Sustainable Income in Volatile Markets: Assessing the Risks and Rewards of Lazard's Return-of-Capital Strategy

In an era of persistently low interest rates and unpredictable market swings, investors seeking income have increasingly turned to high-yield strategies. Among these, the Lazard Global Total Return and Income Fund (LGI) has stood out for its 10.03% forward yield, a figure that appears enticing in a world where even blue-chip equities offer meager returns. However, beneath the surface of its monthly $0.14646-per-share distribution lies a complex interplay of tax mechanics, capital structure, and sustainability risks that demand closer scrutiny.

The Mechanics of the Managed Distribution Policy

LGI's Managed Distribution Policy (MDP) is designed to deliver consistent payouts by blending net investment income (21%), short-term capital gains (4%), long-term capital gains (75%), and—critically—return of capital (0% in the latest distribution but 49% of cumulative distributions year-to-date). This structure reflects a deliberate shift toward capital gains and return of capital to maintain yields in a low-interest-rate environment. While the fund's 9.46% average annual total return over five years is impressive, the reliance on return of capital—a non-taxable but principal-eroding component—raises questions about long-term sustainability.

The fund's heavy use of long-term capital gains (75% of the latest distribution) is a double-edged sword. On one hand, it allows LGI to maintain payouts even when net investment income is insufficient. On the other, it exposes investors to tax inefficiencies: when the fund sells appreciated assets to generate gains, it locks in those gains and may reduce future income-generating potential. Worse, the return of capital component, while tax-free initially, reduces the investor's cost basis, amplifying future capital gains taxes upon sale.

The "Death Spiral" Risk

The most alarming aspect of LGI's strategy is its structural dependence on return of capital. By returning 49% of its cumulative distributions to investors, the fund is effectively returning a portion of the original investment to sustain payouts. This creates a vicious cycle: as the fund's net asset value (NAV) declines—common in volatile markets—it must rely more heavily on return of capital to maintain distributions, further eroding its capital base. This dynamic, often termed a “death spiral,” risks turning the fund into a principal-return machine rather than an income generator.

LGI's use of leverage (11.62% of assets) compounds this risk. While leverage can amplify returns in rising markets, it magnifies losses during downturns, accelerating the need to tap into capital. For investors, this means the fund's high yield may come at the cost of capital preservation, a critical consideration in volatile environments where market corrections are inevitable.

Tax Implications and Investor Due Diligence

The fund's tax treatment is another layer of complexity. While LGI provides a breakdown of distribution sources, it explicitly states these are estimates and not binding for tax reporting. Investors will receive a Form 1099-DIV from their brokers, which may differ from the fund's projections. This uncertainty complicates tax planning, particularly for those in higher tax brackets.

Return of capital should never be conflated with income. Investors must treat these distributions as a return of principal, not earnings, and adjust their tax strategies accordingly. For example, selling shares after receiving return of capital distributions could trigger larger capital gains taxes due to the reduced cost basis.

A Cautionary Outlook

For income-focused investors, LGI's MDP offers a compelling yield but demands a nuanced understanding of its risks. The fund's 10.03% forward yield is attractive, but it must be weighed against the structural return of capital, leverage, and thin liquidity reserves. In a market downturn, the fund's ability to sustain payouts could falter, forcing it to accelerate the return of capital and further deplete its asset base.

Investment Advice

1. Tax Planning is Essential: Investors should treat return of capital distributions as principal returns and factor them into their capital gains strategies.
2. Diversify Income Sources: Relying solely on funds like LGI for income is risky. Pair it with assets that generate true income (e.g., high-quality bonds or dividend-paying equities).
3. Monitor NAV Trends: Keep a close eye on LGI's net asset value. A declining NAV is a red flag for capital erosion and potential payout cuts.
4. Rebalance Periodically: As return of capital accumulates, rebalancing the portfolio to maintain a desired risk profile becomes critical.

In conclusion, LGI's MDP exemplifies the trade-offs inherent in high-yield strategies during volatile markets. While it offers a tempting yield, its reliance on return of capital and leverage creates structural vulnerabilities. Investors must approach such funds with a clear-eyed understanding of the risks—and a plan to mitigate them. Sustainable income, after all, is not just about high yields; it's about preserving capital for the long term.