.7 cents a month.
Dividend Channel-CRF
So we have share price and distribution rates down in excess of 90%. Guess what has gone up by more than 13-fold? Assets under management.
That figure started out near $50 million on the left-hand side and has ballooned to $652 million. That is quite an accomplishment in what was an era characterized by passive fund flows winning over active investments. The assets were raised at a premium to NAV, enhancing returns for existing shareholders.
The Returns
One of the fun things about CRF is that investors regularly debate what the returns are over any timeframe. This is generally not something you see in most investments, the returns are what they are. You can debate whether they are good or bad, whether the outlook going forward is different from the past, or whether the fund took excessive risks to achieve its results. But the actual returns, well that is never debated. Except in the case of CRF and its sister fund Cornerstone Strategic Value Fund ( CLM ). We don't want to dwell too much on this as this does not impact our 12-month outlook, but briefly here is what you get if you pull up Y-Charts data for 10 years with distributions reinvested.
That's the underperformance.
Split History pulls up similar numbers for dividend reinvested returns and downright horrid performance if you consumed the distributions.
Split History
The debate comes from the fact that you can reinvest your distributions at NAV, whereas all calculators take into account distributions reinvested at market price.
That's fair, but as we have shown before, the best place to look for the actual returns is to ask management what the returns were.
From 2007, the costs of paying a large premium to NAV was fully apparent as by CRF's own methodology, the fund produced 2.2% compounded returns. This is even with dividends reinvested at NAV. Right there is the biggest lesson of all. Don't pay premiums for mediocre funds. Eliminating that year, we still get 6.4% compounded returns, trailing SPY by 3% a year.
Source: Fund Returns According To Management
Another way to solve it is to simply ask Y-Charts to do a total return on NAV.
Better, but still underperforming. Here is the same data back to 2007.
The next point of contention comes as investors claim that the best way to deal with this fund is to reinvest distributions at NAV and participate in the multiple secondary offerings, at NAV, while simultaneously selling equivalent shares at market prices.
So the thesis is sell at premium and buy at NAV. Of course, logically speaking, every investor cannot do that. That brings us to our target for the next 12 months.
The End Of The Bubble
Here, we are not necessarily referring to the CRF, but to the stock market bubble as a whole. That was blown to epic proportions with ZIRP (zero interest rate policy) and is finally unwinding. We base this on the current equity risk premium, which compares the earnings yield to the risk-free interest rates. Historically, we see a 700 basis point spread on compressed earnings during recessions.
Mike Wilson-Morgan Stanley
Such a blowout would tank the S&P 500 well below 2,000, if rates are not cut. While we remain agnostic on the possibility of things moving that low, we think 3,200 is a shoe within 12 months. So that's the first source of your drop, 20% lower from the market drop. CRF is, of course, a closet index fund and will match that more or less.
CEF Connect
The End Of The Premium
CRF has commanded a premium in recent years, and that has of course led to the debates about returns. We know that all bubbles end with a significant undervaluation of assets. We don't think CRF will be any different. Just when maximum investors line up to buy at NAV and sell at market premiums, the premiums will turn into humongous discounts.
CEF Connect
So let's combine point #1 and point #2. Assuming the NAV drops 20% and the fund trades at a 20% discount to NAV, we get $4.05 per share. Those two factors alone get us to a 47% drop.
That Unwieldy Distribution
With the current payout of $1.401 per share, the fund is paying far in excess of the 2% yield its underlying holdings generate. That itself should cause a big NAV drop. When we add the three factors together, a sub $3.50 price seems very probable within 12-18 months.
Verdict
Over the last 16 years, discount to NAV has been rare.
Data by YCharts
That has got the crowd complacent. This is very similar to the multiple arguments you saw in the financial sphere suggesting 2.5% 10-year yield was a "great deal". It only was a great deal in relation to the bubble. It was not cheap in relation to any objective measure of what bonds should provide in an era of high inflation. So when CRF finally does go to a discount and stays there, remember the perpetual well of NAV-accretive-fund-raising comes to a standstill. We see that ahead for this fund, and if we are right it will once and for all end the debate about the returns from this point.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
CRF: Why We Are Looking For At Least A 50% Price Drop In A Year