AVK: Inconsistent Distribution Coverage Calls for Caution

Advent Convertible & Income Fund (NYSE:AVK) operates as a closed-end fund with a portfolio of diverse credit investments. The fund aims to provide attractive returns during periods where interest rates are high. However, the inconsistent distribution coverage of the fund warrants caution.

Advent Convertible & Income Fund (NYSE:AVK) operates as a closed-end fund that aims to provide attractive returns through its portfolio of diverse credit investments. The fund, managed by Guggenheim Investments, focuses on current income above capital appreciation, making it appealing to income investors seeking a steady stream of returns [1].

Over the past year, AVK's price has fallen by nearly 7%, primarily due to market reactions to President Trump's tariff proposals. However, when including the distributions paid out to shareholders, the total return jumps to about 4.6%. The fund's generous starting dividend yield of 13.1% is paid out on a monthly basis, making it attractive for income investors [1].

AVK's strategy involves a mix of convertible securities (45.71%), high-yield securities (39.91%), equities (5.79%), cash and equivalents (4.54%), and CLOs (4.06%). The fund is heavily diversified across sectors, with Financials, Technology, and Consumer Discretionary accounting for nearly half of its assets [1].

The fund's aggressive use of leverage, amounting to 39.15% of assets, is intended to amplify returns when attractive opportunities arise. However, this strategy also increases interest expenses and amplifies potential losses if allocated towards poor investments [1].

AVK's valuation has been trading at a discount to net asset value (NAV) of 3.7% over the past year, compared to an average discount of 4.87% over the last three years. This discount may be attributed to the fund's high income generation capabilities [1].

The fund's net investment income has significantly increased with rising interest rates, but it has relied on net realized gains to support its distribution. The fund's NAV has fluctuated over the years, with 2022 and 2023 seeing significant declines. This inconsistency in earnings raises concerns about the fund's ability to support its distribution [1].

A lower interest rate environment could boost AVK's price recovery, as it would likely lead to positive gains in the fund's NAV. However, the Federal Reserve's projections indicate only one interest rate cut for 2025, which may not be sufficient to drive AVK's price recovery [1].

One of the significant risks AVK faces is its exposure to below-investment-grade borrowers, which account for 46.97% of its portfolio. These borrowers are more vulnerable to market downturns and recessions, increasing the risk of defaults [1].

AVK's dividend yield stands at 13.1%, with an estimated annual payout of $1.4064. However, the fund's ability to support this distribution level has been inconsistent, with the fund only outearning the distribution for two of the last five years. This reliance on return of capital to fund distributions has contributed to stagnant NAV growth [1].

In conclusion, while AVK offers attractive income potential, its inconsistent earnings and uncertain outlook related to the interest rate environment warrant caution. Investors should consider the fund's heavy use of leverage, exposure to below-investment-grade borrowers, and inconsistent distribution coverage before initiating a position.

References:
[1] https://seekingalpha.com/article/4778013-avk-cef-inconsistent-distribution-coverage-warrants-caution