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About a year ago, I wrote a cautious article on the Allspring Global Dividend Opportunity Fund (NYSE:EOD). Although the EOD fund had earned modest 10Yr average annual returns of ~3%, it was paying an 11% distribution yield. The gap between the fund’s earnings power and distribution was unusually wide and I worried that the EOD fund would have to liquidate assets in order to sustain its distribution. Since my article, the EOD fund’s market return has struggled, delivering -4% total returns versus the S&P 500, which has gained 11% (Figure 1).
Figure 1 – EOD has struggled (Seeking Alpha)
In this article, I will revisit my thesis on the EOD fund and explain why ‘return of principal’ funds like EOD should be avoided.
Fund Overview
First, for those unfamiliar with the Allspring Global Dividend Opportunity Fund, it is a closed-end fund (“CEF”) that combines equities with high yield bonds. Under normal market conditions, the EOD fund allocates ~80% of its total assets to a portfolio of global dividend paying equities and 20% to a portfolio of non-investment grade bonds (Figure 2). The EOD fund also writes call options on its portfolio to generate additional income.
Figure 2 – EOD asset allocation (morningstar.com)
The EOD fund has $200 million in assets and charged a 2.61% annualized net expense ratio in the half year to April 30, 2023.
Modest Historical Returns…
Overall, EOD’s allocation between global equities and high yield bonds have generated modest historical returns, with 3/5/10Yr average annual returns of 7.5%/6.1%/4.7% respectively to August 31, 2023 (Figure 3).
Figure 3 – EOD historical returns (morningstar.com)
The EOD fund has had a solid rally in the past year, with 1Yr NAV returns of 12.6%. However, to properly assess the performance of the EOD fund, we should find appropriate benchmarks and indices to compare the fund to.
Figure 4 compares the historical market performance of the EOD fund against an 80/20 allocation between the iShares MSCI World ETF (URTH) and the SPDR Bloomberg High Yield Bond ETF (JNK) using Portfolio Visualizer. (Author’s note, closed-end funds’ market returns may differ from NAV returns)
Figure 4 – EOD vs. 80/20 URTH/JNK (Author created with Portfolio Visualizer)
The above analysis is limited by the historical data for the URTH ETF, which began in 2012. However, we can see that in the comparable period since February 2012, the EOD fund has delivered a compounded CAGR return of 5.5% compared to 8.9% for the 80/20 URTH/JNK strategy.
Not only has EOD delivered weaker returns, it also has significantly higher risk, as shown with a 17.6% Standard Deviation of returns vs. 12.8% for the 80/20 portfolio. EOD also had a 32.1% maximum drawdown vs. 23.6% for the 80/20 portfolio.
…Insufficient To Fund Distribution
While the EOD fund earns only modest average annual returns of 4.7% over 10 years, it pays a handsome distribution, with a 10.6% forward yield (Figure 5).
Figure 5 – EOD pays a 10.6% forward distribution (Seeking Alpha)
However, readers should note that the EOD fund has a long history of cutting its distribution, with the most recent quarterly distribution of $0.1064 / share almost 17% lower than the $0.1276 / share I noted in my last article (Figure 6).
Figure 6 – EOD has long history of cutting distributions (Seeking Alpha)
The EOD fund has historically relied heavily on ‘return of capital’ (“ROC”) to fund its distribution (Figure 7).
Figure 7 – EOD has relied on ROC to fund distribution (EOD semi-annual report)
Why Investors Should Avoid Amortizing NAV Funds
‘Return of capital’ is closely related to the ‘return of principal’ concept that I have written numerous articles on. Basically, funds that do not earn their distributions are called ‘return of principal’ funds and are characterized by amortizing net asset values (“NAVs”), as the fund must liquidate assets to fund its unsustainable distribution rate.
For example, EOD’s NAV has amortized from a high of $20 in 2007 to $4 recently (Figure 8).
Figure 8 – EOD has an amortizing NAV (morningstar.com)
There are 2 main issues with ‘return of principal’ funds. First, as EOD has shown repeatedly, distributions for ‘return of principal’ funds can be cut when they become unsustainable. In the past year alone, EOD’s distribution rate has been cut by 17%. In fact, EOD’s current annualized distribution rate of $0.4256 is less than a quarter’s worth of distribution back in 2008 (Figure 9). So long-term investors in EOD would have seen their income shrink by over 75%!
Figure 9 – EOD’s annual distribution has been cut by over 75% (Seeking Alpha)
The other major problem with ‘return of principal’ funds is that their market price tends to track their amortizing NAVs. So if the NAV has declined by 80% in 16 years, the market price would have likely declined by a similar amount. While investors may have no short-term needs for their principal, life can be unpredictable. At some point in the future, investors may need to sell their shares. It would be a terrible shame if when investors need access to their capital, they fund their capital has shrunk by 80%!
‘Return Of Principal’ Analogy For EOD
A simple analogy may best illustrate the problem with ‘return of principal’ funds like the EOD fund. Imagine Jane Doe is a retiree living off a 5% savings rate on a $240,000 savings account balance, which translates into $1,000 a month in retirement income (i.e. EOD earns 10Yr average annual returns of 4.7%). Unfortunately, her monthly expenses exceed her income, to the tune of $2,000 / month or 10% of her retirement savings (EOD currently pays a 9.2% of NAV distribution yield).
In any given month, Ms. Doe’s overspending does not look like a big issue, as she has ample savings to cover the difference. However, over long periods of time, Ms. Doe’s savings will be depleted by the constant overspending. For example, after a year, her savings account balance will be ~$228,000 and her monthly income will have declined to ~$950. After 14 years of spending more than she earns, Ms. Doe’s money would run out (Figure 10).
Figure 10 – Illustrative example of overspending (Author created)
Conclusion
Although the EOD fund has had a nice rally in the past year, returning 12.6%, its long-term track record is still mediocre. EOD’s historical returns pale in comparison to a simple 80/20 portfolio of passive ETFs tracking global equities and high yield bonds.
Investors should think hard before investing in amortizing ‘return of principal’ funds like the EOD. While an earnings shortfall in any given year is not a big deal, EOD’s perennial gap between its earnings and its distribution yield means the fund must liquidate assets to fund the distribution. In effect, investors are just getting their own capital back. Over time, investors in ‘return of principal’ funds lose both principal and income. I continue to believe investors should avoid the EOD fund.
