Torsten Asmus
Fund Overview & Historical Performance
Western Asset Diversified Income Fund (NYSE:WDI) is a fund operated by Franklin Templeton. WDI is an equity closed-end fund that invests primarily in bonds with a focus on generating income for their investors.
Looking at the share price performance since the fund’s inception, WDI’s share price would show a decline of 28% (as of February 26th, 2024). That would be failing to look at the complete picture by excluding the dividends throughout the same time period. Factoring in dividends, the fund performance would be a decline of 6.5% (as of February 26th, 2024).
The performance with dividends is not ideal, but it’s much better than what would appear by only referencing the share price
NAV Discount
WDI’s modest 7% discount to its Net Asset Value (NAV) presents a compelling opportunity for investors (as of February 26th, 2024). NAV, in this context, represents the total market value of all the stocks held within the fund’s portfolio. By purchasing WDI shares at a modest discount to NAV, investors effectively gain exposure to the fund’s entire underlying basket of securities at a reduced price. This is similar to finding your favorite collection of items on sale at a heavily discounted price.
Closed-end funds (CEF) like WDI occasionally experience these discrepancies between their market price and NAV. Market dynamics and investor sentiment can cause these temporary fluctuations. Historically, as market conditions change or investors recognize the inherent value of a discounted CEF, the NAV discount often narrows. This can lead to capital appreciation for WDI holders, in addition to any potential gains from the underlying stocks themselves.
Yield
WDI offers a substantial appeal for income-seeking investors with its 13.45% dividend yield. This yield remains attractive in the current interest rate environment. However, it is essential to consider the risk inherent in equities as compared to risk-free treasury securities.
The key to further potential lies in the evolving monetary policy landscape. As the Federal Reserve pivots towards interest rate cuts, widely anticipated later this year, WDI’s income stream could gain even greater appeal. A recent CNBC survey highlights market expectations for a 75 basis point (0.75%) rate cut. If this reduction translates directly to lower Treasury yields, WDI could offer a significantly enhanced income advantage over these traditionally “safe” assets.
It’s worth noting that this rate-cut scenario could create two layers of potential return for income-oriented investors in WDI:
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Yield Advantage: As Treasury yields decline, the fixed yield from WDI becomes proportionally more attractive.
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NAV Appreciation: Lower interest rates generally boost the valuations of dividend-paying stocks, including those held by the fund. This could potentially contribute to a narrowing of the NAV discount, resulting in capital gains for WDI shareholders.
Fund Holdings
The third and final catalyst for the upside for WDI is the composition of their fund. As WDI is an income-focused fund, most of its holdings are concentrated within bond holdings. Reviewing WDI’s holdings as of 1/31/24, the weighted average YTM is 13.05%. The near-term risk would be the duration of their holdings if the Fed started to cut interest rates, but the average duration of their holdings is 14.38 years, given the fund an extended period of having their rate locked in. There are no holdings within their fund that expose the fund to particular risk, as the largest holding is ~3% of the total fund balance. This leads me to the current dividend yield is locked in for the foreseeable future.
Summary
The combination of WDI’s modest NAV discount, substantial dividend yield, and the potential for underlying asset appreciation positions it as a modest buy. The current discount presents the opportunity to acquire a diversified portfolio of income-focused stocks at a bargain price. Meanwhile, the income stream provides a cushion – particularly during periods of market volatility – and could become even more attractive relative to Treasuries once the anticipated interest rate cuts materialize.
For income-oriented investors, WDI offers a potential alternative to traditional fixed-income assets, especially in a declining interest rate environment. The confluence of rate reductions and WDI’s yield could create a compelling income advantage. Furthermore, lower rates could act as a catalyst for the NAV discount to narrow, potentially leading to additional returns for WDI shareholders.
