CSQ: This Good Blended Fund Is Finally Trading At An Attractive Price

The Calamos Strategic Total Return Fund (NASDAQ:CSQ) is a closed-end fund aka CEF that can be employed by those investors who are seeking a high level of current income from the assets in their portfolios and are unwilling to sacrifice the upside potential of common equity in exchange for income. This is something that was very important a few years ago, although arguably bonds offer somewhat better risk-adjusted returns right now. Unfortunately, though, this fund does not have nearly as high of a yield as some other funds in the market, as its 8.65% current distribution yield is nowhere near sufficient to compete with some of the best assets that can be found in the fixed-income fund space. However, its yield is reasonably competitive with that of many equity closed-end funds.

As regular readers can no doubt recall, we last discussed the Calamos Strategic Total Return Fund in mid-September. The fund’s performance since that time has been reasonable, although it still disappoints compared to some of the other options in the market. As we can see here, the fund’s share price is down 3.60% since the last time that we discussed it, which is substantially worse than the 2.50% gain of the S&P 500 Index (SP500):

This is likely going to disappoint many readers, particularly since people who are interested in this fund are probably trying to get the highest possible return that they can obtain. However, as we have seen in a few previous articles, many funds have actually experienced a share price decline over the past few months and in several cases, they have done worse than this one. In addition, closed-end funds are a bit different from indices or index exchange-traded funds because they deliver the vast majority of their investment return to their shareholders in the form of direct payments, not share price appreciation.

Indeed, most closed-end funds are simply trying to keep their net asset value relatively stable and pay out all of their investment profits to the shareholders. Thus, it is important to consider the distribution when evaluating the performance of a fund such as this one. When we do that, we see that the Calamos Strategic Total Return Fund has only delivered its shareholders a 2.15% loss compared to the 2.50% gain of the S&P 500 Index:

This is certainly still not ideal, as most investors would want to make money as opposed to losing it, but as numerous other articles have pointed out, essentially all of the gains in both the S&P 500 Index and the MSCI World Index (URTH) year-to-date have been due to seven large American stocks. As such, any fund that is not heavily concentrated in those names is going to underperform. As I pointed out in the previous article on this fund, the Calamos Strategic Total Return Fund does invest in different assets than the typical index fund, so that is certainly the case here. It does have heavy exposure to the major technology names that have been driving the recent market performance though, just less than the

Let us investigate and see if this fund could be a good addition to a portfolio right now.

About The Fund

According to the fund’s website, the Calamos Strategic Total Return Fund has the primary objective of providing its investors with a very high level of total return. Specifically, the website states:

The Fund seeks total return through a combination of capital appreciation and current income by investing in a diversified portfolio of equities, convertible securities and high-yield corporate bonds.

We can immediately see from the description that this fund is a bit different from typical closed-end funds. The Calamos Strategic Total Return Fund does not exclusively invest in either equity or debt securities. Rather, it holds a combination of various things in an attempt to get the best returns that are possible based on the current conditions in the market. As of right now, the fund’s portfolio is more heavily weighted to common stocks, however:

When we consider this, we can see that the fund’s objective of total return makes a great deal of sense. After all, common stocks are by their nature a total return instrument because investors typically purchase these assets in order to receive a small amount of income as well as benefit from capital gains as the issuing companies grow and prosper with the passage of time. This is the very definition of total return. The same can largely be said of convertible securities, as while they are income-producing assets to a degree, the fact that they can be converted into common stocks means that these securities still ultimately have capital gains potential. A bond is an income-producing asset, but in this case, the fund seems to be attempting to generate the highest level of return that it can be obtained regardless of where that return comes from. Thus, the total return objective makes sense for this fund.

In the introduction to this article, I stated that bonds may offer better risk-adjusted returns than common equities right now. Vanguard points this out in a recent article on its website:

Bonds are providing healthier yields than we’ve seen since before the 2008 global financial crisis. Higher current yields support a much-improved outlook for bond returns going forward. Higher returns can help reduce risk by acting as a buffer to additional rate increases while also providing a stronger base for future returns if the Federal Reserve starts cutting rates in the future. As a result, bonds may provide you with attractive yields at a lower risk profile than we’ve seen in recent years.

In short, the proposition of bonds right now is that an investor can essentially lock in a 6% to 9% return by investing in corporate bonds right now. As long as the issuing company does not default, it is guaranteed that the investor will receive at least that amount. If the Federal Reserve raises rates further, the investor simply needs to hold until maturity and there will be no realized losses. If the Federal Reserve cuts rates, the bond price goes up and the investor could potentially sell for a profit. This is a far better option than the inherent volatility of stocks, which could result in a loss if purchased at today’s level. After all, the earnings yield of the S&P 500 Index right now is 4.91%, which is not really that impressive when compared to the yield that can be obtained by investing in most corporate bonds.

As we saw the last time that we discussed this fund, the Calamos Strategic Total Return Fund has fairly significant exposure to a handful of very large American technology companies. This is still the case right now:

As I discussed in a previous article, the overwhelming majority of the returns delivered by the S&P 500 Index so far this year have been due to seven stocks: Microsoft (MSFT), Apple (AAPL), Amazon.com (AMZN), Alphabet (GOOGL), Nvidia (NVDA), Meta Platforms (META), and Tesla (TSLA). These stocks have been nicknamed “The Magnificent 7” by various sources. As we can clearly see above, six of these stocks can be found among the ten largest holdings in this fund. This is something that could be concerning, particularly for anyone who is attempting to construct a diversified portfolio. After all, these companies are all technology companies (with Tesla arguably being an exception), and the fact that they currently account for a substantial portion of just about any broad market index or mutual fund means that an investor in multiple funds will have a great deal of exposure to only a few assets. As a result, the concentration risk faced by any investor who holds positions in multiple companies is extremely high right now.

Fortunately, the fund’s weighting to some of these stocks is a bit lower than that of the S&P 500 Index. We can see that here:

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The remainder of the companies that comprise the majority of the fund’s holdings are not going to be a potential problem from a concentration perspective as many funds save four or five slots in their largest positions for opportunistic positioning. As a result, these positions tend to differ from fund to fund.

We can see that in the Calamos Strategic Total Return Fund as well. Apart from energy sector funds, it is not especially common to see Exxon Mobil (XOM) in a fund’s largest positions list. This company is certainly interesting right now in terms of valuation, as the company’s forward price-to-earnings ratio of 11.21 is substantially less than the 20.37 ratio of the S&P 500 Index. In addition, the company’s $59.3080 billion operating cash flow over the past twelve months is comparable to the twelve-month operating cash flow figures that Meta Platforms typically posts:

Thus, there could be some reasons to believe that ExxonMobil is significantly undervalued right now, especially since there is no reason to believe that the global demand for crude oil will be going away anytime soon. In fact, as I have pointed out in a few previous articles, it is more likely that the world will experience a shortage of crude oil by the end of the decade. The fact that this fund includes the company among its top ten positions, which is a rarity, could thus indicate that the fund is trying to provide a certain amount of variety across its positions, although the fund still has heavy exposure to the technology sector.

It is important to note that the Calamos Strategic Total Return Fund’s sector weightings are a bit more balanced than those of the S&P 500 Index:

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We can see a few differences between this fund and the S&P 500 Index. In particular, the Calamos Strategic Total Return Fund is quite a bit less weighted to the Information Technology, Health Care, and Financials sectors than the index. It is overweighted to the Consumer Discretionary sector, which may not be the best position right now considering that there is a growing amount of evidence that the American consumer has reached the limit of their ability to spend on discretionary purchases. After all, according to Adobe Analytics, the strong sales that were seen on Black Friday were being entirely driven by consumer borrowing:

According to CNBC, citing a report from Adobe Analytics, online sales topped $9.8 billion on Friday, a 7.5% rise over 2022. Buy now, pay later, while still a small fraction of overall sales, saw a 47% Black Friday boost over 2022 to $79 million, according to Adobe Analytics.

In various previous articles, I have shown that credit card balances have been increasing over the past few quarters. It now appears that consumers may have tapped out both their savings and their credit cards, and so are relying on yet another source of borrowing. Ultimately, consumers will be forced to cut back on their borrowing activities and begin to pay back all of this debt with interest. That will almost certainly hurt consumer discretionary stocks when it occurs.

It is still nice to see that this fund has much more balance and diversity across its holdings than the S&P 500 Index, however.

Leverage

As is the case with most closed-end funds, the Calamos Strategic Total Return Fund employs leverage as a method of boosting the effective total return yield of its portfolio. I explained how this works in a previous article on the fund:

In short, the fund is borrowing money and using that borrowed money to purchase stocks and bonds. As long as the purchased assets produce a higher return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective return of the portfolio. As this fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates, this will usually be the case.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage because that would expose us to an excessive amount of risk. I typically like to see a fund’s leverage under a third as a percentage of its assets for this reason.

As of the time of writing, the Calamos Strategic Total Return Fund has levered assets comprising 32.43% of its total portfolio. This is roughly in line with the 32.50% leverage that the fund had the last time that we discussed it. That is certainly a positive sign, as it implies that this fund is not really interested in increasing its leverage despite the market rally that we have seen since the middle of October. This is a bit different than some of the other funds that we have discussed lately, as regular readers can likely recall that there have been a few funds that have seen their leverage increase quite a bit over the past two or three months.

Overall, the balance between risk and reward should be acceptable here, but we naturally want to keep watching the fund to ensure that the fund’s management does not begin to leverage up its assets. That would expose us to an excessive amount of risk, especially considering that the fund’s holdings are weighted toward common stocks and other volatile assets.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the Calamos Strategic Total Return Fund is to provide its investors with a very high level of total return. In order to achieve this, it invests in a portfolio that consists primarily of common stocks and various types of bonds. The bonds should provide a fairly respectable level of income considering where interest rates are right now. However, the fund’s common stock holdings are not going to be nearly as good right now. After all, the yield of the S&P 500 Index only yields 1.55% as of the time of writing. The fund thus must realize capital gains from these assets in order to get money that will be added to the pool of investment profits that can be paid out to the investors. It then pays out all of this money to its shareholders net of its own expenses. When we consider the potential capital gains available from a typical common stock investment, it should be obvious how this might result in a respectable yield from the fund’s shares.

This is certainly the case, as the Calamos Strategic Total Return Fund currently pays a monthly distribution of $0.1025 per share ($1.23 per share annually), which gives it an 8.65% yield at the current share price. This is obviously quite a bit above the yields of most index funds or common stocks, but it obviously cannot compete with the double-digit yields that can be obtained fairly easily by investing in a fixed-income closed-end fund. This fund’s distribution history is respectable though, as the Calamos Strategic Total Return Fund has generally been increasing its distribution since the 2009 recession:

This is a much better history than that possessed by most closed-end funds, as we have seen quite a few funds that have had variable distributions over the past decade. There are very few funds that have actually managed to boost their distributions over the trailing ten-year period, so the fact that this one has accomplished that feat is something that any income-focused investor should be able to appreciate. The fact that the fund has consistently increased its distribution over time is very nice to see in today’s inflationary environment, as inflation has caused the purchasing power of the distribution paid by a fund that keeps its payout static to decline. The fact that this fund has managed to boost its distribution with the passage of time helps to offset this problem and ensures that those investors who are living off of the distributions can keep their purchasing power relatively stable over time.

As is always the case though, it is very important that we ensure that the fund can actually afford the distribution that it pays out. After all, we do not want to be the victims of a distribution cut that reduces our incomes and almost certainly causes the fund’s share price to decline.

Unfortunately, we do not have an especially recent document that we can consult for the purpose of our analysis. As of the time of writing, the fund’s most recent financial report corresponds to the six-month period that ended on April 30, 2023. As such, it will not include any information about the fund’s financial performance over the past seven months. This is disappointing, as a great deal has happened in the past seven months. In particular, we had the market continue upward for two months after this report’s end date before it collapsed due to expectations that the Federal Reserve will be keeping interest rates high for an extended period of time. This volatility both gave the fund the opportunity to earn some capital gains and could have caused it some losses. We can very easily see this volatility by looking at the fund’s net asset value, which was certainly volatile since May 1, 2023:

We can see that the fund’s net asset value increased over the period though, which suggests that its performance since the end date of this report has been reasonable. However, we do not know exactly how the fund managed to perform over the past seven months. We will have to wait until its full-year report is released in a month or two in order to have this information.

During the six-month period, the Calamos Strategic Total Return Fund received $21,241,378 in interest and $22,237,524 in dividends from the investments in its portfolio. However, some of this money was considered the payment of principal and so is not considered to be income for tax purposes. As such, the fund only reported a total investment income of $39,150,928 over the period. This amount was not sufficient to cover the fund’s expenses, and it reported a net investment loss of $2,307,554 over the period. That is obviously not enough to cover any distributions, but the fund still paid out 98,076,123 to its shareholders over the period. At first glance, this could certainly be concerning, as the fund is paying out a great deal of money when it does not have the net investment income to afford these payments.

However, the fund does have some other methods through which it can obtain the money that it needs to afford the distribution. For example, the fund might be able to generate some capital gains from the common stock portion of the portfolio. Realized capital gains obviously represent money coming into the fund that is not included in net investment income. Fortunately, the fund enjoyed a great deal of success at this task during the period. During the six-month period, the fund reported net realized gains of $32,223,837 and had another $153,227,355 in net unrealized gains over the period. This was more than enough to cover the distribution, and the fund’s net assets increased by $101,833,583 after accounting for all gains and losses during the period.

Thus, the fund technically did manage to cover the distribution. As we can see above too, the fund’s net asset value per share has actually increased over the seven-month period since the closing date of its financial report, so it seems likely that it also managed to cover it since then. As such, this distribution could certainly prove to be sustainable if the fund can keep up its current performance.

The biggest concern here is that the fund relied on unrealized capital gains to cover the distributions. It did not manage to earn enough net investment income and net realized capital gains to cover the distribution. The problem with this is that unrealized gains can easily be erased the moment that the market turns sour. As such, we should not get too complacent here.

Valuation

As of November 28, 2023 (the most recent date for which data is currently available), the Calamos Strategic Total Return Fund has a net asset value of $14.63 per share but the shares currently trade for $14.32 each. This gives the fund’s shares a 2.13% discount on net asset value at the current price. That is a pretty small discount, and indeed it is less than the 4.33% discount that the shares have had on average over the past month. As such, investors might be able to get a better price by waiting for a better entry point. However, the current price is much better than the premium that the fund’s shares had the last time that we discussed it, so the current price is certainly acceptable compared to what it had earlier this year.

Conclusion

In conclusion, the Calamos Strategic Total Return Fund is one of the more interesting closed-end funds available in the market. The fund is certainly not from one of the major fund houses, so it might be somewhat underfollowed by some market participants. However, the fund does appear to be a very respectable performer right now, as it managed to cover its distribution during the first half of its fiscal year and appears to be covering it since the end of that first half. The fund has also finally started to trade at a discount on net asset value, so the price is much better than it was earlier in the year.

Overall, this fund might be worth considering right now as long as the fund’s exposure to the mega-cap technology sector does not disrupt your overall portfolio diversification.