PM Images Written by Nick Ackerman, co-produced by Stanford Chemist. BlackRock Enhanced Capital and Income Fund (NYSE:CII) is a closed-end fund providing exposure to a portfolio of large-cap equity holdings. The fund’s benchmark is the Russell 1000 Index, which, similar to the S&P 500 Index, is heavily tilted towards tech and the Super Six mega-cap growth names. The fund then has a covered call strategy to help generate a steady monthly distribution to investors. We last covered the fund earlier this year, and it continues to trade at an attractive discount. In fact, the discount has changed little since our prior update. Though there has been a bit of volatility since our prior update, that was during a brief pullback in April. Since then, the broader market and this fund have once again been pushing higher as it bounced rather quickly off those lows. CII Performance Since Prior Update (Seeking Alpha) CII Basics 1-Year Z-score: -1.00 Discount: -7.23% Distribution Yield: 6.04% Expense Ratio: 0.89% Leverage: N/A Managed Assets: $940.7 million Structure: Perpetual CII has a simple objective and strategy; it “seeks to provide investors with a combination of current income and capital appreciation” by “investing in a portfolio of equity securities of the U.S. and foreign issuers.” They will also “employ a strategy of writing call and put options.” Discount Continues To Look Appealing Despite the fund’s similar top holdings to the S&P 500 Index, as we could see above, the fund’s performance had lagged a bit in terms of total returns. That isn’t unusual for a covered call writing fund, as covered calls can cap upside. We’ve also been in a really low volatility period, so options premiums that can be received tend to be reduced in general. Like all investments, there are pros and cons when it comes to making investment choices. Covered calls might cap some upside in a rapidly rising market, but the trade-off is receiving some premiums to fund the distribution to shareholders. It also means that even in a flat market, there could be some gains, and it is also a slightly defensive strategy. That is, if the market is moving sideways or even slightly lower, the fund’s returns could be positive due to receiving the premium from writing calls. The annualized returns provided below are a bit dated, as they are from the fund’s last annual report for the period ended December 31, 2024. That said, it is the table that provides total returns against the fund’s benchmarks. In this case, the fund has put up respectable returns against the Russell 1000 Index and even better returns against the MSCI USA Call Overwrite Index in the last five-year annualized period. CII Performance Vs. Benchmarks (BlackRock) So, for the most part, CII has not given up too much in terms of upside against its benchmark despite the covered call strategy. One of the reasons for this is that CII is an actively managed fund that can adjust the overwrite percentage that they are writing. The latest shows that they were overwritten by nearly 50%. That would put them in a more defensive position relative to their target range of between 30 and 40%. That could indicate the management team is a bit more bearish here. Though, admittedly, they have been overwritten by about 50-55% for our last several updates now. 53.89% of the portfolio was overwritten at the end of January 2024, which was down just a bit from 55.5% in our prior update. This puts them on a more defensive tilt and above their target, given the target overwrites of the fund is between 30-40%. What makes CII a bit more compelling here as well is the fund’s discount. The last time we covered the fund, it was attractive at that time, too, and it hasn’t moved much since. This could be that investors are anticipating that we are nearing a top in the overall market, so CII trading at a discount is just reflecting that. For me, I don’t try to time the market, as I know my limitations. The market can run for years higher and higher. What I can control, is buying when a CEF is literally telling us that it is worth more than what its share price currently reflects. Ycharts CII seems to be going in the opposite direction of all CEFs as well. CEF discounts have been narrowing, in general. The average CEF discount as of June 13, 2024 came to -6.48%. That narrowed from the -7.83% level it was earlier in the year on February 13, 2024. It is also narrowed more materially from the -9.56% seen on the last trading day of 2023. With that said, this discount also opened up the way we like, which is to say that it was the fund’s underlying portfolio as measured by its total NAV return that was outpacing its total share price results. Ycharts Another factor to consider with CII now is that it was included as one of the BlackRock closed-end funds that have adopted the discount management program. Over the next year, should the fund trade at an average discount wider than 7.5% during four measurement periods, the fund will conduct a tender offer for 2.5% of outstanding shares at 98%. Measurement Periods For Tender Offer Triggers (BlackRock) That might not be huge, but that could be up to 10% of shares repurchased over the next year. Some investors will also likely not participate, so the minimum tendered shares will be 2.5%. Given the small amounts, that might make some investors feel it isn’t worth it, and that could lead to an even larger than usual amount being tendered for those that do participate. Only time will tell, but either way, it is a positive for investors-even if only a small positive. This deal was struck with Karpus, but clearly, in the back of their mind, it was also a move to try to thwart Saba’s activist pressures on BlackRock’s other funds. CII isn’t a target of Saba’s, but it is seemingly an indirect beneficiary. Steady Distribution Thanks to steady total returns for this fund, it has been able to deliver a steady monthly distribution to investors for the most part over the last decade. There were a couple of cuts following the Global Financial Crisis, then a smaller one in 2016. However, since then, it has only been maintained or increased. CII Distribution History (CEFConnect) The distribution yield on this name comes to about 6%. That certainly isn’t the highest in the CEF space, and in fact, it is quite low for a CEF. The NAV rate comes to 5.60%, so this fund could be due for an increased distribution. Alternatively, they could choose to maintain the current rate-which is still significantly higher than something like the S&P 500 Index’s yield-and choose to pay out larger year-end specials. In my opinion, I think that might be the more prudent move as the current distribution provides more flexibility in terms of if we are at a market top and we get into a serious correction. They don’t look like they’d be in a position where they’d have to cut the regular even in the event of a market crash due to the modest distribution rate. In terms of distribution coverage, we discussed their annual report previously, and we have no additional updates on that front. NII coverage for CII’s distribution comes to 5.45%. That’s up from the prior year, but that’s because CII paid out a large special in 2022, which saw more paid out as distributions to shareholders. CII Annual Report (BlackRock)Of course, one of the ways the fund can generate those capital gains that it needs is through writing covered calls. That doesn’t always work out as expected, though, and sometimes option writing can create losses. For 2023 being such a strong year, it’s something we’ve seen from a number of option writing funds – that is, the options written are showing realized losses. That was the case for CII, which saw their options generate about $11 million in losses for the fund. Offsetting those losses were realized gains from the underlying portfolio that were way more than enough to offset those losses. CII Unrealized/Realized Gains/Losses (BlackRock)One of the main reasons that the options can generate a loss is because the managers are closing or rolling the positions for a loss. This would be to participate in further upside on a position if they believe it has more room to run. The only thing worth adding is that thanks to strong performance this year, the fund’s NAV has increased. Therefore, as an equity CEF, the fund has been ‘covering’ its distribution on that measurement. CII’s Portfolio Despite the fund’s benchmark being the Russell 1000 Index, the fund does not carry nearly that many positions. They actually carry a rather small number of holdings, relatively speaking, at 53 at the end of May 31, 2024. Of those 53, the top ten comprise over 41.5% of the portfolio. Breaking it down even further, the Super Six names, Microsoft (MSFT), Alphabet (GOOG), Amazon (AMZN), Apple (AAPL), NVIDIA (NVDA) and Meta Platforms (META), are nearly 32% of the fund. CII Top Ten Holdings (BlackRock) So, these names have been working and driving most of the overall equity market results we’ve been seeing in the U.S. However, that does make this fund quite concentrated overall, which is worth considering if one is looking for more diversification. It needs these names to continue to perform in order for CII to perform as well, but frankly, that then also means so does the entire ‘market’ these days. The S&P 500 Index, as measured by SPDR S&P 500 ETF (SPY), has its top ten holdings comprising nearly 36% of the fund. The Super Six there make up 31.2% of the fund, which is perhaps no coincidence that CII’s weighting is nearly identical. SPY Top Ten Holdings (Seeking Alpha) Conclusion CII has provided investors with solid total returns historically and a healthy monthly distribution. The future can’t be predicted based on past performance, but it should generally trend toward similar performance to the broader market. So, if one is optimistic about the long-term prospects of the market, then CII could be an interesting choice for those investors who also seek a monthly distribution. CII’s discount also provides a more appealing time to consider this fund currently as well.
sekar nallalu CII,Cryptocurrency,Nick Ackerman,Stanford Chemist CII: Attractive Total Returns, Attractive Distribution, Trading At A Discount (NYSE:CII)