Cornerstone Strategic Value Fund (CLM): Another Rights Offering

Stock Market


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Investment Thesis

This article will take a look at the Cornerstone Strategic Value Fund (NYSE: CLM). I have looked at CLM several times in this series, and have mostly found that it does a poor job of covering its distribution. This has resulted in many years of NAV erosion. So, how has CLM done since the COVID crash? After a nice bounce from the COVID recovery and an increase in the distribution, CLM has returned to being unable to support the distribution. There is however a way to make money by exploiting the disparity between the popularity of the fund and the value of its portfolio.

What I most want from a CEF is a stable flow of income. I developed a method of determining whether a specific CEF could provide a reliable stream of income after reading this article. As an income investor my thinking is that rather than the share price, how the portfolio of the fund behaves and the income it generates are the determining factors in the reliability of the distribution. I also think it is a mistake to see the fund’s NAV as of the sole component of the fund’s value. It is the fund’s ability to generate cash that is the true value. I look at a CEF and apply my method to determine if the fund has been supporting the distribution. Then based on current holdings and past performance, I try to determine whether or not the fund will be able to support the distribution in the future. You can read an explanation of my method and get links to the other articles in the series here.

Cornerstone Strategic Value Fund

My standard practice is to look at how well a CEF manages its portfolio. What I want to see is that it can reliably generate enough cash from its portfolio to pay the distribution. What I do not want to see is a fund that is eroding its asset base to pay a distribution that is too generous.

To determine if the fund can support its distribution, the first thing I look at is the total return on NAV. This tells me the total return of the portfolio. So, how did CLM do over the last 12 months?

Chart
Data by YCharts

At first glance, 18.52% looks like a pretty good return. But remember, that the fund pays out 21% of its NAV (based on NAV on the prior year October 31). And do not forget that last year the fund also did a rights offering where it sold a bunch of new shares at a 7% premium to NAV.

So how did CLM’s NAV do over the last 12 months?

Chart
Data by YCharts

Well, NAV decreased by almost 3%. And much of that decline happened after January when the new and higher distribution went into effect. The average NAV over the last 12 months is significantly higher than the current NAV.

What do the distributions look like over the last 12 months?

Looking at the data on CEFData, we can see the last 12 declared distributions.

CLM Distributions and claissifications

TTM CLM Distributions (CEFData)

Given the decline in NAV, I am somewhat concerned by the amount of distributions that are designated as ROC. If NAV were increasing, ROC would just decrease the tax base of the investment and delay paying some of the taxes. But let’s complete the analysis to see if the ROC is truly destructive.

Total distributions over the last 12 months are $ 1.9842 (3 at $ 0.1808 and 9 at $ 0.1602). Based on the average NAV of $ 10.02 that works out to be a 19.80% yield on NAV. Using the peak NAV of $ 10.54, I calculate the yield on NAV to be 18.82%. The total return on NAV of 18.58% falls between those two values. However, the new distribution is higher than the distribution paid during most of the last 12 months, and NAV is down significantly from the average NAV. And remember, that last year CLM did a rights offering that boosted NAV. So I am worried about potential NAV erosion.

Chart
Data by YCharts

One final metric to eliminate the possibility of NAV erosion is to look at how the benchmark index has done over the same time. And as we can see in the chart above, SPY’s NAV (and price in this case) has increased just over 16%. That compares to CLM’s 2.92% decline. I have to conclude that over the last 12 months, like many similar periods in the past, CLM has overpaid the distribution and eroded the NAV.

More importantly, the current NAV for CLM is about 9.8% below where the NAV was when the distribution was set. Unless this trend is reversed, CLM will see a distribution cut announced for next year.

Long-Term Trends

While it is important to look at how a fund has done over the last year, it is over longer timeframes that a fund will shine or not. I like to look at distribution coverage over the last 3 years, as that tends to minimize one year being atypically good or bad, while not giving the distant past too much weight either.

So how has CLM done over the last 3 years in managing its portfolio?

Chart
Data by YCharts

While a 57.2% total NAV return is not peanuts, that means that the CAGR was only 16.25%. Remember that by policy CLM is paying a distribution that is 21% of NAV. So while 16.25% looks impressive, it actually fails to cover the distribution. Let’s look at what this meant for the fund’s NAV.

Chart
Data by YCharts

NAV performance is not so great. The average decline in NAV over the last 3 years works out to 5.74% (and that is after a big bounce in the last week or so). How has NAV performed over the last 10 years?

Chart
Data by YCharts

Over the last 10 years, NAV has declined by over 60%. At a rate of 9.59% per year! The best thing that can be said about the NAV erosion is that it has slowed down over the last 3 years. So how has the distribution done?

Distributions since 2012

CLM Distribution History (CEFData)

This is a very ugly distribution pattern. It supports my thinking that CLM overpays its distribution. With a 21% on NAV distribution and the NAV erosion that we have seen over the last 10 years (and really, longer than that), it is not a surprise that the distribution is regularly reduced. My biggest surprise with CLM is not that the fund can not cover the distribution, but actually how close they come to doing so.

Future Distribution Coverage

It is critical to understanding how CLM will perform in the future to first understand how it performed in the past. Over the past 10 years, CLM’s portfolio has generated returns that have averaged 12.8%. While that is impressive, it falls far short of covering its distribution which is set to be 21% of the NAV reported on October 31.

There are several ways for CLM to generate enough cash to support distribution. The first, and I’ll cover that in its own section is to do a rights offering. The second is to make good picks. Let’s look at the portfolio and see if we can see anything that will do a lot better than it has over the last few years.

Industry Exposure and Top 10

CLM Industry Exposure (CEFData)

Exposure to the FAANG stocks is never a bad thing when looking for capital gains. And CLM does not disappoint. It also has a nice exposure to Berkshire (BRK.B) so yet another good thing. It looks like Tesla (TSLA) has fallen out of the top 10, just when I have started to think that it can be a going concern even after the major automotive companies start to take electric vehicles seriously. However, I just do not see any investments that will do better than they have recently to help CLM improve its distribution coverage.

So is the fund trading at a good value relative to its NAV?

Chart
Data by YCharts

Well, not really. One thing to note here is the peaks in premium. In large part, this is because CLM does a rights offering when the premium peaks (it being the best time to sell more shares accretively). And those rights offerings, since while at a premium to NAV are at a discount to market price, reduce the market price of the shares. Or at least they used to do that.

Impact of Rights Offerings

CLM has a long history of doing rights offerings when the premium is high. And with the premium recently exceeding 50%, it should not have come as any surprise when CLM announced a rights offering on February 18.

Currently, the subscription price is yet to be determined. As is usual with the subscription price of a rights offering, it will not be calculated until the end of the subscription period. At which time the subscription price will be the higher of either 112% of the NAV or 65% of the market price. Shareholders as of the record date (still not determined) will be able to purchase 1 new share for every 3 shares they hold on that date. Shareholders who purchase all shares they are allowed can oversubscribe to get more. Cornerstone will issue up to 2 shares for every 3 current shares to cover such oversubscriptions.

Chart
Data by YCharts

CLM’s price did not react much to the announcement, which is somewhat atypical. Based on the NAV on that date, the subscription price would be around $ 10, so a price around $ 14 is still relatively expensive compared to the subscription price. One might think that the offering would have pushed the share price down, but other than a few days, the price has seen little change (and even a small increase).

The Market Does Not Care

The Cornerstone funds often remind me of a TV commercial I have seen for the shingles vaccine. In that commercial we see several different people explaining some healthy actions they take, and then the narrator tells us “Shingles Doesn’t Care!” I have written many times about how poorly I see Cornerstone handling the portfolio for CLM. But so far, the market does not care.

To make good money from owning CLM, you have to do one thing. Get as many shares as possible at a price below what they sell for on the open market. Investors have two ways to do that. They can reinvest the distributions at NAV (and should only use a broker that will allow that) and buy shares during a rights offering. Buy a few shares at the market price, and then fully subscribe to the current rights offering and oversubscribe as well (go for it and ask for as many shares as you can afford to buy, the more you ask for the more you will get, and you might get all you asked for). Then reinvest the distributions. If you need cash, sell some of the new shares from the distribution after they hit your account. Remember as long as the shares are trading above NAV, even if you sell enough shares to get the full dollar amount of the distribution you will continue to build your share count.

Conclusion

I do not like CLM because it does not fully support its distribution. Depending on how you want to manage the position you may be able to ignore that. As long as the market continues to price CLM based on its distribution and not on how it handles its portfolio, you can use the premium to NAV that the shares sell at to make good money. It is a bit too early to tell, but even with the NAV bump from the rights offering, next year’s distribution could be lower than this year’s.



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