Highland Global Allocation Fund's $0.088 Distribution: Sustainable Steadfastness or Risky Reach?

The Highland Global Allocation Fund (HGLB) has raised its monthly distribution to $0.088 per share, marking a notable increase for investors seeking income in a volatile market. This adjustment aligns with the fund's 8.5% NAV-based payout policy, which was reset in March 2019 to provide a level distribution stream. However, the question remains: Can this policy sustainably deliver returns, or is it a gamble in an uncertain economic landscape? Let's dissect the risks, rewards, and strategic underpinnings of this move.

The 8.5% NAV-Based Payout: A Reset with Strings Attached

HGLB's distribution policy recalibrates annually using the average NAV of the final five trading days of the prior calendar year. For Q2 2025, this mechanism set the monthly payout at $0.088, translating to an annualized yield of 8.13% based on NAV (or 13.05% on the discounted share price of $8.09). The policy aims to stabilize income for investors, but its sustainability hinges on three critical factors:

1. NAV Performance: The fund's NAV must grow sufficiently to cover distributions without relying on return of capital (ROC). As of February 2025, HGLB's NAV stood at $12.99, with a 24.81% 12-month NAV return, suggesting recent resilience. However, its 5-year NAV return of 6.49% annually pales against benchmarks like the FTSE All World Index (+32.24% in 2024).
2. Leverage and Expenses: HGLB uses minimal leverage (2.66% of assets), but its 1.51% expense ratio eats into returns. Over time, this could strain the fund's ability to outpace distributions.
3. Market Sentiment: HGLB's shares trade at a 37.72% discount to NAV, a trend worsening over five years (average discount: -28.20%). This discount amplifies volatility, as the fund's market price reflects investor skepticism rather than underlying asset value.

Risks of Return of Capital (ROC)

The specter of ROC looms large. If HGLB's income from dividends or capital gains falls short of the $0.088/month target, distributions may tap into principal, eroding NAV. In 2024, the fund's NAV returned 12.90% annually, narrowly exceeding the 8.5% payout. Yet, sectors like energy MLPs (+21.11% in 2024) and Midwave Wireless Inc. (24.45% of assets) fueled this growth. A downturn in these holdings—especially Midwave, whose valuation depends on unproven spectrum assets—could destabilize the policy.

Global Thematic Strategy: Diversification or Dependency?

HGLB's portfolio is skewed toward cyclical sectors (18.27%), real estate (14.91%), and energy (14.52%), with heavy exposure to U.S. equities (57.30%). While this mix targets global growth themes, it also creates concentration risks. For instance:
- Energy MLPs: Though profitable in 2024, they face regulatory and commodity price risks.
- Affiliated Holdings: Over 65% of assets are in issuers linked to the fund's sponsor, NexPoint, raising liquidity concerns and potential conflicts of interest.
- Level 3 Securities: Nearly half of the portfolio relies on unobservable valuation inputs (e.g., private real estate), introducing pricing uncertainty.

Is the Distribution Hike a Sign of Confidence or Overreach?

Proponents argue the 8.5% policy reflects confidence in asset valuations, particularly in Midwave Wireless and energy MLPs. The fund's 2024 NAV outperformance over its category (+12.90% vs. +14.50%) supports this view. However, critics highlight red flags:
- Historical Underperformance: Over five years, HGLB's NAV returned 6.49% annually, lagging the FTSE All World Index.
- ROC Dependency: Past distributions have included ROC, notably in 2022 when the fund's price returned 23.77% but NAV rose only 18.75%.
- Structural Flaws: The closed-end structure exacerbates discounts, and the board's power to alter the policy without notice introduces operational uncertainty.

Investment Takeaways for the Prudent Investor

1. Evaluate Market Correlations: HGLB's performance is tied to cyclical sectors and energy prices. Investors should assess whether these sectors align with their macroeconomic outlook.
2. Monitor ROC Components: Use the fund's quarterly distribution notices to track whether payouts rely on principal returns. Persistent ROC signals unsustainable distributions.
3. Consider Expense Ratios: The 1.51% fee reduces net returns, so compare HGLB's yield to lower-cost alternatives offering similar exposure.
4. Discount Dynamics: The -37.72% discount to NAV creates a margin of safety—if the discount narrows, investors gain double-digit upside.

Final Analysis

HGLB's $0.088 distribution reflects a calculated bet on its thematic strategy, but investors must weigh the risks. The fund's reliance on volatile sectors, affiliated holdings, and the ever-present ROC threat means this is not a set-it-and-forget-it income play.

Actionable Advice:
- Aggressive Investors: Consider HGLB for its high yield, but pair it with stop-losses and monitor NAV stability.
- Conservative Investors: Proceed with caution. The expense ratio and structural risks may outweigh the 8.5% NAV yield.

In sum, HGLB's distribution hike is a double-edged sword. While it rewards income seekers, its sustainability demands vigilance—especially as global markets test its portfolio's resilience.