Brandywine Global Income: Tax Efficient Way To Live Off Global Bond Coupons

Although justifiable yield generating investments are scarce, there are usually good opportunities somewhere. Today, that opportunity exists in the Legg Mason Brandywine Global Income Opportunities Fund (BWG), trading at a historically wide discount to its NAV at a time when BWG’s tremendous prospects for outsized, tax-efficient yield are especially desirable.

Brandywine Global Income Opportunities is a grossly underappreciated fund in the marketplace. This isn’t helped by the CEF industry site, CEFConnect, which appears to be prematurely estimating what portion of BWG’s 2020 monthly distributions will prove taxable at 2020 interest income rates. Actually, none of BWG’s 2020 monthly distributions can be assumed to be anything but ordinary taxable distributions… yet. And that’s okay. 2021 and forward years will likely prove more important years for its ultimate distribution classifications anyway.

What we do know is that BWG provides legitimate and tax-efficient yield over time. And BWG does so from a well diversified portfolio. Recently, almost 40% was in government bonds. Another 42-43% was in global investment grade and global high yield bonds. These are important groups in investors’ current day asset allocation because their prices aren’t artificially inflated by our Federal Reserve’s intervention. Federal Reserve intervention has really taken the yield out of most domestic bonds. Obviously, like many closed-end funds, there is the generic benefit of cheap leverage too. And that spread between what the portfolio yields and what the leverage costs is greater here than most bond CEFs.

But the single biggest advantage of BWG isn’t the unique asset class exposure, rather BWG’s tendency toward tax efficient distributions over time.

BWG investors who know what they are doing hope for what are called “Distribution Reclassifications” each year. These reclassifications take the monthly distributions that were paid monthly (and which came from underlying bonds yield) and for tax purposes reclassifies some or all of those monthly distributions to NOT have been taxable as income. In 2018, for example, less than 14% of BWG’s distributions ended up being taxable distributions. The other 86% of the distributions simply lowered the shareholders’ cost basis.

Distributions Reclassifications are possible through the fund company offsetting its incoming coupon payments with short-term losses. Most commonly, the fund selects currency risk-hedging positions it can close while underwater and while short term.

Such reclassifications can’t be assumed by investors. But tax efficient reclassifications can be produced fairly easily by such internationally diversified bond funds that hedge currency risk. In BWG’s case, the reclassifications were done in 2016, 2017, 2018, but not 2019. We don’t yet know for 2020. Such reclassifications may become increasingly important in 2021 and forward if tax rates increase. Obviously, tax efficient yield is coming into demand for 2021 and forward based on the possibility of higher domestic tax rates.

BWG bought back 20% of its outstanding shares at 99.5% of NAV through a tender offer in late September. Obviously, tenders like BWG’s are great for investors. Investors can tender, selling shares at a price above market. Some take a tax loss, then repurchase their shares 30 days later at a lower price. The tender arbitrageurs who know nothing about the fund have certainly helped by blowing out of their excess positions after the oversubscribed tender.

In time, markets are fairly efficient. BWG provides outsized justifiable and tax-efficient yield. And there are 20% fewer shares outstanding to go around than there were last month. Notably, BWG also has a substantial long-term capital loss carryforward, which has also increased by 25% on a per share basis by virtue of the recent tender offer.

Disclosure: I am/we are long BWG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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