2023-05-20 00:43:05 ET
Summary
- DIAX is an equity "buy-write" closed-end fund from Nuveen.
- The fund aims to replicate the Dow Jones Index through its portfolio composition and then write call options on the underlying names.
- The fund managers have introduced an unwanted basis this year by writing options on the S&P 500 rather than the Dow Jones.
- This speculative relative value strategy has back-fired this year, bringing DIAX down almost -4% in 2023 versus a positive performance for the Dow Jones.
- The fund's prospects in the current set-up are dim, with the growth versus value basis underperforming on the back of strength in tech.
Thesis
The Nuveen Dow 30 Dynamic Overwrite Fund (DIAX) is an equity buy-write fund that we have covered before. The vehicle is geared towards the Dow Jones index. As per the fund's literature:
The Fund is designed to offer regular distributions through a strategy that seeks attractive total return with less volatility than the Dow Jones Industrial Average (DJIA or "Dow30") by investing in an equity portfolio that seeks to substantially replicate the price movements of the DJIA, as well as selling call options on 35%-75% of the notional value of the Fund's equity portfolio (with a 55% long-term target) in an effort to enhance the Fund's risk-adjusted returns
With a very tight range in the Dow Jones (DIA) this year, we are going to explore how DIAX has fared, especially through the lens of reaping benefits from selling options in a range bound market.
Without any analysis, the general thought process here is that DIAX should outperform, given the fact it is able to generate additional revenue from writing options in a range bound market. Bull markets are instances where buy-write funds underperform, since the call options they write get triggered.
The reality is unfortunately very different. DIAX is down -3.6% this year versus a +2% positive performance in the Dow Jones. The main driver behind the underperformance is the basis the fund managers have introduced in DIAX CEF by writing calls on the S&P 500 while holding a portfolio that replicates the Dow Jones. Why have they done this? We are not quite sure, but it might have been a bet that value will outperform growth. Irrespective, not only it has backfired, but this fund is not supposed to do this. A retail investor (as well as us) will always be under the impression that DIAX will try to capitalize on the implied volatility exhibited by the Dow Jones, not enter into speculative relative value arbitrage trades between the Dow Jones and S&P 500. That is not the mandate here.
If DIAX would have stuck to its mandate and written call options only 3% out of the money it would have outperformed the Dow Jones this year, and would have posted a total return in excess of 2% for the year. If you look in the 'Performance' section below you will notice that the Dow Jones has been stuck in a rough -3% to +3% range this year, hence 3% out of the money calls would have not been triggered. Instead of making money, the CEF is down almost -4%. That is unacceptable in our view. This year has been the best environment for buy-write funds in the value space, with a very tight range in the index. Instead of doing what it is supposed to do, the CEF has entered into highly speculative relative value trades that we cannot reconcile with the CEF's mandate. We do not like what the managers have done here and given our dim view for the wider markets later in the year we are a Sell on DIAX.
Performance
On a year to date basis, DIAX has underperformed the Dow Jones Index:
Not only has DIAX underperformed, it is negative for the year!
Similarly, when looking back during the past year, we see a similar pattern:
DIAX constantly underperforms, and fails to add value via its options writing mandate.
Holdings
The fund holds the 30 stocks which make up the Dow Jones index, but has some particularities:
The rows highlighted in yellow above represent the sold options and the additional component in this fund that an investor would not find in the Dow Jones, namely the Vanguard Total Stock market ETF ( VTI ) which represents 1.33% of the portfolio. Why would this fund buy VTI instead of DIA, we do not understand. Does not make much sense to have a CEF trying to replicate DIA but purchasing VTI in its portfolio.
The other item to note which is of significant concern is the fact that the fund writes options on the S&P 500 index rather than the Dow Jones. This is a massive basis, which has backfired significantly in 2023. The Dow has been static, while the S&P 500 has rallied over 7% driven by the large cap megatech companies.
Here are the strike details regarding the written options:
Please note the follows details regarding the above nomenclature:
Average Call Option % Coverage is the percentage of the Fund's underlying equities overwritten by call options; equals sum of notional values of call options divided by the market value of equities in the portfolio.
Average Call Strike vs. Spot Price is the average ratio of call option strike prices vs. spot prices, weighted by the notional value of the calls. A figure > 100% indicates that option strike prices, on average, are above their current spot prices and the calls are "out of the money". A figure < 100% indicates that option strike prices, on average, are below spot prices and the calls are "in the money."
Premium / Discount to NAV
The fund is now trading at a substantial discount to NAV, and rightfully so:
In our mind the market is correct in assigning a high discount to this CEF. In our opinion, the managers are not doing what they are supposed to, introducing a large value versus growth basis in the structure. Their bet has backfired, with growth outperforming value and the CEF suffering a significant underperformance.
Conclusion
DIAX is an equity buy-write fund. The CEF tries to replicate the Dow Jones portfolio though equity purchases, but instead of writing call options on the Dow it has written them of the S&P 500 this year. This strategy has introduced an unwanted relative value basis between the tech growth names in the SPY and the value names in the Dow. This undertaking has been disastrous for DIAX this year, seeing the CEF down almost -4% versus a 2% performance in the Dow Jones and an 7% return in the S&P 500. If the CEF would have stuck to its mandate and written call options on the Dow it would have made money, given the tight range in the index this year. We are disappointed with the choices made by the managers here, and feel this is outside the stated mandate for this name. We have a dim view on the equity markets for the rest of the year, hence we are a Sell on this name given its set-up.
For further details see:
DIAX: Disappointing Performance, Prospects Look Poor