Written by Nick Ackerman, co-produced by Stanford Chemist. A version of this article was originally published to members of the CEF/ETF Income Laboratory on March 21, 2022.
Saba Capital Income and Opportunities Fund (New York Stock Exchange: BRW) East Either they really take their time positioning their portfolio or they will be a heavy SPAC fund. They finally gave us a little update on their holdings. All in all, I’m not too excited at this point. It will be interesting to see where the fund goes next.
A SPAC, of course, is a special purpose acquisition company that we had heard about in 2020. These started to really fall apart in 2021, and now most pre-merger SPACs are below price $10 key. That’s before they even make a deal.
After reaching an agreement, the situation worsens, the average share price of SPACs that found companies to merge with in 2020 and 2021 was $8.70 at the end of December 2021. Given market conditions, this does not It’s probably only gone down since then.
It might come as a bit of a surprise that BRW had almost 80% of its portfolio in SPACs at the end of January 2022. A pretty big jump for the fund when in July 2021 it had around 27% exposure. They were still in transition after taking over the fund from Voya. Previously, it was a senior loan fund. So, at that time, they still had nearly 69% exposure to senior secured senior loans.
On the other hand, if they are holding these SPACs simply as a place to put money to deploy it into better investments, that could also make a lot of sense. This fund is a bit of a gamble overall as we still don’t really see how it will be positioned. Saba is a closed-end fund activist, which made me believe that we would see a much heavier weighting for CEFs. In July 2021, the CEF weighting was 1.46%, which is now 9.36%. Overall, I expected a lot more. To be fair, that would be a massive leap on a relative basis.
In a recent announcement, they approved a 1-for-2 reverse stock split. It doesn’t fundamentally change anything to the fund. This will cut the number of shares in half and the price will double. This is expected to happen on May 20, 2022.
- Z-score over 1 year: 0.85
- Discount: 5.24%
- Distribution yield: 12.74%
- Expense ratio: 1.38%
- Leverage: 24.32%
- Assets under management: $407 million
- Structure: Perpetual
BRW’s investment objective is “to provide investors with a high level of current income, with a secondary objective of capital appreciation”. Their website emphasizes that they will “invest in high yield credit”. They will also “opportunistically invest in other products, such as closed-end funds and special purpose acquisition companies.” Finally, they “will also use derivatives when they believe they can achieve attractive risk-adjusted returns as a means of reducing portfolio risk.”
The fund is a good size and the leverage is not too high either. Either way, leverage adds risk and should be considered before investing.
The fund’s expense ratio stood at 1.38% when they last reported in their annual report. However, this jumped to 3.03% when including leverage spending as reported at the end of February 2022. Given the nature of the underlying investments, this is one more reason why I hope to see a step change in their wallet.
Performance – Attractive discount
One of the most attractive features of the fund right now is the discount. It last came in at 7.82%. That hasn’t changed much since Saba commandeered the fund. In my opinion, this is a bit shocking given the distribution yield the fund is currently paying. We often see better paying funds immediately start trading at higher valuations, whether the higher valuation is warranted or not.
I suspect we can see this drifting towards a tighter discount over time. This is a smaller fund and was not that popular before, so it may take years for investors to break into the CEF space. Of course, if it performs terribly and continues to erode its net asset value, it could scare off investors. With the uncertainty in the fund at the moment, this could also play a role in the steep discount.
The chart below of NAV RESET was from June 22, 2021 to present. June 22, 2021 is when the transition officially took effect.
Performance since then is less relevant given the transition they’ve been through. However, below are the total stock price and net asset value returns since then. The price itself has been quite volatile.
Distribution – 12% Managed Plan
When we previously covered the fund, they announced an 8% target managed plan. Since that time, they have now increased that percentage to 12%. It’s an important reminder that this doesn’t mean they’re earning that much, just that’s how much they’ll pay shareholders each year, regardless of coverage. This will be adjusted monthly, which takes away some of the appeal. The most recent payout was $0.047. A slight decline from previous months as the net asset value declined in line with the broader market.
In terms of coverage, we can take a quick look at the latest annual report. However, we cannot glean too much information from it as it is a very different fund at present.
Net investment income was still a fairly large amount in the fund at the end of fiscal 2021. As the portfolio is compounded now, it should be based entirely or almost entirely on capital gains. The reason is that NII is simply dividends and interest less expenses.
Total income will be low due to the absence of dividend and interest positions in the underlying portfolio. At the same time, spending is increasing, with leverage spending increasing. I wouldn’t be too surprised to see the next report show a negative NII figure.
For tax purposes of the distribution, anyone can really guess how this will fall at the moment. Right now, I’m mostly expecting a return of capital unless they drastically change their portfolio from here.
To some extent, I also believe that we will also see a destructive return of capital used, the kind where it will erode the net asset value over time. The reason is that the 12% plan means they need to have a portfolio that can earn that every year. At the current positioning, I think that would be impossible – and it’s already an ambitious plan if it were better invested.
Not surprisingly, BRW’s turnover rate during last year’s fiscal year, they reported, was a high of 94%. As I mentioned above, most of this is currently in SPACs.
I suspect this will continue to evolve over time. However, I’m still a bit shocked by the amount of SPAC exposure. I thought they would be a bit quicker with their transition. On the other hand, this means that they did not participate in the decline that the rest of the broader market experienced. Below is the YTD performance comparison between BRW and SPDR S&P 500 ETF (SPY).
Looking at the fund’s top positions, I’d say we’re getting a lot of what we expected: mostly SPACs and a few CEFs. CEFs are all geared towards heavier energy-focused funds.
One of them is the PIMCO Energy & Tactical Credit Opportunities Fund (NRGX), for which I just provided a full update very recently. There is also the Miller/Howard High Dividend Fund (HIE). This is another portfolio from Income Lab and one of my portfolios as well. As such, I also regularly provide cover for this fund. It’s not specifically an energy-focused fund, but it does have a fairly large weighting in the sector as a fund focused on high dividends.
There is also the Salient Midstream & MLP Fund (SMM). This was a fairly recent acquisition in the Tactical Income-100 portfolio after the sale of the Guggenheim Strategic Opportunities Fund (GOF). The main driver of Stanford Chemist’s alert on SMM was Saba’s position in the fund. They held 16.71% of the fund at last look. Confirmation that BRW will participate in their activist activities, which is one of the main reasons to invest in BRW in the first place.
Overall, the fund is still in transition and we can probably expect to see more changes in the future. Granted, I’m not thrilled with their exposure right now. I wanted to see less SPAC exposure and more allocation to real investments.
Exposure to SPACs can really pay off if you invest in the good ones. However, they have hundreds of investments and a seemingly endless number of SPACs they invest in when looking at their full portfolio list. Even if one or two hit the jackpot, the wallet won’t really feel it. For example, Digital World Acquisition Corp (DWAC) is one of BRW’s positions.
You will notice in the chart that DWAC had really exploded higher. This took place in October 2021, when a merger deal was announced with Trump Media. BRW’s net asset value also jumped $0.17 that day, but it looked like a mistake that happened on the same day. The next day, the net asset value fell back to $0.16. Anyway, the main point is that DWAC is up around 580% and BRW hasn’t benefited noticeably due to its hundreds of posts.
Overall, it continues to be a wait-and-see attitude. The discount is attractive, but given the uncertainty, it seems justified.