Source Capital, Inc. Q4 FY2021 earnings call

Key Points

• Source's portfolio management team aims for balance between capital appreciation and income while being mindful of downside.
• FPA Partners and employees increased their investment in the fund last year, owning shares valued approximately $4 million.
• Private credit exposure increased: ended 2021 with almost 25% exposure (including capital commitments) and 14.6% funded exposure, up from 11.7% and 7.5% respectively in 2020. Targeted yield for private credit is at least 8%.
• Source Capital's discount to NAV narrowed from 11.96% at year-end 2020 to 5.47% at year-end 2021.
• Board approved maintaining monthly fund distributions at $0.185 per share through May 2022, equating to an annualized 6.42% unlevered distribution rate.
• SPAC investment strategy: Bought SPACs at or below trust value before deals, with redemption rights and warrants for potential upside. In 2021, SPAC bucket contributed 0.6% to gross return with average 6.8% weight suggesting ~8.8% aggregate return.

As of year-end 2021, Source Capital had 62% in equities, 33% in credit, and about 5% in cash. The gross yield run rate was approximately 3.25%, which was higher by about 1.25% from the end of 2020 and almost double the yield of the global balance index. Equity contributed 62% to revenue, credit contributed 33%, and cash contributed 5%.

Guidance Points

• Board to maintain monthly fund distributions at $0.185 per share through May 2022.
• If the fund's discount to NAV exceeds 10%, it will tender 10% of shares outstanding at 98% of NAV (commitment valid for 2022 and 2023).
• Hope to increase fund's yield by further increasing credit book yield, drawing down cash, and adding leverage via the credit line established last year.

Risks

• Market conditions may impact the ability to migrate the yield of the public credit book higher.
• SPAC investments could be affected if market views on proposed transactions are dim, though redemption rights and warrants provide some protection.

Q: Please address the fund's SPAC investment strategy in more detail on how successful it has been so far for the portfolio.

A: While it's important to note SPACs are trading at a fraction, prices mostly happened after announced deals. They assembled a basket of SPACs around 7% of the fund at year-end, buying them roughly at or below their trust value before a deal was announced. This provides a free option in case other investors take a favorable view when the SPAC announces its targeted acquisition. If the market takes a dim view of the proposed transaction, they can exercise redemption rights to receive the trust value in cash. Often, they buy a share in a SPAC with a unit for warrants attached, allowing them to retain warrants and participate in future upside of the SPAC even if they sell or redeem shares prior to acquisition closing. In 2021, Source's SPAC bucket contributed 0.6% to the fund's gross return. A back-of-the-envelope calculation, given the average 6.8% weight during the year, suggests around 8.8% return for the SPACs in the aggregate.