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A little while ago, I wrote an initiation article on the Adams Diversified Equity Fund (NYSE:ADX). I recommended the fund as a buy based on its long operating history and attractive distribution yield. I remarked that “the ADX fund may appeal to income-oriented investors who don’t mind trading 70-100 bps of returns relative to the S&P 500 Index for 4x the market’s distribution yield”.
Since my initiation, the ADX fund has performed well, returning 8.0% in total returns, amply keeping up with the S&P 500 (Figure 1).
Figure 1 – ADX has performed well in 2023 (Seeking Alpha)
Given a significant amount of time has passed since my last article and we are in the midst of an equity correction, let us refresh our thesis on the ADX fund to see if it is a ‘buy the dip’ candidate.
Brief Fund Overview
The Adams Diversified Equity Fund is a long-running closed-end fund (“CEF”) that has been in operation since 1929. The ADX fund invests in a broadly diversified portfolio of high-quality large-cap equities to deliver superior performance over time.
The ADX fund uses a time-tested investment process that looks at secular growth drivers to find companies with consistent earnings growth and returns on capital (Figure 2).
Figure 2 – ADX investment process (adamsfunds.com)
The ADX fund skews towards large-cap growth in terms of fund style (Figure 3).
Figure 3 – ADX is a large-cap growth fund (morningstar.com)
The result of ADX’s investment process is strong long-term performance, with 3/5/10/15-year average annual returns of 9.3%/9.3%/11.3%/10.1% respectively to September 30, 2023 (Figure 4).
Figure 4 – ADX historical returns (morningstar.com)
While the ADX fund lags the SPDR S&P 500 ETF Trust (SPY), a passive ETF that represents the U.S. large-cap equity markets, by 50-100 bps per annum, it compensates for lower returns by paying investors a distribution yield that is 4x that of the market (Figure 5).
Figure 5 – SPY historical returns (morningstar.com)
For example, the S&P 500 currently has a 1.6% dividend yield while the ADX fund pays a minimum 6.0% distribution commitment to unitholders, including 6.3% in 2022.
Expect A Large Year-End Distribution
Given the fund has only declared three $0.05/share distribution so far in 2023, investors should be on the lookout for a large year-end distribution payment in the coming months (Figure 6).
Figure 6 – Only $0.15 in distributions have been declared YTD (adamsfunds.com)
As a reminder, the 6% minimum annual distribution rate is based on the average month-end market price of the fund’s common stock for the twelve months ended October 31. Assuming ADX’s fiscal year ended today, I estimate ADX will announce at least a ~$0.80 final dividend in the coming weeks (Figure 7).
Figure 7 – ADX is estimated to announce a ~$0.80 final distribution (Author created with stock price from Yahoo Finance)
Fine Example Of Long-Term Sustainable Distribution
As I have been writing ad nauseam, there is a difference between funds that pay a sustainable distribution and those that do not. Given ADX’s long-term returns of 11.3% over 10 years and 10.1% over 15 years compared to its 6% minimum distribution, I believe ADX is in the former category. Since 1990, ADX’s annual distribution has ranged from $0.30 in 2014 to $2.98 in 2021 (Figure 8). When times are good, investors are well rewarded, and when times are lean, investors still earn a decent yield.
Figure 8 – ADX annual distributions (Seeking Alpha)
Portfolio Well Positioned For Current Markets
Looking at ADX’s current portfolio, it appears the ADX fund is well positioned for the current tough equity markets, as the fund has large exposures to top-performing growth stocks like Microsoft, Apple, and Alphabet that are collectively called the Magnificent 7 (Figure 9).
Figure 9 – ADX sector allocation and top 10 holdings (adamsfunds.com)
In fact, as I have written in past articles, the Magnificent 7 (AAPL, MSFT, GOOGL, NVDA, AMZN, META, TSLA) have contributed the vast majority of equity market returns in recent months, including 11.7% of the S&P 500’s 12.0% YTD gains (Figure 10).
Figure 10 – S&P 500 returns modeled using SPY ETF (koyfin.com)
So although the market is up a solid 12% this year, most equity funds have underperformed. It is comforting to see that ADX is not one of these underperforming funds.
Risks To ADX
Of course, having large weights to the Magnificent 7 means that if those stocks were to underperform, ADX could also be negatively affected. For example, following the dot-com bubble, the ADX fund suffered a peak-to-trough decline of 62% in its NAV, and the fund’s NAV still has not recovered from the peak NAV in 2000 (figure 11).
Figure 11 – ADX declined by 62% in 2001 when dot-com bubble popped (morningstar.com)
So investors in the ADX fund should be mindful that if the current Magnificent 7 is a bubble similar to the dot-com bubble, then there may be significant downside to the fund’s NAV.
Unfortunately, while I fear we are in the midst of an ‘AI bubble’, it is hard to tell whether we are in 1999 or 2000, if we use the dot-com bubble as an analog (Figure 12).
Figure 12 – Are we in circa 1999 or 2000? (Author created with data from St. Louis Fed)
Timing is important because if current conditions are similar to 1999, then there may still be an upcoming blow-off rally.
What I would watch for is for the Federal Reserve to start cutting its short-term interest rates, as that would be a signal the Fed is concerned about growth. As long as the economy performs and the Fed remains on hold, stocks may yet reaccelerate into year-end and beyond.
Conclusion
The Adams Diversified Equity Fund is a top-performing growth-oriented CEF with a history dating back to 1929. The ADX is well positioned for the current environment, with large weights in the ‘Magnificent 7’ group of stocks that have powered equity returns in the past year. With strong performance in 2023, investors should be looking forward to a large year-end distribution. I continue to recommend the ADX fund as a buy for growth-oriented investors looking for income.
