OPP CEF: too many cooks in the kitchen, 17% sour yield (NYSE: OPP)

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Thesis

It’s not often that we see funds with negative Sharpe ratios. But RiverNorth/DoubleLine Strategic Opportunity Fund (OPP) is one of them. With a negative Sharpe ratio over 3 and 5 years, OPP is taking on significant risk with virtually no gain on a long-term: the fund’s 3-year total returns are negative while the 5-year total returns are stable. Yes, you read that right. If you had bought OPP a while ago, you would have nothing to show for today, and when adjusting for inflation, you would actually lose money. For a buy-and-hold investor, the OPP is something to run away from, not go away, but run away from.

OPP sells itself on the idea that having two investment managers could somehow create “magic”:

RiverNorth allocates the Fund’s assets under management between two primary strategies: the Tactical Closed-End Income Strategy (managed by RiverNorth) and the Opportunistic Income Strategy (managed by DoubleLine). RiverNorth determines what portion of the Fund’s assets are allocated to each strategy based on market conditions. The Fund may allocate between 10% and 35% of its assets under management to the CEF Tactical Income Strategy and 65% to 90% of its assets under management to the Opportunistic Income Strategy.

Source: Fund Fact Sheet

Allocation is dynamic, resulting in ever-changing factorization and risk weighting. We generally don’t like these types of funds because they rely too much on the timing capabilities of the manager rather than the alpha generating capabilities of the assets. These types of funds also tend not to have a proper benchmark due to their “unique” investment setup. From this angle, OPP does not fail to provide total returns. The market is also aware of this, with the fund trading at a -5% discount to NAV.

The fund currently has a dividend yield of 17%:

what is the dividend

Dividend yield (Looking for Alpha)

This is not supported and it will likely be reduced, as the fund did previously in January 2022. The fund is relatively new, having IPO in September 2016. Since the IPO, CEF managed to lose half of its net asset value and given the unsupported return, it will continue to do so in the future. We tend to see this type of behavior from underperforming fund managers – when a CEF is unable to generate healthy long-term returns, it navigates to the dividend yield angle very high to generate interest in the fund. Over the long term, this strategy erodes net asset value, hence the recent fund rights offering.

The fund has a large allocation to MBS (over 37%), most of which are non-agency. Much non-agency MBS paper is also below investment grade. As mortgage rates have risen this year, duration has increased on MBS bonds due to lower homeowner prepayments (lower refinances), leading to lower prices and lower net asset value for OPP .

There’s not much to like about this fund. Could you buy it after a big sale and make a profit? Sure. Are there much better alternatives in the CEF space to do this? You bet. We don’t like the rolling risk factoring setup for the fund, nor the large allocation to non-agency MBS bonds. The current tightening of financial conditions will continue and we have not seen any increase in mortgage rates. This will keep pressure on MBS bonds and increase duration via lower CPRs for many of them. We think OPP is a prime example of having too many cooks in the kitchen resulting in sour soup. Fresh money and buy-and-hold investors should steer clear of the OPP – it offers very low rewards for the risk taken. Existing stakeholders may want Hold until the end of next year in order to recover part of the 2022 levy.

Assets

Currently, the fund is overweight the opportunistic income strategy:

allocation

Strategy Breakdown (Fund website)

This configuration resulted in a large portfolio allocation to non-agency MBS:

what do i want

Assets (Fund website)

Many non-agency MBS are below investment grade:

what is my grade

Credit ratings (Fund website)

We can see from the chart above that over 44% of the fund has a rating that falls into the high yield category. By analyzing the assets, we can deduce that a significant proportion of the non-agency tranche falls below investment grade.

Performance

The fund is down almost -20% in total return in 2022:

what is the return

Year-to-date total return (Looking for Alpha)

The fund has a negative performance over 3 years:

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Total return over 3 years (Looking for Alpha)

OPP also has very poor 5-year total return indicators:

what do I have

5-Year Total Returns (Looking for Alpha)

Distributions

More than 60% of the current dividend consists of a return of capital:

How old am I

Section 19a (Funds)

We expect this to persist into 2022 as the fund underperforms from an NAV perspective. If the assets do not generate enough cash flow to pay the dividend yield, that money comes from the investor’s “principal”.

The CEF has already reduced its distribution and we expect another reduction this year:

What

Distributions (Cef Connect)

Conclusion

OPP is a bond CEF that allocates its liquidity between two main strategies. Both strategies are managed by different asset managers, namely RiverNorth and DoubleLine. This configuration provides for rolling risk factoring and dynamic portfolio allocation. Current positions are overweight in the DoubleLine strategy and non-agency MBS. Due to the violent repricing of mortgage rates this year, the underlying MBS bonds have seen their duration increase and their price fall, which has led to a decline of almost -20% in the OPP in 2022 on the basis of the total return. The fund has an unsupported dividend yield of 17% and we expect the distribution to be reduced this year. With a negative 3- and 5-year Sharpe ratio, OPP takes on significant risk with virtually no long-term gain: the fund’s 3-year total returns are negative while the 5-year total returns are stable. Fresh money and buy-and-hold investors should steer clear of the OPP – it offers very low rewards for the risk taken. Existing stakeholders may want Hold until the end of next year in order to recover part of the 2022 levy.

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