CRF: Why, When, And How To Invest In This High Yield Total Return Fund (2024)

I have read many comments and articles over the years on Seeking Alpha and other investing websites that discuss the Cornerstone Total Return Fund (NYSE:CRF) in either a “glowing, love the concept and the returns” language, or more often, why investors should steer clear of the fund and its cousin fund, Cornerstone Strategic Value Fund (CLM). Both funds invest in equities, trade at a significant premium to NAV, currently yield near 20% annually (paid in monthly distributions), and operate in a similar manner, typically announcing an RO (rights offering) about once each year.

Much of the recent coverage on CLM has been quite negative, with Sell and Strong Sell ratings by several authors. In my opinion, the fund is a Buy for its total return potential over the next several years. The 2021 total return was one of the best years ever in terms of performance for CRF reaching 45.5% by year end. However, that outperformance is unlikely to reach a similar level in 2022 due to the changing nature of the market and many of the fund’s holdings that have seen a rough start to the year. Still, the fund is likely to be a solid long-term investment at the right price and for the active investor who is willing to do more than just buy and hold.

I am going to lay out a case for investing in the fund with the knowledge to understand why it is a good investment - assuming that it meets your objectives and risk tolerance; when you should consider buying shares in the fund; and how to take advantage of the RO. The next chance to participate in the RO will likely be again next year since there is currently an active RO in place for both CRF and CLM until June 10. Anyone who owned shares in CRF (or CLM) prior to the ex-rights date of April 14, 2022, is entitled to participate in the RO and would have received 1 right for every 3 shares owned. One right is needed to purchase one share at the offering price that will be determined at the termination date:

NEW YORK, May 23, 2022 — Cornerstone Total Return Fund, Inc. (the “Fund”) (NYSE American: CRF) (CUSIP: 21924U300) announced today that the subscription period for its previously suspended rights offering for shares of the Fund's common stock (the "Rights Offering") will resume on Monday, May 23, 2022 and the expiration date will be extended so that the Subscription Period will expire at 5:00 p.m., New York time, on Friday, June 10, 2022, unless further extended by the Fund (the “Expiration Date”). The original record date will continue to be April 18, 2022.

Why Cornerstone?

The Cornerstone Total Return fund first commenced trading in May 1973. The fund is a diversified equity closed-end fund ("CEF") with an investment objective of capital appreciation with current income as a secondary objective. The fund adviser uses a balanced approach including both growth and value stocks trading at reasonable prices in a diversity of sectors and industries that demonstrate long term growth characteristics. The fund’s average returns as of December 31, 2021 over the past 1 year, 5 years, and 10 years have outperformed the S&P 500 Index, according to the fund’s 2021 Annual Report.

As of March 31, 2022, the fund’s net assets amount to $572,566,565. The fund currently uses a small amount of leverage at 9.5%. The NAV is updated weekly and at month end on the fund’s website and as of May 31, 2022, was $7.71. At the closing market price of $10.55, the fund is trading at a 36.8% premium. That high premium is typical for CRF based on past performance and is just slightly above the 52-week average.

The top 10 fund holdings as of December 31, 2021, as shown in the Annual Report, are as follows.

The top 10 holdings in the fund make up about 35% of the total portfolio value. Many of the top holdings are top equity holdings that you would find in other similar equity funds and include Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOG), Meta (FB), and Berkshire Hathaway Inc. (BRK.B). The heaviest concentration is in technology, followed by healthcare, financials, communications, and consumer cyclical. Other CEFs make up about 8% of the holdings. The complete breakdown as of March 31, 2022 can be found here.

The fund expenses are relatively low, with a 1.0% management fee and about .15% in other expenses. The fund does not intend to use leverage unless necessary for temporary or emergency purposes as spelled out in the 2021 Annual Report:

The Fund has no current intent to use leverage; however, the Fund reserves the right to utilize limited leverage through issuing preferred shares. The Fund also may borrow money in amounts not exceeding 10% of its total assets (including the amount borrowed) for temporary or emergency purposes, including the payment of dividends and the settlement of securities transactions, which otherwise might require untimely dispositions of Fund securities. In addition, the Fund may incur leverage through the use of investment management techniques (e.g., “uncovered” sales of put and call options, futures contracts and options on futures contracts). In order to hedge against adverse market shifts and for non-hedging, speculative purposes, the Fund may utilize up to 5% of its net assets to purchase put and call options on securities or stock indices.

Distribution Policy

The fund operates using a Managed Distribution Plan that delivers a consistent monthly distribution (with interim adjustments as necessary) that is based on the NAV of the fund. That distribution is reset each year based on the NAV at the end of October and is intended to offer a consistent monthly distribution for the following 12-month period. In November 2021, the Board of each fund, CRF and CLM, announced that the distribution for 2022 would equal 21% of NAV at the time, same as the previous year.

Those distributions have now been declared through September 2022. At the end of October this year, the following year’s (2023) distributions will be announced and may be 21% of NAV again, or it may be reduced if the fund’s performance does not improve in the second half of the year.

Sources of distributions include income, capital gains, and some ROC (return of capital). The ROC in this fund does reduce the cost basis of your investment if held in a taxable account. Note that in 2021, ROC represented 38.5% of the distributions. Also, ordinary income dividends do meet the criteria to be treated as qualified dividends, another potential tax advantage for those holding in a taxable account.

Over the past one-, five-, and ten-year periods, the total returns from reinvesting dividends have propelled the fund to offer excellent returns. It is my opinion that the next 5 to 10 years will continue to offer investors outsized returns if those investors take advantage of the Dividend Reinvestment Plan (allowing stockholders to reinvest cash distributions at NAV, which offers a discount to the current market price based on the premium at the time), and by leveraging the rights offerings to purchase shares at heavily discounted prices.

Rights Offering and When to Consider Buying

As you can see in the chart below from CEFconnect, the premium was rising over the 12-month period up until the RO record date, and then the premium was reduced considerably as the market price plummeted, before starting to increase again in the past few weeks.

On May 16, the RO was suspended due to the more than 10% drop in NAV that occurred between the initial announcement of the RO on April 8, where the NAV was $8.65, and May 13, when the NAV was $7.45. A week later, on May 23, the RO was resumed with a June 10 expiration date (unless further extended). During that period the NAV of the fund was falling, along with the rest of the S&P 500 during most of April and early May. Since May 23, the NAV has risen back up slightly along with the broader market recovery.

The terms of the RO indicate that the offering price will be the greater of 65% of market price, or 112% of NAV, whichever is greater as of market close on June 10 (unless extended). As of today, 112% of NAV = $8.64 and 65% of market price = $6.86, so if today was the termination date, the offering price would be $8.64 for stockholders with subscription rights. Investors are betting that the NAV will likely rise between now and June 10 and that may be why the premium started to increase again.

How to Buy Shares of CRF/CLM

The historical pattern of a steadily increasing premium above NAV up until the announcement of the RO, followed by the drop after, is one way that investors can take advantage of the opportunity presented. For those investors with a long history investing in CRF, or who bought shares at a much lower market price – let’s say in March or April 2020, one can realize some profits by selling some shares at the high premium, keeping some shares to participate in the RO. Then, after the RO is announced, they can either decide to participate in the RO or simply buy back shares at the considerably lower market price, post-announcement.

Another opportunity to leverage the RO without participating in it is by simply waiting until after the termination date when the new shares are issued to rights subscribers. The market price typically drops to a lower premium even if the RO is accretive to NAV, and in past offerings that has been the case.

The reason why it becomes accretive to offer shares under the RO is because the fund advisers can use the additional funds raised during the RO to grow the holdings in the portfolio. In the 2021 RO, a total of 20,584,726 shares were issued raising $210.58M (minus $197,000 in offering related expenses). With the general market still trying to recover from a correction (or possibly entering the first phase of a bear market), the current prices for adding new shares to existing holdings may indeed lower the cost basis and increase the overall portfolio value as those newly raised funds are put to work.

Another consideration for those wishing to participate in the RO is the oversubscription option. Anyone who has rights to participate in the RO can elect to oversubscribe at the time they decide to participate. As stated in the press release regarding the RO, stockholders may elect to oversubscribe based on number of shares available when the offering is concluded, up to 100% of the initial allotment:

In addition to the shares offered in the primary subscription, the Fund may offer a 100% over-allotment to oversubscribing stockholders. Stockholders who fully subscribe in the primary offering will have the option to oversubscribe for additional shares, to the extent available.

The NAV has been rising again over the past week (from $7.45 on May 23 to $7.71 on May 31), so that is a positive trend that will be beneficial to the RO if it is completed according to plan. But the tide could turn, and the NAV may experience another drop if the overall market begins to trend down again. In that case, it is possible that the RO could be suspended another time, or possibly even terminated, although I believe that is unlikely to happen.

It is not a requirement to participate in the RO, and that is not the only way to invest in the fund. One could also simply buy shares of the fund during times of market weakness and then hold and reinvest the monthly distribution at NAV. Because of the fund’s DRIP (Dividend Reinvestment) policy, those monthly distributions can be reinvested at NAV, or at the average market price of the shares over the 5 trading days preceding the payment date, whichever is lower. Because the fund typically trades at a high premium to NAV, the DRIP option is a good way to buy additional shares at a very reduced price.

Over the past 5 years the average premium has been around 17%, however, over the past 1 year the average premium has risen to 33%. The only time in the past 5 years that the fund traded at a discount was in March 2020, and it came close to a discount in December 2018. There was no RO in 2019 or in 2020, but you can clearly see the pattern in other years (2017, 2018, 2021, and 2022) when the premium dipped after the RO was announced.

Risks and Recommendations

An investment in CRF (or CLM) is a bet on the long-term growth story of the stock market, and the U.S. economy in general, as the majority of holdings are domiciled in the U.S. If the stock market descends into bear territory it may be unwise to initiate a new position in CRF/CLM at this time. Furthermore, at the elevated premium that the fund is currently trading at, the market price is in danger of reversion to the mean. If that were to happen and the premium were to come back down to the 5-year average, that would result in a price drop of 15% or more.

If you are new to the Cornerstone funds and are interested in starting a long position, I would suggest at least waiting until June 13, the first trading day after the RO termination date. It is likely that the market price will drop substantially to be closer to the offering price (plus a premium) that will be determined at that time. It is difficult to predict how much of a price drop the fund will experience, and it depends on several factors including how many shares were issued, the impact to NAV, and the general market sentiment in mid-June.

The dividend record date was also adjusted to June 10, so there is no real advantage in buying shares prior to that date to take advantage of the monthly distribution. If you missed the opportunity to participate in the RO this year, you may still be able to take advantage of the price action that comes with it by waiting to buy shares at a lower price after the RO is completed.

As with any high yield fund, there are additional risks to consider. The principal risks include general stock market volatility, geopolitical and post-pandemic supply chain disruptions, and the inflationary impacts associated with the current environment. Many of the top holdings are large cap tech stocks (FB, AMZN, MSFT) that have seen massive price drops of 20% or more so far in 2022, which has caused the NAV to drop over the past 6 months or so. If that trend continues into the second half of 2022, the distribution for 2023 may be reduced substantially, which in turn could lead to further reductions in the market price of the fund and negatively impact the total return going forward.

Damon Judd