NIE: Best Way To Gain Through Growth Stocks, Covered Calls, And Convertibles

~ by Snehasish Chaudhuri, MBA (Finance)

AllianzGI Equity & Convertible Income Fund (NYSE:NIE) is a CEF that invests in a combination of large-cap growth stocks, covered calls, and income-producing convertible securities. Last time I covered this fund, it was trading at a deep discount of 13.5 percent, and this discount was not expected for a very long period. Over the long term, NIE has been a reasonably good fund with a quite strong yield and an equally strong total return. The fund has been paying quarterly dividends since 2008 on a consistent basis, despite facing the global financial crisis, and Covid-19 pandemic. It is able to generate strong yields due to investing in growth stocks and selling call options on a substantial portion of its equity portfolio. Having convertible securities to the extent of 35 percent of total assets was also helpful to NIE for generating strong and steady yield.

NIE Has Invested in the Right Growth Sectors and generated Strong Returns

AllianzGI Equity & Convertible Income Fund invested 68.25 percent of its equity portfolio in four of the potential high growth sectors of industrial, healthcare, financial, and information & communication technology (ICT). Due to innovative and revolutionary technologies, changes in industrial structure, and rise in demand for better healthcare facilities, equity stocks belonging to healthcare, ICT and industrial sectors are expected to generate above-average growth in the coming decade. Financial sector is a default beneficiary of economic growth in any form. Such investments have so far been able to achieve the desired results, as NIE recorded an annual average total return of 18.8 percent during 2016 and 2021. NIE however has a very high portfolio turnover ratio of 71 percent and an equally high expense ratio of 1.12 percent.

NIE Has Benefitted from Convertible securities and its Covered Call Strategy

Convertible securities held by AllianzGI Equity & Convertible Income Fund have a weighted average maturity of 3.7 years. In a rising interest rate scenario, these securities generally outperform the traditional fixed income securities. Convertible securities also create a protective shield from extreme volatility that is seldom experienced by growth stocks in technology, financial and healthcare sectors. However, these securities have a very low weighted average coupon of 1.37 percent. So, convertibles act as a cushion, and not meant for generating strong returns. Covered calls, on the other hand, help to generate risk-adjusted returns significantly higher than equity-only portfolios. In my opinion, this fund has been quite successful in diversifying its portfolio and wisely allocating its AUM of $600 million in various types of securities.

Analysis of Top 25 Investments of AllianzGI Equity & Convertible Income Fund

Top 25 investments in AllianzGI Equity & Convertible Income Fund make up 40 percent of its total assets. It constitutes a sample of technology stocks such as Microsoft Corp. (MSFT), Apple Inc. (AAPL), Alphabet, Inc. (GOOG) (GOOGL), Amazon.com Inc. (AMZN), Meta Platforms, Inc. (META), Nvidia Corp. (NVDA), Tesla Inc. (TSLA), Booking Holdings Inc. (BKNG) and ServiceNow, Inc. (NOW). NIE also invested 3 percent of its total assets in the BlackRock Liquidity Funds FedFund Inst (TFDXX). Past three months have been excellent for the technology sector as all these nine stocks recorded a price growth between 16 to 93 percent. Here, what impressed me is that despite strong growth witnessed by technology stocks, NIE has replaced some stocks that generated relatively less returns, although much higher than other stocks.

Few stocks from financial and industrial sectors also make it in the list of top 40 percent of the fund’s investments. Examples include Union Pacific Corp (UNP), Waste Management Inc (WM), Wells Fargo & Company (WFC), JPMorgan Chase & Co. (JPM), Mastercard Incorporated (MA), and Moody’s Corporation (MCO). Healthcare stocks such as Thermo Fisher Scientific Inc. (TMO), AbbVie Inc. (ABBV), Zoetis Inc (ZTS) also makes this list. A few large-cap stocks from the energy and retail sector complete NIE’s list of top 25 investments. These stocks are Exelon Corporation (EXC), Costco Wholesale Corp (COST), Schlumberger Limited (SLB), The Home Depot Inc (HD), NIKE, Inc. (NKE) and DuPont de Nemours, Inc. (DD). These stocks on an average performed poorly during this period. Only three stocks – ZTS, MCO, COST – registered a price growth in excess of 4.3 percent. However, during the past six months, barring WFC, all other stocks registered positive price growth.

If we compare the current portfolio with that of three months back, we find that it has been rebalanced to a large extent. Some popular large-caps like Visa Inc (V), Accenture plc (ACN), Intuit Inc. (INTU), Palo Alto Networks, Inc. (PANW), CrowdStrike Holdings, Inc. (CRWD), UnitedHealth Group Incorporated (UNH), McKesson Corporation (MCK), IQVIA Holdings Inc. (IQV), Eli Lilly and Company (LLY), DexCom, Inc. (DXCM), Intuitive Surgical, Inc. (ISRG) ConocoPhillips (COP), Devon Energy Corporation (DVN), etc. no longer rank among the top 25 investments of AllianzGI Equity & Convertible Income Fund. Investors won’t be much disappointed due to this rebalancing, as only five out of those 13 stocks – PANW, CRWD, INTU, V and ACN were able to register positive price growth during these past three months. Interestingly, all these five stocks are technology stocks, in which NIE became highly overweight.

NIE Reduces Risk Through Diversification, But Macroeconomic Risk Prevails

If any security accounts for too much of the portfolio, then it may end up dragging the entire fund down with it. Fortunately, there is no asset that accounts for more than 4 percent of the portfolio. This diversification reduces portfolio risk of NIE. But, AllianzGI Equity & Convertible Income Fund has significant exposure to a few high-growth volatile stocks that incurred substantial price loss over the past one year. This has impacted NEI’s performance, and in turn its distribution. Supply chain breakdown due to the war in Ukraine and an appreciating US dollar also resulted in loss of exports. In addition to that, rising inflation, increase in oil-price and low level of consumer spending impacted large-cap healthcare, energy and retail stocks. However, of late, the technology stocks have performed much better.

Investment Thesis

Convertible securities can be quite attractive because they offer the dual benefits of high yields of fixed income instruments as well as scope for capital gains provided by common stocks. Unfortunately, these securities are not well-followed by investors. Investing in a closed-end fund that specializes in convertible securities, thus can be of immense help. AllianzGI Equity & Convertible Income Fund is one such fund that heavily invests in convertible securities. NIE is still trading at a high discount of 11.01 percent to its net asset value. As was discussed during my last coverage, the bearish trends are slowing down and are expected to be over soon. Should that happen, the stocks in NIE’s portfolio will come back to their long-term growth trajectory.

Its price performance has been poor this year, primarily due to poor performance of healthcare and financial stocks. However, the fund has been able to generate an exceptionally high yield of 20.3 percent this year, and 14.8 percent during the last year, i.e., 2022. Otherwise, the average yield stays within a range of 5 to 8 percent, which also is also above-average. Quarterly payment of dividend over the past 15 years also works to its advantage. This consistency in yield has been possible due its investments in growth stocks in the right sectors and investing a substantial portion in convertible securities as well as selling call options. In my opinion, AllianzGI Equity & Convertible Income Fund is very much suitable for income-seeking investors, purely because of consistent high yield, which I also presume to be sustainable.