~ by Snehasish Chaudhuri, MBA (Finance)
Virtus AllianzGI Diversified Income & Convertible Fund (NYSE:ACV) is a closed-ended balanced mutual fund that invests three-fifths of its portfolio in three of the potential high growth sectors of information & communication technology (ICT), healthcare, and financial. Majority of its assets are invested in convertible securities. Currently this proportion is 61.33 percent. ACV aims to generate strong and stable total returns over the long term. It has been able to achieve the desired results through generating a trailing twelve-month yield of 12.6 percent and recorded an annual average total return of 25 percent during 2016 and 2021. Moreover, ACV offers a monthly payout which is quite lucrative for income-seeking investors. The fund is also available at a discount of 8 percent from its net asset value. ACV however has a very high portfolio turnover ratio of 108 percent and an exceptionally high expense ratio of 3.22 percent.
ACV has Invested in Various Asset Categories and Generated Strong Returns
Launched and managed by Allianz Global Investors Fund Management LLC, this fund has a primary objective of generating total return through a combination of current income and capital appreciation, while seeking downside protection against capital loss. Virtus Diversified Income & Convertible Fund allocate its assets across equities, bonds, preferred and convertible securities. It has a policy of investing at least half of its assets in convertibles and also writes call options on its equity holdings. Over the long term, this has been a reasonably good fund with a quite strong yield and an equally strong total return. The fund has been paying steady monthly dividends since 2015, and did not slash its pay-out even after Covid-19 pandemic.
Investing in Convertibles and Call Options Helped ACV in Multiple Ways
Virtus Diversified Income & Convertible Fund has been quite successful in diversifying its managed asset of $318 million in various types of securities. Allocating its assets over a gamut of securities such as equity, bonds, convertibles, call options, etc. reduces the risk and volatility of ACV’s portfolio. Interest bearing securities held by ACV have a weighted average price of 98.34. In a rising interest rate scenario, these securities are generally a safer bet over volatile equity stocks. However, these securities have a very low weighted average coupon of 2.57 percent. On the other hand, selling call options enables ACV to generate risk-adjusted returns that are significantly higher than that of equity funds. Thus, despite a very high expense ratio and turnover ratio, the overall risk profile and volatility level of this balanced CEF is within control.
ACV Invests in Various Securities from ICT, Healthcare and Financial Sectors
ACV’s top 20 investments in the ICT sector consist mostly of widely known technology firms such as Microsoft Corp (MSFT), Apple Inc. (AAPL), Alphabet Inc. (GOOG), Amazon.com, Inc. (AMZN), Meta Platforms, Inc. (META), Nvidia Corp., (NVDA) Tesla, Inc. (TSLA), Booking Holdings Inc. (BKNG), ServiceNow, Inc. (NOW), Liberty Broadband Corp (LBRDA), Accenture plc (ACN), Intuit Inc. (INTU), Zillow Group, Inc. (Z), Block, Inc. (SQ), Etsy, Inc. (ETSY), Aptiv PLC (APTV), Wolfspeed, Inc. (WOLF), Five9, Inc. (FIVN), Palo Alto Networks, Inc. (PANW) and CrowdStrike Holdings, Inc. (CRWD). In most cases, Virtus Diversified Income & Convertible Fund have made multiple investments in various asset classes, such as equity, fixed income securities or convertibles.
On the other hand, top 20 investments in the healthcare and financial sectors primarily include a large pool of biotechnology companies, medical device manufacturers and banking and processing companies. This list includes AbbVie Inc. (ABBV), Thermo Fisher Scientific Inc. (TMO), Sarepta Therapeutics, Inc. (SRPT), Evolent Health, Inc. (EVH), Exact Sciences Corporation (EXAS), CONMED Corporation (CNMD), Zoetis Inc. (ZTS), Insulet Corporation (PODD), Intuitive Surgical, Inc. (ISRG), Boston Scientific Corporation (BSX), UnitedHealth Group Incorporated (UNH), Halozyme Therapeutics, Inc. (HALO), Eli Lilly and Company (LLY), DexCom, Inc. (DXCM), Wells Fargo & Company (WFC), Barclays PLC (BCS), Shift4 Payments, Inc. (FOUR), The Goldman Sachs Group, Inc. (GS), JPMorgan Chase & Co. (JPM), Mastercard Incorporated (MA), and Moody’s Corporation (MCO).
Leverage Ratio, Expense Ratio and Risk Profile of ACV’s Major Investments
The first thing that comes to my mind while looking at the above list is that the companies in which Virtus Diversified Income & Convertible Fund has invested in general have a very high volatility. That’s why the presence of a high proportion of convertibles is of great help to this fund. ACV also has an exceptionally high expense ratio of 3.22 percent. Even if we consider the presence of levered assets, this ratio is still very high. If we exclude interest expense on borrowings, net expense ratio will still be 2.12 percent. Fortunately, the fund adviser of ACV has contractually agreed to limit its annual operating expenses to not exceed 0.17 percent on an annualized basis. Moreover, as most of ACV’s leverage is fixed, investors should not bother too much about it.
However, the fund does operate with a high leverage to the extent of 33 percent. This is certainly a factor worth considering as the fund has allocated the majority of its assets to the often-volatile ICT and healthcare sectors. While this leverage problem does not raise serious concern, the fund may experience some short-term weakness as the broader markets remain under pressure, and inflationary pressure continues to impact the market, especially in the technology and financial sectors. But, for a longer-term investor, Virtus Diversified Income & Convertible Fund might still be quite attractive.
Investment Thesis
I find the Virtus Diversified Income & Convertible Fund to be lucrative according to my “7 Factor Model for Evaluating Funds.” By applying the “7 Factor Model for Evaluating a Fund”, I try to find out whether the stock qualifies with respect to some minimum requirements such as current market price of $5, AUM of $200 million, yield of 4 percent, and the level of diversification of its investments. Afterwards, portfolio risk and sustainability of its current yield determines the attractiveness of the fund for both income-seeking investors and growth-seeking investors. I also prefer the funds which are trading at a reasonable discount from its current NAV.
Virtus Diversified Income & Convertible Fund has a significantly large asset base, qualifies for the minimum requirements with respect to stock price, and has a decent average yield since the time this fund has been in operation. The fund is also trading at a decent discount. ACV’s portfolio is highly diversified among various asset classes, and its risks are under control. The portfolio’s composition reflects ACV’s preference for less-volatile asset categories, but at the same time focusing on industry segments that have high growth potentials. Its portfolio is composed of large-cap equities, bonds, convertible securities and covered calls.
Monthly pay-out, strong enough yield, high total return, smart diversification, and manageable risk – makes this fund lucrative. However, a very high expense ratio and turnover ratio, coupled with a high leverage, may create some short-term weakness for this fund. As the broader markets remain under pressure, and inflationary pressure continues to impact the market, especially in the technology and financial sectors, funds like ACV will generate some undesired risk for its investors. In my opinion, Virtus Diversified Income & Convertible Fund is suitable for both income-seeking and growth-seeking investors, but only in the long run.
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