Highland Global Allocation Fund's Elevated Distributions and Risk of Capital Return

The Highland Global Allocation Fund (HGLB) has long positioned itself as a compelling option for income-focused investors, leveraging a level distribution policy to deliver consistent monthly payouts. However, as the fund's 2025 distribution rate of 8.5% of net asset value (NAV) underscores, the sustainability of these returns hinges on a delicate balance between income generation and the potential erosion of capital. With projections indicating that up to 62% of the 2025 distribution could constitute a return of capital (ROC), investors must scrutinize both the financial mechanics and tax implications of this strategy.

Distribution Rate and Sustainability

HGLB's monthly distribution of $0.085 per share for January through March 2026 reflects its commitment to maintaining a stable payout, recalibrated annually to 8.5% of the average NAV per share. As outlined in the fund's prospectus, this approach prioritizes consistency over flexibility, with adjustments tied to NAV performance rather than underlying income generation. While this model provides predictability, it also introduces a critical risk: the fund may distribute more than its net investment income, necessitating a return of capital to sustain the rate.

Such a practice is not uncommon in closed-end funds or business development companies (BDCs), but it raises questions about long-term sustainability. A return of capital, while boosting short-term yields, effectively redistributes a portion of an investor's initial investment rather than generating earnings. This distinction is vital for assessing the fund's ability to maintain distributions without compromising its asset base.

Return of Capital Risk

The 2025 distribution data highlights the magnitude of this risk. For the fourth quarter of 2025, HGLB's $0.088 per share payout-equivalent to an 8.5% annualized rate-was recalibrated based on the 2024 NAV. Crucially, approximately 62% of this distribution is projected to qualify as ROC. This suggests that the fund's income generation may lag significantly behind its payout obligations, forcing it to return principal to meet its distribution targets.

While ROC is not inherently problematic-investors may welcome higher yields-it carries two key drawbacks. First, it reduces the fund's total assets, potentially diminishing its capacity to generate future income. Second, repeated ROC distributions can erode the fund's net asset value over time, undermining its long-term growth prospects. For investors seeking capital preservation alongside income, this dynamic represents a significant trade-off.

Tax Implications

The tax treatment of HGLB's distributions further complicates the investment calculus. Unlike ordinary income, which is taxed at standard rates, returns of capital are generally tax-deferred until the investor's cost basis is exhausted. However, this deferral comes at a cost: ROC reduces the investor's taxable basis, meaning future gains will be taxed at higher rates once realized.