Virtus ACV: High-Yield Income or a Recipe for Capital Erosion?

The Virtus Diversified Income & Convertible Fund (ACV) has long been a beacon for income-seeking investors, offering a steady $0.18-per-share monthly distribution since early 2024. However, a closer examination of its May 2025 distribution reveals a stark reality: 100% of the payout is classified as a return of capital, marking a dramatic escalation from the 83.3% return of capital (ROC) reported in February 2025. This raises critical questions about the fund's ability to sustain its high distribution rate amid rising capital erosion risks. For investors, the allure of a 10.38% annualized distribution rate must now be weighed against the fund's 5-year net asset value (NAV) return of 11.95% and the looming 2030 termination deadline. Let's dissect the data to determine whether ACV is a buy, a hold, or a risky gamble.

The Distribution Dilemma: ROC at 100% in May 2025

The May 2025 distribution, set at $0.18 per share, marks the first time in recent records that the fund's payout is entirely sourced from return of capital. Historically, distributions have included small portions of net investment income and capital gains—such as the 16.7% non-ROC components in February 2025. But the May shift to 100% ROC signals a troubling trend.

This reliance on ROC reduces investors' tax basis and implies the fund is returning principal rather than generating earnings. While the fund's 5-year NAV return of 11.95% (as of early 2025) aligns with its distribution rate, the YTD NAV performance as of February 2025 was -3.25%, highlighting a disconnect between underlying performance and payout levels. Sustaining distributions at this rate may require continued erosion of capital, a red flag for long-term investors.

Risks Lurking Beneath the Surface

1. Capital Erosion and Tax Basis Reduction

When a fund returns capital, shareholders' cost basis decreases, potentially triggering capital gains taxes upon selling shares—even if the fund's NAV declines. For instance, if ACV's NAV drops over time but distributions remain high, investors may face a double whammy: reduced principal and taxable gains from a diminished basis.

2. NAV Discount and Liquidity Risks

ACV trades at a persistent discount to its NAV, averaging -2.5% to -3.8% over recent years. This discount could widen if investors lose confidence in the fund's ability to sustain distributions. A falling NAV combined with an increasing ROC reliance could further deter buyers, trapping shareholders in a liquidity crunch.

3. The 2030 Termination Deadline

The fund's lifespan is capped at May 22, 2030. By that date, assets must be liquidated and distributed to shareholders. Investors holding until 2030 face two risks: - NAV Volatility: The fund's convertible-heavy portfolio (50% of assets) and leveraged structure (34.31% leverage as of April 2025) expose it to market swings. - Liquidity Squeeze: A rush to exit ahead of 2030 could depress prices further, especially if distributions decline as ROC becomes unsustainable.

Why Investors Still Might Buy ACV

• High Income in a Low-Yield World: With a 10.38% annualized distribution rate, ACV offers outsized income compared to Treasury yields or many corporate bonds. This appeals to retirees or those needing cash flow.
• Historical Performance Cushion: The fund's 5-year NAV return of 11.95% suggests its strategy—investing in convertibles, equities, and income instruments—can generate growth over time, even if short-term ROC is elevated.
• Managed Distribution Discipline: The fund's policy of maintaining consistent payouts aligns with investor expectations, even if it requires dipping into capital.

The Bottom Line: A High-Reward, High-Risk Gamble

Prospective investors must ask themselves: Are you comfortable with a fund that returns your principal to maintain payouts, risks widening NAV discounts, and has a hard expiration date in seven years? For income-focused investors willing to accept these risks, ACV could provide a boost to yields—but with a caveat.

Action Plan for Investors: 1. Focus on Near-Term Income: ACV is best suited for those needing cash flow before 2030, not long-term growth. 2. Monitor ROC Trends: If distributions exceed 90% ROC consistently, consider exiting. 3. Beware the 2030 Cliff: Factor in the fund's termination when calculating total returns.

In short, ACV is a high-octane income play with expiration date risk. The fund's May 2025 distribution—a stark 100% ROC—serves as a wake-up call: the clock is ticking, and investors must decide whether the yield is worth the erosion of their capital.

Final Verdict: Buy for aggressive income seekers with a 2020s horizon, but tread cautiously—this fund is a sprint, not a marathon.