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USA started the year off on a weak note. The second quarter showed notable improvement. But the big news this year is a distribution change. Liberty All-Star Equity Fund (NYSE: USA ) is a unique closed-end fund, or CEF, in that it brings together five different managers in one fund. The goal is to create a so-called core fund that can provide investors with broad market exposure. That’s a great story, but there are other things to consider here… like the recent change to the dividend policy. A different approach Most CEFs take a single approach to investing in equities. And most CEFs have a single team running the show. USA deviates from this , employing five different asset managers to handle the investing with three using a value approach and two focused on growth. It’s kind of like a fund of funds approach, with each asset manager getting roughly equal portions of USA’s portfolio to run. USA’s management, meanwhile, is watching over the individual asset managers to make sure they are doing a good job for shareholders. For an investor looking for a way to get broad equity exposure without having to do much work there are some structural things to like in this fund. An up and down year That said, this hasn’t been the best year for USA so far. For example, the fund’s NAV return was slightly negative in the first quarter and up only about 1% in the second . Through the first six months, then, the fund was up around 0.75%. To be fair, the S&P 500 was up only about 1.25% over the same span. While on a percentage basis USA lagged greatly, on an absolute basis it didn’t. It’s worth noting that, over the long-term, this isn’t out of line. USA has historically lagged behind the S&P based on NAV total return, which includes distributions. For example, over the trailing 15-year period through June the CEF’s annualized NAV return was roughly 3.6% while the S&P returned nearly 4.4%. So why buy a fund that lags over time? In the case of USA, the answer is likely the distribution. The fund started the year with a 6% of NAV annual distribution target. For income investors that would easily beat the yield offered by the S&P in recent years. Add in the fund’s trailing 3-year discount is nearly 12% and the yield a USA investor gets is even higher than the 6% target. For reference, the 10-year average discount is around 11%, according to the Closed-End Fund Association . But wait, there’s more! That, however, was the distribution goal at start of the year. In March the fund kicked that up to 8%. The reason for the change was to ” better align ” the fund’s distribution policy with historical market returns. While that may, indeed, be true, distributing more assets makes it harder for a fund to grow its net asset value. In other words, USA may have just made life more difficult for itself. That said, over the last five years, destructive return of capital hasn’t been a big issue. But with the distribution bump, you’ll want to keep a closer eye on this going forward. If the market turns south, as it has lately, USA may have little choice but to dip into capital to meet its target. On the plus side, the target is actually 2% of assets per quarter, which will by design fluctuate up and down with the fund’s NAV. In the end, 8% may work just fine. I simply wouldn’t want to let this change go unwatched. Why do it? USA’s current discount to NAV is roughly 15%. It’s been hovering around this level all year after trading at a narrower discount most of last year. And an even narrower discount the year before that. With the discount widening, it’s possible that the distribution boost was an attempt to attract investors to the fund and, thus, narrow the discount back toward its historical levels. That’s a cynical view of things, but this is a tactic often used in the CEF world. The problem is that upping the distribution to gain investor attention can be a counter productive move if it ends up making the NAV shrink over time. That said, USA isn’t a bad fund, it’s just not a really good one. If you are looking for a core fund that spits out a decent income stream, though one that fluctuates over time, you should put USA on your watch list. And with a wider than normal discount, it’s not a bad time to take a look. But you’ll want to pay attention to what the distribution change does to the fund. The higher yield may come with strings attached. And for long-term holders, you’ll want to keep a closer eye on the fund over the next few years. A 25% boost in the distribution may feel nice right now, but it will feel awful if it starts to hamper the fund’s performance. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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