(This article was co-produced with Hoya Capital Real Estate)
While most fund reviews I see on Seeking Alpha and other investment sites talk about what to own, top performers, this article does not. With all funds available, I think it is useful to narrow the scope by highlighting those that might not be the “best choice” in the asset class/sector they are investing in.
Virtus AllianzGI is the lead manager of six closed-end funds, five of which have an allocation to convertible securities. Unfortunately, the AllianzGI Convertible & Income Fund II (NYSE: NCZ), nor her sister CEF, the AllianzGI Convertible and Income Fund (NCV) offer investors what they expect. This is why I have a sell rating on NCZ (and NCV) as there are better choices even within the Virtus AllianzGI family of funds.
Understand the AllianzGI Convertible & Income Fund II
Seeking Alpha describes this CEF as follows:
AllianzGI Convertible & Income Fund II is a closed-end bond mutual fund launched and managed by Allianz Global Investors Fund Management LLC. The fund is co-managed by Allianz Global Investors US LLC. It invests in US bond markets. The fund invests primarily in convertible securities and non-convertible high yield bonds rated below investment grade. NCZ started in 2003.
Source: seekalpha.com NZ
The managers list the following as NCZ’s investment objectives:
- The Fund seeks total return through a combination of capital appreciation and high current income.
- Invests in a diversified portfolio of domestic convertible securities and high yield bonds rated below investment grade.
- Seeks to invest at least 50% of its portfolio in convertibles, but determines its allocation based on changes in equity prices, changes in interest rates and other economic and market factors.
- For the convertible portion, Allianz Global Investors seeks to capture the upside potential of equities with potentially less volatility than a pure equity investment.
- In seeking investment opportunities, the manager looks for issuers that will be able to adapt to change, exceed minimum credit statistics and present the most promising operational performance potential.
Source: virtus.com NCZ
NCZ has $292 million in assets with an expense ratio of 140 basis points. The forward yield is a very generous 11.7%, which is ideal for investors more concerned with generating income than total return. NCZ has an expense ratio of 1.55%, with a net expense ratio of 1.40%, as a contractual expense reimbursement is in effect until 02/01/2023. Both figures are indicated by the manager with the important note that the expenditure of leverage is excluded!
Review of NCZ Holdings
As of 3/31/22, when the last holdings were reported, NCV held 262 assets. Unlike some recently reviewed funds, NCZ provided investors with an almost pure allocation of fixed income securities, and not mixed with many equities (
Being all fixed income, ratings and maturity distribution become important.
“BBB” being the lowest quality rating, approximately 11% qualify for this designation. Less than 2% is rated below “B” where the risk of default jumps. While above 55%, the “Not Rated” percentage is not unusual.
With rates rising, having a high turnover rate (54%) should help replace low-coupon debt with higher-yielding debt. The average coupon is currently 3.56%. The above percentages reflect the high leverage ratio used by NCV. The NCV has an effective duration of 4.6 years and a weighted maturity of 2.9 years. It is very rare for the term to exceed the maturity; that I can’t explain.
The assets are distributed over the following sectors.
One site listed utility stocks as the vast majority of equity exposure; a sector that mimics the movement of debt securities.
Fixed income assets are split between convertibles (52%), bonds (33%) and preferred stocks (15%).
As part of NCZ leveraged finance, they use Auction Rate Preferreds. There have been times when the auction preferred rate market has frozen, which adds risk. That said, note that rates were decreasing as new ARPs were retired.
The above items have a market value close to $162 million. There is also $109 million outstanding in the AllianzGI Convertible & Income Fund II 5.5% Cum Pfd Registered Shs Series A (NCZ.PA). Recent leverage data has been listed as follows:
NCZ Cast Review
It’s not a model that investors, especially those with income, want to see; a constant reduction in payment. Preliminary notices to investors indicate that 100% of recent distributions were from “paid-up capital above par”, which I assume means ROC. The previous ones showed discrepancies of around 35%/65% between NII and ROC.
NCZ Price and Net Asset Value Review
They say “a picture is worth a thousand words”, but here are a few. The price was $15 initially; net asset value of $14.33, already putting early investors nearly 5% underwater. As you can see, it only got worse! NCZ’s CAGR has been just 4.24% since inception, assuming reinvestment, just 2.18% otherwise. Other fixed income funds fared much better, including its sister fund, NCV.
The current discount is 9.33%. An optimist would look at the chart above and see that NCV has often traded at a premium, and that would be correct. These investors are betting on the deterioration of the net asset value which will not continue as much as on the improvement in the prices.
While the past may not repeat itself as investors are often told, knowing the history should still be helpful.
These are the years where current inflation rates match. Convertible funds were the best of these asset classes. Calamos Investments is another major player in convertibles. The following chart shows how their convertible strategy performed against other fixed income strategies as rates rose.
The following table shows the Virtus CEFs which I consider close enough in strategy to be considered as an alternative to investing in NCZ.
Only one CEF with 5-year data did worse than NCZ. The two best performers, Diversified and Convertible Income Fund (ACV) Virtus AllianzGI and AllianzGI Equity & Convertible Income Fund (NIE) were definitely helped by holding a decent amount of stock; both were recently reviewed by me.
The following table includes convertible funds from other managers. I have also included several floating rate funds, given the rate environment we find ourselves in. In this group, NCZ ranks last using 5-year CAGR figures.
When doing due diligence before investing in a fund, it is important to consider the possible alternative choices. A starting point is the Seeking Alpha Peers feature, which for NCZ lists the following:
There are data comparison pages, and you can edit the list as you see fit, but here are links to their Seeking Alpha homepage for the three not listed above:
- Advent Claymore Convertible Securities&Income Fund (AVK)
- Calamos Convertible&High Income Fund (CHY)
- AllianzGI Convertible & Income Fund 5.625% Cum Red Perp Pfd Registered Shs Series A (NCV.PA)