Virtus AI Fund: Tax-cut sale creates bargaining opportunity in this tech-based CEF (NYSE:AIO)

Written by George Spritzer in association with Alpha Gen Capital

(Unless otherwise noted, the data below are from Virtus and BlackRock websites.)

Author’s note: An earlier version of this article was posted to Yield Hunting members on November 17. 21, 2022. Check out the latest Data before investment.

At the end of each year, many investors look at their portfolios and look to offset losses against previous capital gains, or incur new losses to carry forward to future tax years. For closed-end funds, this tax-loss sell-off effect can create strong selling pressure in specific sectors that were particularly weak earlier in the year. This usually results in a bigger discount.

In 2022, there are many weak sectors in both fixed income and equities. But one of the weakest areas is funds like the Cathie Wood ARK ETF, which specializes in “disruptive” technologies.

In this article, I describe a technology-based closed-end fund that trades at a relatively high discount. It should benefit from a rebound in tax-loss sales once the tax-loss sales period ends.

At one time, this rally in tax-loss selling would happen early in the new year, but recently it’s happened earlier. Sometimes, as we get closer to the end of the year, you see a nice rally in late December.

Extreme AI & Technology Opportunity Fund Code: (NYSE: AIO)

Date of establishment: October 31, 2019

Total assets under management: 803.9 million

Total ordinary assets: $673.9 million

Base expense ratio = 1.53%

Leverage: 16.26%

Discount = -14.51%

Average 1-year discount = -10.74%

Annual distribution rate (market price) = 10.61%

Current monthly allocation = $0.15

Annual Distribution = $1.80

Associate Advisor: Voya

Investment targets

AIO invests in securities issued by artificial intelligence companies and other companies that will benefit from artificial intelligence and other technological opportunities.

The fund seeks to generate a steady stream of income while growing capital using a multi-asset approach.

Investment Strategy

Differentiated Approach – AIO employs a differentiated multi-asset approach, striving to create an attractive risk/reward profile through fundamental research and dynamic allocation of public and private investments in convertible securities and equities.

Portfolio Sector Breakdown (as of September 30, 2022)

AIO – Top 10 Holdings (as of September 30, 2022)

limited time feature

AIO is set up as a limited-duration fund with an end date of October 29, 2031. This will provide a tailwind as the current 14.5% discount should wear off as we approach the end date in nine years.

The Board has the option to extend the fund’s termination date by 18 months. Note that the Fund is not a “target duration” fund and does not seek to return the Fund’s initial public offering price per share.

AIO – Institutional Ownership

Institutional investors own approximately 15.7% of the outstanding shares. As of September 30, 2022, the top two institutional investors are Morgan Stanley with $15.7 million and Karpus Management with $11.2 million. Many of Morgan Stanley’s shares may be held by financial advisors in managed accounts.

Apart from Karpus Management, I don’t see any other CEF activist investors with significant stakes. Karpus increased its stake significantly in the third quarter of 2022, adding 421,038 shares, bringing its current total holding to 666,465 shares.

Source: Nasdaq.com

AIO – Investment Performance: NAV return to 18 November 2022

YTD -20.42%

1 year – 21.97%

3 years +10.98% annualized

NAV performance has been negative through 2022, but AIO has actually beaten its peers during this period. Morningstar ranked No. 1 among five funds in its technology category.

Source: Morningstar.com

One machine- three year discount history

Effective leverage has been around 20% of assets under management. They primarily use reverse repurchase agreements or other derivatives with embedded leverage.

Z-score analysis

The NAV discount as of November 23 was -14.51%.

Here are some current discounted Z-scores:

three Month: -0.27 six Month: -0.49 Year: -0.93

Source: cefconnect

summarize

I like the AIO here for several reasons:

• Year-end tax-loss sell-offs occurred on many of their holdings. Towards the end of the year or early 2023, we may see a rebound.
• Tailwind from 14.5% discount and end date in 2031.
• Potential “AI disruptive” portfolios don’t just have high-risk AI research stocks. The top two holdings are UNH and DE, which are solid blue chips using AI technology.

I would try to get an AIO at a discount of 14% or more. The fund is quite liquid with an average daily trading volume of over 125,000 shares.