Description

Hi, guys –

Well, this is embarrassing. I'm back with another PA-only fixed-income closed-end fund idea. This time the thesis is so simple that it's going to be a stretch to pad this write-up out to some respectable size. I'm going to start with the basics, explain the juice, and then finish up with some philosophical ramblings on why anyone should care.

Basics

Western Asset Global Corporate Defined Opportunity Fund (NYSE: GDO) is a small cap global bond closed-end fund. Here's a quick snapshot:

Price: $17.36
NAV: $19.71
Discount: 12%
Yield: 7.84%
Assets: $379MM
Leverage: $71MM
Leverage %: 19.4%
Fees (as % of assets): 1.17%
Duration: 3.84

Let's zoom in to the portfolio:

Credit Quality:
AAA 0.99%
AA 2.34%
A 20.48%
BBB 39.82%
BB 17.44%
B 10.28%
CCC 4.27%
Not Rated 4.40%

Top 5 Countries of Issue:
United States 41.46%
United Kingdom 13.34%
France 5.24%
Brazil 4.51%
Australia 3.35%
 
Emerging Market Exposure: 17.78%

Top 10 Holdings:
STATE STREET REPO 0.0000% Mat 11/03/2014 2.20%
BARCLAYS 7.63% 11/21/22 2.13%
VERIZON COMMUNICATIONS 5.1500% Mat 09/15/2023 2.01%
JPMORGAN CHASE + CO JR SUBORDI 6.0000% Mat 12/31/2049 1.98%
ING BANK NV SUBORDINATED 05/23 6.8750% Mat 05/29/2023 1.73%
NATIONAL AUSTRALIA BANK SUBORD 6.7500% Mat 06/26/2023 1.38%
GOLDMAN SACHS GROUP INC SUBORD 4.7500% Mat 10/12/2021 1.34%
NOTA DO TESOURO NACIONAL SENIO 10.0000% Mat 01/01/2017 1.32%
WACHOVIA CAP TRUST III 5.5698% Mat 12/29/2049 1.21%
INTL LEASE FINANCE CORP 8.7500% Mat 03/15/2017 1.15%

This is not widows-and-orphans stuff. There's some leverage. There's some junk. There's some EM. But it's not nuts, it's all within limits. There will be defaults and who knows where credit spreads might go, but I have a hard time seeing how this thing blows up. There's minimal rate risk and they're hedging out the currency exposure, so you're left with credit and a modest amount of emerging markets risk. I've scrolled through their portfolio; with regard to the worries du jour, they have a small amount of energy and a bit of Russia.

The Juice

So here's this CEF with a 12% discount and an ~8% coupon. The discount is towards the high end, but it's not hard to find larger, and the yield is, if anything, unexciting. Why is this VIC-worthy?

GDO is a term fund. On December 2, 2024 – ten short years from now! – they're going to liquidate and give the proceeds to the shareholders. That means that the current 12% discount will go to zero over by 2024, and maybe even sooner if the CEF retail investor base ever takes a shine to the fund.

Really roughly: The added income from the leverage covers fees and interest expense with something left over (I'm hand-waving away the additional NAV volatility caused by the leverage). The discount adds 90 basis points of coupon to the underlying portfolio, to which you can then add 130bps of annual discount narrowing, for 220bps outperformance. And that's pretty much it.

So Who Cares?

This is a fixed-income investment. (NB, I don't count distressed debt as being fixed-income.) The first question is one of asset allocation: What percentage of your portfolio do you want to allocate to fixed-income? Maybe the answer is, “zero”. Historically, that's what I've said, but these days if I can find something that looks like it could deliver equity-ish returns with some margin of safety, I'll buy it.

GDO could deliver equity-ish returns. This is an actively managed fund with some significant short/intermediate term maturities, so I'm going to take a static approach instead of trying to forecast actual results, which will depend on defaults & recoveries, and how rates and spreads evolve over time. We've got a 7.8% yield + 1.3% of discount compression for a headline 9.1% annual return. You're not going to get that because of defaults, so whack that down to 8% (this is roughly correct, I didn't just make up the 1.1%). That's not bad. Let's haircut it further to account for the “unknown unknowns”, to use Donald Rumsfeld's famous phrase. I dunno – call it 6%. Guess what, that's not bad either, what's your forecast for 10-year S&P 500 returns?

So I expect absolute returns to adequate. On a relative basis, you will wind up outperforming the underlying portfolio by some 2%/year, which in bond-land makes you an absolute freaking hero.

Motivated by a question raised about my JPI write-up, let me say a few words about the size of the discount and my approach to trading this stuff. A 12% discount is meaningless for a stock, but pretty much as good as you're going to get for something with a maturity date. Saying that a straight bond price is off by, say, 20% implies that the market is wildly wrong about the chances of default. Personally, I regard this discount as a really good deal, but not necessarily a screaming buy, obviously 15% is better. And it may get there. If it does, I'll buy more, and in any event plan to clip some coupons while I'm waiting. Conversely, if we get a nice January effect bounce and the discount narrows to, I don't know, 7%, I'm likely to sell.

A Couple Of Other Notes

Some people say of their investing style, “I'm not looking to hit home runs, I just want to get on base, singles and doubles are fine by me.” But sometimes just fouling off the pitch and staying in the batter's box is good enough. Like now.

GDO has approved a buyback program for ~10% of their shares. They actually seem to be bought back 20,000 shares at some point.

CEF's are actually a decent vehicle for bond funds; it's possible for the manager to add some value, because they are never forced to sell, they don't have to give up the 25bps or 50bps or whatever to entice someone to take some product of their hands in order to meet redemptions.

Yours,
Bowd

Catalyst

Coupon, time