The Gabelli Equity Trust (NYSE:GAB) invests across a wide range of stocks with a primary objective of achieving long-term capital appreciation. With an inception date in 1986, the fund has impressively outperformed the S&P 500 on a total return basis and is recognized as a reference among closed-end funds. The attraction here is also a 10% managed distribution policy through a quarterly payout making GAB an interesting option for income-focused investors.
While GAB faced volatility in 2022 alongside the rest of the market, the fund has continued to perform well next to several benchmarks. Favorably, GAB has rallied from its lows in recent months with a sense that the market momentum is turning a corner into an improving macro outlook.
What we like about the GAB is that compared to alternative or comparable equity CEFs funds with a similar level of high yield, the underlying holdings profile is relatively unique with some exposure to international stocks. By this measure, GAB can work well in the context of an existing portfolio for investors by adding diversification with the income component. Into 2023, we’re bullish on stocks and view GAB as well-positioned to deliver positive returns.
What is the GAB Fund?
A key point for investors to recognize is that GAB is actively managed, meaning the fund is not intended to follow any particular index. All holdings are at the discretion of the investment management team that has an otherwise open mandate outside of an 80% minimum policy of equity holdings.
On this point, while the fund can invest in preferreds and convertible stocks, the current strategy can be described as long-only with over 93% allocation to equities. Note that the fund does utilize leverage which was last reported at a level of 21% which adds to the volatility and risk profile.
The largest holding at the end of December with a 3.6% weighting was Sweden-based “Swedish Match AB”, a multinational tobacco products producer. On this point, the company was acquired by Philip Morris International (PM) in a deal announced in November. It’s notable because the local shares of the group have more than doubled over the past year as a contributor to GAB’s performance over the period. Keep in mind that the portfolio regularly changes.
Down the list of positions, we note several high industry leaders from various sectors with companies like Mastercard Inc. (MA), Berkshire Hathaway Inc. (BRK.B), Deere & Co. (DE), and Texas Instruments Inc. (TXN) among top holdings. While most of these stocks are recognized as S&P 500 Index constituents, what’s more telling is the absence of mega-cap tech names.
Again, it’s that differentiated exposure in the equities strategy that makes GAB stand out. Our data shows that approximately 15% of the fund is in international stocks which are in contrast to other examples of equity CEFs or high-yield ETFs that are based directly on underlying S&P 500 holdings.
For example, we can bring up the Cornerstone Strategic Value Fund (CLM) and Nuveen Core Equity Alpha Fund (JCE) which essentially attempt to boost the yield on the S&P 500 through various strategies including covered calls. The tables below confirm that CLM and JCE along with the Global X S&P 500 Covered Call ETF (XYLD) simply stick with the same underlying exposure.
We bring this up because it highlights the value of GAB which has impressively outperformed over the past year, curiously flat over 1 year on a total return basis at the NAV, while the group has an average loss in line with the S&P 500 performance.
Taking a step back, GAB has also delivered a stronger return over the past three years compared to a broader group of high-yield broad-market equity CEFs with various strategies. GAB is up 28% on a total return basis compared to its level just before the pandemic crash in 2020, above the 28% return from Royce Value Trust (RVT) and 27% gain from Adams Diversified Equity Fund (ADX) as the next biggest winners.
To be clear, we’re not suggesting GAB is the greatest fund in the world and will always beat out the competition over every time frame, but the performance here speaks for itself.
Where Does GAB Go From Here?
Oftentimes when screening for CEFs, it’s a balancing act for investors with different funds offering a series of strengths and weaknesses. With GAB at the current level, what we like is its combination of good total return potential and yield level of around 10%. Again, there are funds with a higher yield or larger discount to NAV, but our takeaway is that GAB does a good job overall for its intended purpose.
Compared to the CLM fund, for example, the strategy supports a higher yield but also comes at the expense of a particularly wide premium to NAV at 17%. On the other side, the Royce Value Trust trades at a -9% discount to NAV while offering a similar yield level as GAB at 9%, but has lagged in performance over the past year, down -4% at the NAV level.
As it relates to GAB’s current premium to NAV at 7%, there are several reasons to justify such a spread. First, its equity strategy offers something different compared to simply a reworked version of the S&P 500 which is the case for CLM and JCE. The Gabelli family of funds carries its history of institutional-level money management over several decades which makes it a vehicle investors value.
There is also the dynamic of its distribution in part representing a return of capital, which a segment of investors value for its tax-efficiency purposes. Typically, funds that make distributions in the form of ROC trade at a premium as existing shareholders are incentivized to hold over the long run to maximize the tax advantage as they work to lower the cost basis. The result is a sort of scarcity in the share that support a premium, all-else-equal.
That said, we note that GAB’s premium has narrowed significantly in recent months from a high above 20% during the first half of 2022. By this measure, there is a case to be made that the fund is relatively undervalued compared to levels investors have purchased shares in the past.
Looking ahead, we see the macro backdrop as supportive of equity gains in 2023. With an optimistic outlook, the setup of easing inflationary pressures and normalizing interest rates could jumpstart a global economic rebound. Themes like a weakening Dollar and the reopening of China are positive for global growth. GAB’s exposure to international stocks beyond the core U.S. equity holdings can capture these tailwinds for the year ahead.
From the price chart, GAB is approaching the $6.00 share level. A breakout higher from here could jumpstart improved sentiment towards the fund and ultimately help the premium to NAV widen back towards the early 2022 level. The fund through its modest use of leverage can outperform on the upside going forward, in our opinion.
In terms of risks, a deeper deterioration of economic conditions would likely add to financial market volatility and open the door for another selloff. Investors need to watch for indications of re-accelerating inflation with implications for the next steps in Fed policy. Over the near term, it will be important for GAB to continue trading above ~$5.35 as a key level of support.