Guggenheim Strategic Opportunities Fund: The Income Investor’s Friend
I’m a big fan of the Guggenheim Strategic Opportunities Fund (NYSE: GOF) as a way to add income to any portfolio. Due to its efficiency of approximately 13%, one can easily create the desired performance by increasing or decreasing exposure to it. The fund’s strong track record of distributions, high yield, and its fairly predictable trading range make this fund an easy choice for me when building my income portfolio.
The first thing to consider is that GOF is a closed-end fund (CEF), not an exchange-traded fund (ETF), and the two are very different. One way they are different is the expenses. CEFs are generally much more expensive. Expensive ETFs still have an expense ratio below 1%, but the GOF reaches a whopping 1.74%, as advertised on their website. This does, however, include the interest charges of the leverage of the GOF. Thus, the actual expense ratio will rebound based on leverage and rates. The pre-interest expense ratio is 1.50%, according to the Guggenheim. It should be noted that the 1.74% figure quoted by Guggenheim is from November 2021, before rates went vertical. It’s certainly not cheap, but CEFs tend to be expensive. According to the Fidelity CEF filter, the market median is 1.53% and CEFs range from 1.1% to 2.7%.
Another difference between CEFs and ETFs is that CEFs trade outside of their net asset value, or net asset value. CEFs are floated on the stock exchange with a set number of shares and then traded on the open market going forward. The CEF issuer does not issue new shares and does not buy or sell securities based on demand for the fund itself. This means that a CEF will trade on the open market at a potentially different price than the underlying assets (i.e. net asset value). A CEF whose market price is lower than the net asset value is considered to be trading at a discount. The reverse is also true: a CEF that trades for more than its net asset value is trading at a premium. GOF almost always trades at a healthy premium. The current premium as of July 20e (all other figures, unless otherwise stated, are as of June 30e) is 16.51%. For context, the average premium for the first half of 2022 was 21.08%, but the average premium since the start of 2017 is only 12.07% (data from Yahoo Finance Data Tool). I think of the premium like this: the net asset value of the fund fell 20% in the first half of the year, but since the distribution hasn’t budged, the price of the fund has actually held up enough, all things considered, since it only fell by 12.2%.
Usually a very high bounty would freak me out, but I think the story is different here. GOF has shown that it can maintain the distribution payout regardless of the market environment, so people keep buying it, keeping the price high (despite the underperformance of the underlying assets) . I’ll talk more about how GOF maintains distribution in the next section, but in my opinion the way to look at the right entry points for GOF is not based on its relative premium or discount, but on its price relative to its yield. The reason is clear: it is not a vehicle for capital appreciation and you should not treat it as such. The less you can buy that $0.1821 monthly payment, the better.
Before buying GOF, you should understand that it is a mailbox fund, not a capital appreciation vehicle. Of course, if you bought the 2020 low on March 18 at $11.82, you’d have a nice little 18.5% return and a 36% upside to boot. These opportunities will not come often; I advise against trying to time this or, really, any fund or stock.
GOF’s median price since 2017 is $20.00 (also its IPO price, coincidentally), and its price limits at one standard deviation are $18.40 and $21.60. At today’s closing price of $15.74, it is 14% below the 68% confidence interval. Everything has been affected in 2022, and the GOF is not excluded. I am long most of the market at these levels, especially GOF. As I said above, I just buy this monthly payment of $0.1821 cheaper today than before.
Even though the price return is mediocre, the returns on a DRIP basis are quite competitive: GOF has a total return for 2020 through the first half of 2022 of 19.1%. SPY, for the same period, has a return of 22.6%. For the first half of 2022, these figures are -6.2% and -16.9% respectively. Not bad, considering the marketing environment we’ve all operated in so far.
A big yield always raises the question of stability. It is not advisable to buy something with an amazing yield without understanding why it is so high and if it is durable.
The GOF has never lowered its distribution payment, it has paid a distribution every month since September 2007, and it has increased the distribution three times (the last in 2013). GOF’s monthly payout streak is 178, and that includes the 24 months of 2008 and 2009. At least from a historical standpoint, the distribution is rock solid.
Another way to look at the sustainability of a CEF’s distribution is to compare its net asset value to its distribution. You want to see some stability in the net asset value after taking into account the distribution payment. During the 2017-2021 period, GOF paid out $10.93 in distributions and made a profit of $8.65, so the net asset value fell by $2.28. NAV was not enough to cover all distributions, but it covered most of them. 2022 has been a different story, and I’m keeping an eye on the NAV vs. payout dynamic, but I’m not worried yet (source: Yahoo Finance and author’s analysis).
Approximately 60% of GOF’s distribution from 2019 to 2021 was treated as a return of capital. This trend seems to continue in 2022 (on the Guggenheim website). The important point is that a fund’s distribution method is not an economic, tax-only concept (earned and unearned distributions can be a return of capital). Distributions paid as returns of capital reduce your tax base, but they are not considered taxable income like ordinary dividends. This postpones the year in which taxes are paid on the distribution and potentially reduces taxes on long-term capital gains. For those lucky enough to use it as their main source of income, it’s a huge advantage to defer 60% of your income taxes to an unknown future date, potentially after your death.
You have to worry about the interest rate sensitivity of a debt fund, and that of the GOF is about average for its peer group, at around 3.5 years. The net asset value of the GOF has a correlation with the federal funds rate is weakly positively correlated, at 0.21 since the beginning of 2017.
The actual assets of the GOF portfolio are approximately one-third each of high-yield corporate bonds and bank loans, asset-backed securities (13%) and investment-grade corporate bonds (9%). Cash and other types of fixed income securities make up the remainder. Loans in progress represent 23% of the fund. This data is as of May 31–2022.
Really, two things about GOF’s holdings pique my interest. First, high liquidity (~25%) and leverage (23%). Why does the fund hold so much cash if it has essentially the same leverage? Dry powder, I guess. Second, the fund holds approximately 65% of its assets in companies rated BB to CCC. You can get this return without taking any risk, but it’s definitely something to consider. It’s also worth noting that, according to Standard and Poor’s research, a BB-rated company has less than a 10% risk of default over an eight-year period (all holdings data is from the Guggenheim).
GOF is definitely not a one-size-fits-all wallet. There are risks. The fund depends on its strong distribution to attract investors and thus maintain its high price. If the fund is unable to pay even a single month of distribution, or if it ever decreases the distribution, the price will likely fall. Since GOF always trades at a premium to NAV, largely because investors are drawn to the distribution, even a mistake would be costly. You could wipe out years of distribution gains if GOF management ever cuts or misses a distribution payment. Since distributions are always at the discretion of management, this is always a possibility, no matter how small.
Moreover, credit spreads have exploded a lot this year, with BB spreads rising from 2.06% in January to a high of 4.17% on June 30.e. That’s great from a yield standpoint, but junk rates don’t go up like that unless there’s a higher probability of default. It is also somewhat of a leading indicator of recession.
Alternatives and parting thoughts
Every investment has alternatives vying for your attention. GOF is not unique in this sense. There are many high distribution monthly funds available. The most obvious are covered call ETFs (QYLD and its sister funds) or anything from Brookfield Asset Management, especially their Real Assets Income Fund, RA. The QYLD family is a great choice for passive income. He sells monthly at-the-money call options on the Nasdaq. The other funds in this family slightly modify this strategy. Brookfield Real Assets Income Fund is essentially a real estate fund, but it has an excellent income track record.
I own GOF and think it’s a great way to supplement any portfolio with income. I advise against owning it without understanding the tax implications and how NAV and distribution play together. If you’re at a time in your life where you’re not looking for capital appreciation and just want stable, predictable income, GOF may be just what you need.