Is GOF's Dividend Safe?

The Guggenheim Strategic Opportunities Fund (GOF) invests primarily in junk-rated bonds, senior floating-rate loans, collateralized loan and mortgage obligations, and other fixed income securities.

With little exposure to equities, fixed income funds like GOF rely on interest income rather than capital appreciation to fuel their total returns and support their distributions.

Since 2015, GOF's net investment income (NII), or the interest and dividends earned by the fund less expenses, has averaged around $35 million per year compared to an average realized gain of roughly $11 million (with high volatility any given year).

But even in good years, such as 2022 when the fund realized over $50 million of capital gains, GOF has struggled to cover its distributions (net of reinvestments) with the fund's NII and realized gains and losses ("Total Income" below).

With more money going out the door to shareholders than being generated internally by the fund's investment performance, GOF's net asset value (NAV) per share, or the value of the fund's investment assets net of any liabilities, has steadily eroded.

The uptick in interest rates (bond prices fall as rates rise) since early 2022 has applied pressure to NAV as well, though GOF's exposure to floating-rate debt reduces its overall sensitivity to fluctuating interest rates.

Many funds would consider cutting their distributions to stop bleeding NAV, but GOF finds itself in an unusually nice situation.

Boasting a high yield and a track record of paying uninterrupted distributions since 2007, shares of GOF have sleepily traded at an ever higher premium to the fund's NAV.

Prior to 2018, the fund's premium rarely exceeded 10%. Today, shares of GOF trade hands at a 27% premium, meaning investors are paying $1.27 for every $1.00 of net assets on the books.

GOF has capitalized on this favorable disconnect by selling over $400 million of shares to external investors during the last two years alone.

This capital infusion more than plugs the shortfall between GOF's dividend and total income. Issuing shares at a premium also increases NAV per share to offset some of the decay that GOF's distribution policy has caused over the years.

As long as enough investors are willing to buy GOF shares at non-dilutive prices and management remains comfortable with the fund's distribution rate, this situation could persist.

However, shareholders are bearing a lot of risk in the event that anything changes.

If GOF, which is under new leadership following the late 2022 death of chief investment office Scott Minerd, ever did reduce its dividend, the fund's premium would likely disappear. This would represent a quick loss of around 20%.

A distribution cut could be steep as well.

Following the downturn in bond prices due to higher interest rates and recession concerns, GOF is now distributing 18% of its NAV yearly to shareholders.

This distribution rate is the hurdle GOF's total returns need to exceed going forward to cover the distribution and stop NAV per share from eroding further.

Over the last decade, GOF's distribution rate averaged closer to 12% of NAV. Barring much stronger bond returns in the years ahead, which may be unlikely if interest rates stay higher for longer and the economy slows, GOF will continue struggling to earn its payout.

Distribution policy aside, GOF over the past decade has put up strong total returns compared to its peers with only average volatility. The fund's somewhat higher expense ratio has been worth it.

However, investors considering the fund must accept the risks that come with GOF's high premium and aggressive distribution rate.

More conservative investors might find greater comfort with Pimco's Income Strategy Fund II (PFN), which sports a similar yield with better distribution coverage and does not trade at a high premium to NAV.

We will continue monitoring GOF's performance and provide updates as needed.