Assessing the Sustainability of Lazard Global Total Return and Income Fund's Return of Capital in a High-Yield Environment

In the ever-shrinking universe of high-yield investments, the Lazard Global Total Return and Income Fund (LGI) has carved out a niche as a closed-end fund offering a 10.03% forward yield. But beneath the attractive surface lies a complex interplay of return of capital, leverage, and market exposure that demands scrutiny. For long-term investors, the question is not just whether LGI can sustain its distributions, but whether those distributions are structurally sound—or if they mask a gradual erosion of principal.

The Mechanics of LGI's Managed Distribution Policy

LGI's monthly payout of $0.14646 per share is funded by a mix of net investment income (21%), short-term capital gains (4%), long-term capital gains (75%), and return of capital (0% in the latest quarter, but 49% cumulatively for the fiscal year). This structure is not uncommon for closed-end funds, but the heavy reliance on long-term capital gains and return of capital raises red flags.

Return of capital, while not taxable, effectively returns a portion of the investor's original investment. Over time, this can reduce the cost basis of shares, amplifying capital gains taxes when the position is sold. For LGI, the fund estimates it has distributed more than its net investment income and realized gains, suggesting that return of capital is becoming a structural crutch. This is a double-edged sword: it ensures consistent payouts in a low-yield environment but risks undermining the fund's long-term value.

Leverage and Liquidity: A Balancing Act

LGI's leverage ratio of 11.62% (as of September 2023) is a calculated risk. By borrowing to amplify exposure to global equities, the fund aims to boost returns, but this leverage also magnifies downside risk. In a market downturn, the fund's net asset value (NAV) could contract rapidly, forcing it to rely even more heavily on return of capital to maintain its distribution. This creates a vicious cycle: falling NAVs lead to higher return of capital, which further erodes the fund's capital base.

The fund's liquidity reserves are opaque, though its portfolio includes forward currency contracts and debt instruments. However, with only $367,640 in cash as of the latest quarter, LGI's liquidity cushion appears thin. This is a concern in volatile markets, where forced asset sales could exacerbate NAV declines.

Market Exposure and the Role of Emerging Markets

LGI's portfolio of 60–80 global equities, including emerging markets, adds another layer of complexity. While emerging markets offer growth potential, they also introduce currency risk and geopolitical volatility. The fund's exposure to forward currency contracts is a hedge, but it's not foolproof. A sharp depreciation in emerging market currencies could pressure the fund's returns and force it to dip deeper into return of capital.

Implications for Long-Term Investors

For income-focused investors, LGI's 10.03% yield is tempting, but the fund's distribution strategy requires a nuanced approach. The return of capital component means investors must treat these payouts as a return of principal rather than income. This distinction is critical for tax planning and portfolio management.

Moreover, the fund's historical performance—9.46% average annual total return over five years—must be weighed against its leverage and return of capital trends. While the fund has outperformed many peers in terms of yield, its NAV has underperformed in periods of market stress. Investors should monitor the fund's discount to NAV, which has ranged from -6.92% to -12.29% over the past three years, as a barometer of market sentiment.

A Cautionary Note on Sustainability

LGI's managed distribution policy is a marvel of engineering, but its sustainability hinges on the fund's ability to generate sufficient capital gains and income. If global equity markets stagnate or decline, the fund may be forced to accelerate return of capital, potentially leading to a “death spiral” where the fund's capital base erodes faster than it can replenish it.

Investors should also consider the broader macroeconomic context. In a rising interest rate environment, closed-end funds like LGI face pressure as bond yields rise, making alternative income sources less attractive. The fund's leverage could amplify this risk, particularly if borrowing costs increase.

Final Thoughts: A High-Yield Gamble

LGI is not for the faint of heart. It offers a compelling yield in a low-interest-rate world, but the return of capital component and leverage make it a high-risk proposition. For long-term investors, the fund could serve as a satellite holding in a diversified portfolio, provided they understand the tax implications and are prepared for potential NAV volatility.

In the end, LGI's managed distribution policy is a testament to the ingenuity of fund managers in a yield-starved world. But as with any high-yield strategy, the devil is in the details—and for LGI, those details include a careful balance between income generation, capital preservation, and the ever-present specter of return of capital. Investors who navigate this balance wisely may find a place for LGI in their portfolios, but they must do so with eyes wide open.