NIE: CEF That Combines Growth Stocks, Covered Calls And Convertibles

AllianzGI Equity & Convertible Income Fund (NYSE:NIE) is a closed-end equity mutual fund (“CEF”) that invests in a combination of diversified large-cap growth stocks, covered calls, and income-producing convertible securities. The stock is currently trading at a discount of 13.5 percent to its net asset value (“NAV”), which is significantly low. Its price performance has been poor this year, primarily due to poor performance of technology and pharmaceutical stocks. However, due to such a huge fall in its market value, the fund has been able to generate an exceptionally high yield of 14.5 percent this year. Otherwise, the average yield stays within a range of 5 to 8 percent, which also is quite impressive. Consistent quarterly payment of the dividend over the past 15 years also works to its advantage.

AllianzGI Equity & Convertible Income Fund Has An Interesting Portfolio

NIE was launched as AGIC Equity & Convertible Income Fund on Feb 27, 2007, and is co-managed by Allianz Global Investors Fund Management LLC and Allianz Global Investors U.S. LLC. AllianzGI Equity & Convertible Income Fund has $665 million in net assets and has a market capitalization of $563 million. The fund employs fundamental analysis emphasizing on factors like technological innovation, competitive advantages, return on equity, earnings growth, healthy balance sheet, steady cash flow, and sufficient liquidity.

The top 50 percent of its equity holdings constitutes a sample of technology stocks such as Microsoft Corp (MSFT), Apple Inc (AAPL), Alphabet, Inc (GOOG), Amazon.com Inc (AMZN), Tesla Inc (TSLA), Accenture plc (ACN), Booking Holdings Inc. (BKNG), Intuit Inc. (INTU), Palo Alto Networks, Inc. (PANW), Meta Platforms, Inc. (META), ServiceNow, Inc. (NOW), and CrowdStrike Holdings, Inc. (CRWD).

Healthcare stocks such as UnitedHealth Group Incorporated (UNH), Thermo Fisher Scientific Inc. (TMO), AbbVie Inc. (ABBV), Eli Lilly and Company (LLY), DexCom, Inc. (DXCM), McKesson Corporation (MCK), IQVIA Holdings Inc. (IQV), and Intuitive Surgical, Inc. (ISRG) also makes this list. Together, these two sectors – tech and healthcare – account for 51 percent of the fund’s total investments.

Despite the fund investing a relatively low percentage of funds in financial and energy stocks, a good number of companies from these two sectors make it in the list of top 50 percent of the fund’s investments. Examples include ConocoPhillips (COP), Schlumberger Limited (SLB), Exelon Corporation (EXC), Devon Energy Corporation (DVN), Wells Fargo & Company (WFC), JPMorgan Chase & Co. (JPM), Mastercard Incorporated (MA), and Visa Inc. (V). Together these two sectors account for around 11 percent of the fund’s total investments. AllianzGI Equity & Convertible Income Fund has also made significant investments in convertible securities and employed a strategy of writing (selling) call options on the equity shares held by the fund.

Technology Stocks Performing Poorly, Healthcare Stocks As Well

2022 has been a relatively bad year for technology and pharmaceutical stocks, where NIE has invested the majority of its funds. The NASDAQ 100 Technology Sector Index (NDXT) witnessed negative growth during most months. This is despite the fact that technology stocks performed relatively well during 2020 and 2021 though the market was highly impacted by covid-19 pandemic. Between April 2020 and December 2021, NDXT recorded positive growth in 16 out of 21 months, and marginal negative growth in the remaining 5 months.

Price declines in the S&P 500 Pharmaceuticals Index Industry (SP500-352020) started only during the last quarter. The index almost doubled between April 2020 and June 2021, before falling by more than 10 percent during the past three months. None of the 12 technology stocks recorded positive growth during this year, and also during the past 3 months. Among those 8 healthcare stocks, only MCK and LLY recorded significant growth in 2022. DXCM was able to post significant growth during the past three months.

Combination Of Growth Stocks, Covered Calls, Convertibles Delivering Fruits

Fortunately, AllianzGI Equity & Convertible Income Fund invested more than 35 percent of its fund in convertible securities, with a weighted average maturity of 3.7 years. Convertible securities historically outperformed traditional fixed income securities during periods of rising interest rates. Convertible securities also protect NIE from extreme volatility of growth stocks in the above-mentioned sectors. However, the weighted average coupon is quite low at 1.44 percent, which otherwise will fail to generate strong return.

So, these securities can be best used as a cushion. Allianz Global Investors Fund Management LLC runs another fund, AllianzGI Diversified Income & Convertible Fund (ACV), which puts much higher emphasis on convertible securities than the equity shares. ACV has lost 48 percent of its value during the past 1 year, whereas NIE lost 31 percent.

Loss of exports resulting from strengthening of the U.S. dollar, rising inflation, low level of consumer spending, increase in oil-price, supply chain breakdown due to the war in Ukraine, had a major impact on the mega-cap technology and pharmaceutical giants. Healthcare stocks other than the pharmaceuticals did comparatively better. All these negative impacts of a depressionary market situation led to a fall in the market price of NIE. However, I feel these bearish trends will be over within a few months and these stocks will come back to their long-term growth trajectory. In addition, AllianzGI Equity & Convertible Income Fund is also benefiting from its covered call strategy.

Covered call is a hedging strategy in which the equity shareholder sells a call option on the same stocks that he/she is holding and thus receives an upfront option premium, for undertaking the risk of potential loss in the call option. By this way, the equity shareholder earns additional cash flows that create additional income. Covered call CEFs like AllianzGI Equity & Convertible Income Fund also enjoy the scope of generating risk-adjusted returns significantly higher than equity only portfolio that doesn’t employ any hedging strategy. According to America’s largest investment management firm BlackRock, “by using an equity covered call strategy, investors can reduce portfolio volatility by capturing option premiums, without having to sacrifice long-term performance.”

Investment Thesis

Historically AllianzGI Equity & Convertible Income Fund has been a reasonably good fund with a reasonably strong yield and exceptionally high total return over the long term. It has been delivering consistent quarterly distributions for the past 15 years, despite facing the 2008 global financial crisis, and covid-19 pandemic. Over the past 5 and 10 years, the fund generated total returns of 48 percent and 156 percent, respectively.

Writing call options on the majority stocks of its equity portfolio has made it easier for NIE to offer a steady yield. Convertible securities also protect NIE to a certain extent from extreme volatility of large-cap stocks in the technology and pharmaceutical sectors. With NIE falling for the entire year of 2022 and the fund currently trading at a deep discount of 13.5 percent, now might be a good time to buy NIE.