HEQ: Weak Equity CEF Cutting Its Distribution

Thesis

The John Hancock Hedged Fairness & Revenue Fund (HEQ) is an fairness closed finish fund. The car has capital appreciation and present revenue as its predominant goals, and falls within the international equities allocation bucket. The fund has the power to overlay lined calls, and it has completed so previously, however not in a scientific style.

Its historic efficiency may be very weak when in comparison with vanilla ETFs and a worldwide equities CEF from Eaton Vance:

On the flip aspect, HEQ units itself as being benchmarked in opposition to the MSCI AC World Index, which is finest tracked by the iShares MSCI EAFE ETF (EFA), which has completed solely barely higher than HEQ. Funds with a worldwide tilt however skewed in the direction of the U.S. have fared considerably higher, particularly not too long ago because of the U.S. tech mega-caps allocations.

As a reminder, fairness CEFs merely convert fairness market returns into dividend distributions. To the extent there isn’t any constructive elementary efficiency within the underlying portfolio, the CEF will simply use ROC to fund its distribution, which is NAV harmful:

We are able to see that HEQ is used to overdistributing. Very properly run fairness CEFs could have a secure NAV all through time, punctuated by dips correlated to recessions, however the NAV retraces upwards after. Not right here. HEQ shows a pleasant decrease trending NAV, which suggests it has constantly overdistributed by means of time. The fund at present has a 11% said dividend yield, however it’s unsupported, which has lead administration to a contemporary distribution cut:

BOSTON, June 30, 2023 /PRNewswire/ – The John Hancock Hedged Fairness & Revenue Fund (NYSE: HEQ) (the “Fund”), a closed-end fund managed by John Hancock Funding Administration LLC (the “Adviser”) and sub-advised by Wellington Administration Firm LLP (the “Sub-adviser”), introduced in the present day that its Board of Trustees voted to amend its present managed distribution plan (the “Plan”), reducing the quantity of its quarterly distribution by 14 p.c.

Below the Plan, the Fund will make quarterly distributions of an quantity equal to $0.2500 per share, a lower from the earlier quarterly distribution of $0.2900 per share. This new quantity might be paid quarterly till additional discover.

Pursuant to its Plan, the Fund declared its quarterly distribution in the present day as follows: Declaration Date: June 30, 2023, Ex Date: September 08, 2023, Document Date: September 11, 2023, Fee Date: September 29, 2023

This new distribution quantity equates to an annualized distribution fee of 8.78% primarily based on the Fund’s NAV of $11.39 and 9.42% primarily based on the closing share value of $10.62 as of June 29, 2023.

A distribution lower is the precise factor to do in our opinion given the shortage of efficiency from the underlying belongings. The extra you overdistribute the much less doubtless it is possible for you to to ‘catch-up’ to the general indices when the market enters a bull run.

The fund is at present buying and selling at a small -6% low cost to NAV, which we really feel may be very a lot warranted:

We’re not in love with the MSCI AC World Index as a result of it’s underweight massive tech mega-caps which have pushed fairness rallies previously 12 months. Moreover we don’t like how HEQ is chubby Financials, a cyclical sector set for weak point in a recession. The low cost right here is justified and would possibly get wider.

We imagine the distribution lower was already priced within the HEQ pricing, so no additional motive to regulate positioning right here. In case you are already holding this title, proceed to Maintain into a brand new bull market to divest. New traders ought to look elsewhere nonetheless since HEQ doesn’t exhibit the chance/reward analytics mandatory for a sturdy international equities CEF.

Holdings

The fund accommodates a worldwide equities portfolio:

Whereas the U.S. has the best weighting right here, the fund’s portfolio is certainly international and diversified. From a person title standpoint the car’s high holdings are primarily composed of enormous cap multi-nationals:

The fund is granular, with not one of the holdings accounting for greater than 2% of the fund. Whereas this function makes it a pleasant diversified fund, this 12 months has labored in opposition to diversified builds, with many of the good points to date targeting a handful of Tech mega-caps.

One other constructing function to note is the truth that the CEF has a price tilt, and is chubby cyclicals by way of its massive Financials bucket:

Financials make up greater than 22% of the fund right here, they usually have labored in opposition to this title in 2023 on the again of the regional banks disaster.

The fund additionally has the power to enter into lined calls, as an overlay technique, and whereas it has completed so (as seen from its Annual Experiences), it doesn’t present any particulars on the present protection by way of the actual fact sheet.

Conclusion

HEQ is a worldwide equities CEF. The fund goals to trace the MSCI AC World Index and has capital appreciation and revenue as its objectives. The fund has a 11% said dividend yield which isn’t supported. The CEF has simply introduced a -14% discount in its distribution with the intention to make the most of much less ROC. Traditionally this title may be very weak, getting used to overdistribution, as mirrored in its -38% NAV loss previously decade. The fund’s composition is chubby financials, which we don’t like, and underweight tech mega-caps. We’re not followers of this title and take into account it a really weak fairness CEF. If you happen to already personal the title, Maintain till a brand new bull market is established to divest, whereas new traders would do properly to take a look at the likes of EXG within the international fairness CEF house.