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Investment Thesis
This article is one in a series of articles where I use a common set of metrics to evaluate a CEF beyond just the yield. In this article, I will take another look at Cornerstone Strategic Value Fund (NYSE:CLM) following my January article where I rated it a Sell. For many years CLM has not managed to cover its distribution. A proponent of the fund recently remarked that the fund had covered the distribution about 30% of the time. This has resulted in reductions in the distributions on a fairly regular basis. Five years ago in 2018, the monthly dividend was $0.2365, while for 2023 it is $0.1228. A 48% reduction. Has anything changed with the fund’s performance such that it is reasonable to expect something different in the future? Since the new distribution was announced, CLM NAV has mostly been on a toward trajectory that indicated a probable distribution cut for 2024. Is that still the case?
Since the distribution is a fixed 21% of the fund’s NAV on October 31 of each year, that means NAV has declined just as much. Cornerstone has managed this NAV erosion with reverse splits and rights offerings where shares were sold at a discount to market price but a premium to NAV. So far this year the fund has done a good job of recovering from a big hit it took at the end of last year. The NAV currently sits just a bit above where it was on November 1, 2022. As we head into August, it is time to look and see what is likely to happen with the distribution.
What drives my analysis of every CEF I look at is that I want a stable flow of income from the investment. While I am willing to actively manage a position to enhance my income or its safety, I don’t want to own a fund where the cash paid from each share isn’t reliable. I have developed a method of determining whether a specific CEF could provide a reliable stream of income. I developed my method after reading this article.
I think that rather than using the share price or even the ratio of the share price to the NAV, using how the portfolio of the fund behaves and the income it generates is the better way to determine the reliability of the distribution. It is, to my way of thinking, a mistake to see the fund’s NAV as the sole component of the fund’s value. But it is important not to erode NAV with too high a distribution because fewer assets backing each share make it harder to continue to generate a steady income stream. Just look at CLM as you can see that the NAV declines even in years when the S&P500 is up. And that NAV decline reduces the distribution.
In this article, I take another look at CLM and apply that method to determine if the fund has been supporting the distribution. Then based on current holdings and past performance, I try to determine whether or not the fund will be able to support the distribution in the future. You can read an explanation of my method and get links to the other articles in the series (published before March 27, 2022) here.
Cornerstone Strategic Value Fund
While my past reviews of CLM have shown that it wasn’t fully covering the distribution, let’s see what the coverage is for the past year. I want to see that the fund can reliably generate enough cash, at least, from its portfolio to pay the distribution. What I don’t want to see is a fund that is eroding its asset base to pay a distribution that is too generous. I don’t just want cash today, I want it well into the future as well. In the past, CLM has frequently paid out too high of a distribution. This has resulted in both the erosion of its NAV and a decline in the distribution it pays out the next year. So the question is, is that still the case?
Total return on NAV is a good metric to judge the performance of a fund’s portfolio. Let’s first take a look at the CLM’s total return on NAV for the last year. This performance will determine how much the fund can afford to pay out in distributions to its shareholders.
So over the last year, the total return on NAV has been 12.5%. While that sounds impressive, remember that the distribution is based on paying out 21% of NAV. It is worth noting that on the positive side, the total return on NAV since the beginning of the year is over 20%. But let’s do the actual calculation of yield on NAV. First, we look at NAV for the last 12 months.
Here I’ll note a couple of things. First, NAV hit a high last fall of $8.28. NAV had fallen significantly through the fall but surged up in the early winter before falling back to near its low to start the year. We can also see that since March or so, NAV has been on an uptrend. From this chart, we pull the peak NAV of $8.28 and the average NAV of $6.968. Next, let’s look at the distribution for the last 12 months. I get this data from CEFData.
CLM Distribution Data (CEFData.com)
Because CLM sets its distribution for the following year based on 21% of the NAV at the end of October, they already know what the distribution will be. So they do declare distributions well out in front of paying them. So since last August (this will give us 12 payments for the TTM), CLM has paid out 5 distributions of $0.1808 and 7 of $0.1228 for a total distribution of $1.7621.
Using the average NAV of $6.698 the distribution payment of $1.7621 produces a yield on NAV of 26.31%. This is higher than the 21% of NAV policy, but that isn’t surprising given that almost half the payments were based on a much higher NAV from 2021. Using MAX NAV of $8.28 we get a yield value of 21.28%. The most recent NAV is $7.12 which with the distribution payment in line with policy ($1.4736), produces a yield of 20.70%. All of these are below 12.5% total NAV return, so the distribution does not seem well covered. That said, with the NAV currently at $7.12, if that holds until November 1, the dividend will be increased to $0.1246. That is an increase of about 1.5%.
Once again we can see that CLM’s portfolio lags behind SPY, another indication that it is paying out too high a distribution.
One big change since the beginning of the year is that CLM’s NAV is now on an uptrend. The most recent NAV is above the NAV from October 31, 2022. If NAV maintains its current level CLM will maintain or even increase the distribution. Quite a different story from when I looked at this fund in January.
Long-Term Trends
Because funds can have really good years, and really bad years, a single year might not be representative of a fund’s long-term performance. Everything hits a rough patch now and again, for me, it’s the long-term performance that matters. And in fact, a short period of underperformance can provide a nice entry point. While I did review the 3-year data back in previously, it is possible that enough has changed to tell a different story.
So my next item to examine is how CLM managed its portfolio over a 3-year period. This is a good tradeoff to show longer-term performance while still showing pretty recent data.
So how did CLM manage its portfolio over the most recent 3 years?
Well, again, 13.19% CAGR for total NAV return is pretty good. Except for that large distribution. We can also see why the distribution was increased for 2022 and cut for 2023.
The 25% decline in the NAV is why the total return on NAV is so low. Note too that the average NAV is quite a bit above the current NAV. Total distributions paid over the last 36 months are equal to $5.8781. This produces a total yield on NAV of 67.29%. That being well above the total NAV return of 45.98% indicates that the distribution wasn’t well covered. The decline in the NAV, while SPY was up also indicates poor distribution coverage.
Some dismiss the fact that 2/3rds of NAV has been eroded away by paying too high a distribution because their position has more shares and pays more than it used to. However, if you are losing assets to cover the distribution for each share, you just can’t make that up in volume. Another analogy is the boat owner who doesn’t think the hole in the side is a long-term problem because they have a pump that can remove more water than what comes in the hole. Coupled with that decline in NAV over the last 10 years, the distribution has declined 69.96%.
CLM Distributions (CEFData)
CLM is not a cyclical fund, it invests in stocks in the S&P500. So this is exactly the frequent pattern of distribution cuts that I don’t want to see. And we have no confidence that the most recent cut will be the last one.
Future Distribution Coverage
While CLM hasn’t been covering its distribution, the more important consideration is whether or not it will be able to do so in the future. Understanding how CLM performed in the past is the first step to understanding how it might perform in the future. While past performance is not a guarantee of future performance, the how and why of that performance is our best guide to the future.
Over the past 10 years, CLM’s portfolio has generated returns that have averaged 11.9%. While that is impressive, it falls far short of covering its distribution which is set to be 21% of the NAV reported on October 31. You can look up what is in the CLM portfolio at the CEFData website (which has a link to the CLM’s site as well). My problem with CLM isn’t its stock picks. In fact, it has done very well. Just not well enough to cover a 21% distribution without any leverage.
So far this year, CLM has been doing pretty good, both price and NAV are up. At the start of the year, the TTM total NAV return of both SPY and CLM’s portfolio was negative, so this is an improvement YTD. Last year SPY lagged CLM by about 200 bps, so 400+ bps is an even better performance by CLM. This was helped in part by the big drop it took last year, so some of this is due to reversion to the mean. But a large portion of it is because the stock market in general is doing well. SPY, has a total return so far this year of just over 20%, how much gas does it have left?
Remember, that CLM is overpaying its dividend, so it needs the market to go up just to keep the NAV constant. Right now the NAV is such that the distribution will go up a bit less than 2% in my view.
Conclusion
CLM is doing a lot better now than it was in January. I expected the lack of a rights offering to boost NAV would have a much bigger negative impact and to virtually ensure a distribution cut. That doesn’t look to be the case now. While there still remains the risk of a distribution cut, I no longer think it is a virtual certainty.
The next FOMC meeting is in September. We have several more employment, GDP, and inflation reports as well before the determination of the distribution for 2024. Right now, I think there is about a 30% chance of a distribution cut. All that is required is for NAV to decline to $7 or lower. With the number of shares from recent rights offerings, a lot of holders of CLM have not seen back-to-back dividend cuts. What happens to their willingness to buy shares at a premium if the 2024 distribution is reduced?
