Monday, January 28, 2013

WIW: Another Dollar Selling For 90 Cents

Finding Fixed Income Value In A Closed End Fund

In recent months, it has become increasingly difficult to find reasonably priced buying opportunities, especially in the realm of fixed income.  Even the closed end fund (CEF) world has been bid up as there are very few funds that meet my investing criteria (market cap of at least $500MM, no excessive leverage or management fee, and at least a 10% discount to net asset value).  In fact, more often than not when I screen CEFs there are no funds that meet my hurdles.  However, there appears to be one very attractive bargain still available in fixed income CEFs, the Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW).

WIW is rare in the current market environment.  It is a non-exotic fixed income fund with no leverage and a big 11+% discount to net asset value.  This fund is fairly liquid, with significant trading volume and a market cap in excess of $900 million.  With a management fee of .60%, the fund is not being greatly overcharged by its manager (a distressingly common problem in the CEF world).  As I detail in a prior post, WIW meets all of my screening criteria for finding a clear value in CEFs (see

So what does this fund actually hold?  As you can see below, the fund has over 75% of its assets in US TIPS and another 8.4% in non-US inflation linked bonds (largely developed economy bonds).  The remaining 15% of the portfolio is a smattering of high yield, investment grade corporates emerging markets bonds, and other miscellaneous bonds.

Portfolio Concentration

as of 10/31/12
Source: Guggenheim Investments  
Asset Class%
US TIPS77.36 %
Non US TIPS8.40 %
High Yield Corp4.85 %
Investment Grade Corp3.84 %
Emerging Markets2.98 %
Mortgage Backed Securities0.72 %
Other1.85 %
US TIPSNon US TIPSHigh Yield CorpInvestment Grade CorpEmerging MarketsMortgage Backed SecuritiesOtherUS TIPSPortfolio Concentration: 77.36%
Happily, credit quality is quite high as illustrated below.  88% of the fund's assets are rated AAA/Aaa and only 6% of total assets are rated less than investment grade.  As a result, the risks the fund is taking are dominated by things other than credit risk.  As investors are not being compensated well for taking credit risk (junk spreads are at multi-year lows presently), a lack of significant credit risk is a good thing for this fund.

Credit Quality

as of 10/31/12
Source: Guggenheim Investments   
Credit Ratings%
AAA/Aaa88.03 %
AA/Aa0.71 %
A1.33 %
BBB/Baa3.84 %
BB/Ba4.33 %
B1.50 %
Below B0.19 %
Not Rated0.07 %

AaaAA/AaABBB/BaaBB/BaBBelow BNot RatedAAA/AaaCredit Quality: 88.03% So what are the chief risks here?  First and foremost, the fund sports a duration of a hefty 9.06 years which is well above that of the Barclays Aggregate Bond Index of 4.62 years.  This indicates substantial interest rate risk, although since the fund is largely comprised of TIPS this risk is keyed to movements in real interest rates rather than nominal rates (real rates equate to a nominal rate by adding the real rate to the inflation rate as expressed by the Consumer Price Index (CPI)).  Given the fund's average duration of 9.06 years, a 1% increase in real rates should yield a loss of about 9% of NAV.  Since 10 year TIPS real rates are currently about -.60% (yes, minus .6%), the possibility of an adverse rate move is significant.  Second, the manager of the fund attempts to hedge the fund against major risk events using derivatives.  While I think that in general a periodic hedging strategy is probably a good idea because it should tamp down volatility, a risk of WIW is that the manager gets the hedging strategy wrong or fails to hedge against an event that turns out to be unexpectedly deleterious to the fund.  Finally, WIW has the risk of all CEFs which is that the discount to NAV could widen even further than it already has.

The case for WIW is relatively simple.  I would like to maintain an allocation to TIPS in my portfolio to complement the modest amount of I bonds I am able to buy ($10,000 per year per social security number).  The problem with TIPS is that they appear rather generously priced and sport negative real yields (compared with I bonds which have a real yield of 0%).  Because WIW is trading at a significant discount to NAV, it effectively enables an investor to buy 10 year TIPS (with some extraneous stuff in the non-TIPS 15% of the fund's portfolio) at a real yield of about positive .5%.  Positive .5% real yields are not exactly going to blow the doors off for anyone, but they are far more attractive than 0% (I bonds) and -.6% (10 year TIPS).  The fund yields about 3% (paid monthly) and the large discount to NAV will likely narrow at some point (could be days, months or years), offering the possibility of a capital gain over and above whatever the underlying assets do.

I think WIW is one of the best values in the fixed income CEF universe at present.  Given the fund's relatively modest volatility, it also offers an opportunity to add some less volatile assets to one's portfolio.

As always, the above is not intended as investment advice.  Do your own due diligence, consult your advisers and be careful.  You can lose money on this stuff.  Not guaranteed by anyone.

Disclosure: I am currently long WIW and may purchase more without warning or updating this post.

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