TY: Massive Discount, But Variable Distribution Might Not Appeal To Everyone

alberto clemares expósito The Tri-Continental Corporation (NYSE:TY) is a closed-end fund, or CEF, that investors can purchase to gain exposure to equity securities from issuers around the world. As is the case with most closed-end funds, the Tri-Continental Corporation boasts a reasonably high yield, although at 3.82%, it is far from being the highest available in this asset class: Fund Name Morningstar Classification Current Yield Tri-Continental Corporation Hybrid-U.S. Allocation 3.82% Bexil Investment Trust (OTCPK:BXSY) Hybrid-U.S. Allocation 7.56% Calamos Strategic Total Return Fund (CSQ) Hybrid-U.S. Allocation 7.42% Eaton Vance Tax-Advantaged Dividend Income Fund (EVT) Hybrid-U.S. Allocation 8.46% Franklin Universal Trust (FT) Hybrid-U.S. Allocation 7.43% GDL Fund (GDL) Hybrid-U.S. Allocation 6.08% Click to enlarge As we can clearly see, Tri-Continental Corporation has a significantly lower yield than most of its peers. This is something that might lower the fund’s appeal for many investors, especially those who are seeking to earn a very high level of income. As most investors who would consider purchasing shares of a closed-end fund are in the market for income, this low yield probably does not do very much for the fund’s popularity. However, the Tri-Continental Corporation does have a much higher yield than all the American common equity indices: Wall Street Journal The fund’s yield is also higher than that of the Dow Jones Industrial Average (DIA) and even the Dow Jones Utility Average, which are known for having higher yields than the much broader market indices: Wall Street Journal As such, investors for whom maximizing their income is not the highest priority or investors who are planning to hold their shares in a vehicle that does not boast any particular tax advantages may be reasonably satisfied with this fund’s payout. In addition, the Tri-Continental Corporation has a history of raising its distribution over time. This is something that you do not often see with a closed-end fund, but it is nice for investors with a very long-term horizon because it can result in the fund having a much higher yield on cost several years down the road than if you purchased a fund with a very high current yield. Another advantage to distribution growth over time is that it helps to offset the deleterious effects that inflation has on the purchasing power of a fund’s distribution. This is also something that very long-term investors will appreciate, especially since I do not believe that the Federal Reserve will be successful in bringing inflation down to under 2% annually on any sort of long-term basis. Unfortunately, the Tri-Continental Corporation’s performance track record leaves something to be desired. Over the past five years, the shares of the fund have only appreciated by 14.81%. This is far worse than the 85.71% increase that the S&P 500 Index (SP500) delivered over the same period: Seeking Alpha We do see that the Tri-Continental Corporation managed to beat investment-grade bonds over the period, but that is not particularly difficult to accomplish. After all, the bond index declined by 12.43% over the period. Overall, investment-grade bonds have been a pretty bad deal for investors ever since the financial crisis, due to the ultra-low interest-rate environment that has persisted ever since the collapse of Lehman Brothers. However, investors in this fund did do a bit better than the share price performance would lead us to believe. As I explained in a recent article: A simple look at a closed-end fund’s share price performance does not necessarily provide an accurate picture of how investors in the fund did during a given period. This is because these funds tend to pay out all of their net investment profits to the shareholders, rather than relying on the capital appreciation of their share price to provide a return. This is the reason why the yields of these funds tend to be much higher than the yield of index funds or most other market assets. When we include the fund’s distributions in the performance chart shown above, we get this alternative chart that shows how investors in this fund actually did over the past five years: Seeking Alpha This is certainly much better than what we saw previously. As we can see, the fund delivered a total return of 71.89% to its shareholders over the period. This is still not nearly as good as what the S&P 500 Index managed to deliver, but this fund managed to get pretty close at times. As I have stated in the past, there are some investors who are willing to sacrifice a little total return if it gets them a higher yield, and those investors might be willing to accept the performance that we see here. The Tri-Continental Corporation did not manage to outperform its peers over the past five years, though, despite getting close to the S&P 500 Index. We can see that here: Seeking Alpha The total returns provided by these six funds are all over the place, but we can clearly see that the Bexil Investment Trust and the Calamos Strategic Total Return Fund managed to outperform the Tri-Continental Corporation. The Calamos Strategic Total Return Fund even managed to outperform the S&P 500 Index over the period. We can clearly see that the Tri-Continental Corporation managed to get very close to the Bexil Investment Trust and substantially outperformed all three of the lower-performing funds. Thus, this fund’s historic performance does not look terrible, even if it has not been the best one in the category. As we all know, a fund’s past performance is no guarantee of future success. So let us take a look at the fund’s portfolio, finances, and overall positioning today and see if purchasing it makes any real sense for our purposes right now. About The Fund According to the fund’s website, the Tri-Continental Corporation has the primary objective of providing its investors with long-term capital growth and current income. The fund’s website does not specifically state how the fund will accomplish this goal. The only real insight that it provides us regarding the fund’s strategy is that it will be investing mostly in common equities: Columbia Seligman The annual report, however, does provide a bit more insight into the fund’s strategy: The Fund invests primarily for the longer term and has no charter restrictions with respect to its investments. With respect to the Fund’s investments, assets may be held in cash or invested in all types of securities, that is, in common stocks, bonds, convertible bonds (including high yield instruments), debentures, notes, preferred and convertible preferred stocks, rights, and other securities or instruments, in whatever amounts or proportions the Investment Manager believes best suited to current and anticipated economic and market conditions. The Fund may invest in debt/fixed income instruments and securities that, at the time of purchase, are rated below investment grade or are unrated but determined to be of comparable quality. The Fund may invest in debt instruments of any maturity and does not seek to maintain a particular dollar-weighted average maturity. As we can see, the website states that the Tri-Continental Corporation will invest primarily in equity securities. However, the annual report basically says that it can invest in whatever it wants. These two statements are not mutually exclusive, as any asset allocation that includes at least a 50% weighting to common equity securities will satisfy both statements. The fund’s first-quarter 2024 holdings report indicates that this is the case right now. Here is what the report provides for an asset allocation as of March 31, 2024: Asset Type % of Net Assets Common Stocks 72.4% Convertible Bonds 7.1% Convertible Preferred Stocks 2.5% Corporate Bonds & Notes 16.4% Preferred Debt 0.3% Warrants 0.0% Money Market Fund 0.9% Click to enlarge As might be expected for a Columbia Seligman-managed fund, the money market fund that Tri-Continental Corporation uses to store its cash is a Columbia Seligman money market fund – the Columbia Short-Term Cash Fund. This money market fund is not listed as available for sale on Columbia Seligman’s website, nor does it have a ticker symbol. However, the first-quarter 2024 holdings report for Tri-Continental Corporation states that it boasts a 5.543% yield as of March 31, 2024. That is a pretty good yield for a money market fund right now, so there is no reason to think that using an in-house cash fund is hurting our returns as investors in Tri-Continental Corporation. We can clearly see from the above asset allocation that the fund is invested primarily in common stocks, which fits well with the description on the website as well as the fund’s objective of long-term capital appreciation. After all, capital gains are the primary way through which common stocks deliver their total returns. It is important to note though that these appear to be mostly American common stocks. For example, all ten of the common stocks that comprise the largest positions in the fund are based in the United States: Columbia Seligman All of these companies are among the largest domestic companies, and many of them are also found among the largest positions in just about any other closed-end fund that invests in American stocks. In particular, we see six of the “Magnificent 7” stocks on the above chart. As I pointed out before, the Magnificent 7 is a group of mega-cap stocks that have accounted for an outsized proportion of the total gains of the S&P 500 Index over the past few years. However, increasingly, it looks like “Magnificent Nvidia,” as many of the other stocks in this group have substantially underperformed Nvidia (NVDA) year-to-date: Seeking Alpha Apple (AAPL) has been relatively flat year-to-date, Tesla (TSLA) has declined by 30.06%, Meta Platforms (META), Alphabet (GOOG), Amazon.com (AMZN), and Microsoft (MSFT) have all delivered double-digit gains year-to-date. However, Nvidia is a total standout as it has risen by a whopping 143.51% year-to-date. As all of these stocks except for Apple and Tesla have outperformed the S&P 500 Index year-to-date, the index is becoming very concentrated in these names. This, unfortunately, means that most investors who are holding domestic stock funds are also probably highly exposed to these companies. When we consider the outsized performance of these funds relative to the rest of the market, that undoubtedly presents a risk to most investors. After all, these companies all declined substantially more than the market back in 2022. The comments to some of my articles recently suggest that people are seeking options to reduce their exposure to these stocks. Unfortunately, it does not appear that the Tri-Continental Corporation will help anyone do that. It does look like this fund is generally underweight to these names compared to the S&P 500 Index, though, so that is a good thing. We also see a few names here that are sometimes uncommon to see in a domestic equity fund. In particular, I cannot think of any broad-market fund that owns Bristol-Myers Squibb (BMY) or Exxon Mobil (XOM) among their largest positions. These companies are frequently seen among the largest holdings in healthcare-specific and energy-specific funds, respectively, but rarely among the largest positions of funds that invest across the entire domestic market. There could be an excellent reason for the inclusion of these companies in this fund, however. Tri-Continental Corporation specifically states on its website that it aims to deliver a higher yield than the S&P 500 Index. Bristol-Myers Squibb and ExxonMobil have long been among the highest-yielding stocks in the market: Company Current Yield ExxonMobil 3.36% Bristol-Myers Squibb 5.64% Click to enlarge One easy way to achieve a higher yield than the S&P 500 Index is to overweight stocks that have higher-than-average yields. Tri-Continental Corporation has done this, as Exxon Mobil and Bristol-Myers Squibb had 1.11% and 0.21% weightings respectively in the S&P 500 Index on April 30, 2024. This fund had 1.25% of its assets invested in ExxonMobil and 1.19% of its assets invested in Bristol-Myers Squibb as of the same date. It seems likely that the fund is also overweight some other companies that have higher-than-average dividend yields to generate more income than it would if it just bought the index. Unfortunately, though, as some of us know, high-yielding value stocks underperformed the market during the ultra-low interest rate environment that dominated the 2010s, so this strategy might cost the fund some upside in an accommodating monetary environment. The Federal Reserve’s statements strongly imply that officials want to return to a loose monetary environment, but I doubt that will be possible unless they are willing to abandon the fight against inflation. Nonetheless, policymakers might have to reduce interest rates at some point to lessen the pressure on the Federal government budget. The fund’s current positioning could cause it to underperform in such an environment. With that said, this could be a long way off, as some central bank officials look to be hawkish in the immediate term. Distribution Analysis The primary objective of Tri-Continental Corporation is to provide a high level of capital growth and current income. The fund aims to have what it calls a “reasonable yield” compared to the incredibly low yields offered by most American domestic indices, however. To that end, the fund pays a quarterly distribution of $0.2905 per share ($1.162 per share annually). This gives the fund a 3.82% yield at the current price. However, that is not the only distribution that shareholders in this fund receive. From the second-quarter 2024 distribution announcement: Tri-Continental Corporation today declared a second quarter ordinary income distribution of $0.2960 per share of Common Stock and $0.6250 per share of Preferred Stock. In addition, the Corporation declared a total long-term capital gain distribution of $0.2878 per share of Common Stock. The fund’s annual report describes its distribution policy as follows: The Fund has an earned distribution policy. Under this policy, the Fund intends to make quarterly distributions to holders of Common Stock that are approximately equal to net investment income, less dividends payable on the Fund’s Preferred Stock. Capital gains, when available, are distributed to Common Stockholders at least annually. As we can see, the fund is basically distributing a roughly equivalent ordinary distribution to its net investment income, along with occasionally making a special distribution of capital gains. As might be expected, this gives the fund a variable distribution: CEF Connect We can see some considerable variation here, although the distributions have tended to rise since the 2009 recession. This is both a good and a bad thing, depending on one’s perspective. It has resulted in a rising level of income for investors that has helped them maintain their purchasing power in the face of inflation. However, at the same time, those investors who are dependent on their portfolios to provide the bulk of their income may be somewhat turned off. However, take a look at the fund’s regular distributions over the past year: CEF Data We see regular distributions of $0.2607 per share, $0.2765 per share, $0.2560 per share, and $0.2905 per share over the past year. Thus, the fund has been relatively consistent with its distributions if we exclude the capital gains special distributions. This is what I did when I calculated the 3.82% yield, since that seems to be something that is reasonably reliable. During most years in which the domestic market rises, though, investors should expect to realize a higher yield. The fund’s earned distribution policy should result in it covering its distribution. Let us take a look at its financial results anyway, just to make sure, though. The most recent financial report is the annual report that corresponds to the full-year period that ended on December 31, 2023. A link to this report was provided earlier in this article. Admittedly, this is not as recent of a report as I would prefer since it does not include any information about the past five months, but it is still the best that we have right now. For the full-year period that ended on December 31, 2023, the Tri-Continental Corporation received $37,022,044 in dividends and $30,115,231 in interest from the assets in its portfolio. From this amount, we subtract the money that the fund had to pay in foreign withholding taxes to arrive at a total investment income of $67,102,535 for the period. The fund paid its expenses out of this amount, which left it with $59,488,518 available for shareholders. That was not sufficient to cover the $68,618,533 that the fund paid out in distributions during the period. Tri-Continental Corporation was able to make up the difference through capital gains. For the full-year period, the fund reported net realized gains of $18,837,562 and had another $174,754,773 in net unrealized gains. Overall, its net assets increased by $134,057,947 after accounting for all inflows and outflows during the period. It is worth noting, though, that the fund’s outflows during the period included $50,404,373 that was spent on stock buybacks. If this figure is excluded, the fund’s net assets would have increased by $184,462,320 after paying the distributions. The fund’s net realized gains and net investment income together were more than sufficient to cover all the distributions that were paid out during the period. Thus, this fund did manage to achieve full distribution coverage over the full-year period. The fund’s earned distribution policy should result in it fully covering its distributions over the long term, and indeed that is what we have seen over the past five years. This chart shows the fund’s net asset value per share over the past half-decade: Barchart As we can see, the fund’s net asset value per share has increased by 14.05% over the period. This tells us that this fund is mostly just paying out its investment profits over time. This is something that we like to see for long-term sustainability, but it is not necessarily perfect for those who desire a consistent income. Valuation Shares of the Tri-Continental Corporation are currently trading at a 12.06% discount on net asset value. This is very much in line with the 12.13% discount that the shares have averaged over the past month. As such, the current entry point appears to be just fine. Conclusion In conclusion, the Tri-Continental Corporation is a little-known closed-end fund that provides investors with a higher yield than the S&P 500 Index yet can deliver relatively similar performance. The fund is not a particularly good choice for those individuals who wish to reduce their exposure to the Magnificent 7 or to domestic stocks in general, but it does appear that it is overweight to dividend stocks, so that is nice compared to other funds. The fund’s variable distribution might also be a problem for some investors, but it has resulted in the fund generally having no real trouble with sustainability or with covering its distributions. The valuation is very attractive, as the fund is currently trading at a double-digit discount to the market value of its assets. Thus, investors can currently obtain the fund’s assets for a lot less than they are worth. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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