It wouldn't surprise me if I've used that title before. Barron's writes several times a year about the "opportunities" in closed end funds (CEFs). It seems like it's always the same article, citing the discounts to NAVs being high, making the funds cheap and this weekend's article is no different.
The basic mechanics of CEFs is they are exchange traded but unlike ETFs which create or redeem shares based on money coming and going, CEFs have a fixed number of shares so open market buying and selling can cause the market price of the fund to deviate widely from the net asset value (NAV), the actual value of the holdings. Many years ago, like back in the 90's, it was very common for CEFs to trade above NAVs but I can't remember a time in the last 15 years where a lot of them traded above their NAVs. It seems like they've been below their NAVs collectively that whole time maybe longer. CEFconnect.com is a good resource for the space including.
Most CEFs seem to be income oriented. Not that they are all bond funds but they typically exist to generate income. Usually that income is far above the prevailing market rates which should tell you something right off the bat. If something is paying 10% in what is now a 5% world, then you are taking some sort of risk. That's only a problem if you don't understand the risk you're taking.
The reason CEF yields are usually so high is because they use leverage to increase their holdings which increases the payout. As a result of the leverage, when bad things happen in income markets and bonds go down, CEFs usually go down a lot more.
Some historical examples include June/July 2003, the Taper Tantrum in 2013 and of course now we can add 2022 to this list. Interestingly, although most of the products I've looked at did fair worse then the aggregate bond funds they didn't do as bad as I might have guessed. I'd have thought there'd be a lot that would have fallen 30% but based on a casual glance, it wasn't that bad.
There are enough incidences here though that anyone buying these should expect that they are adding a lot of volatility to their portfolios. Again, that's not necessarily bad but it is bad to buy one and not realize it might be very volatile. So here are some long standing closed end funds to paint a picture of their performance.
Dividends reinvested (total return).
And not reinvesting the dividends (price return only).
The current yields on the three are 10.5% for HYT which is the Blackrock fund, 12.7% for JQC the Nuveen Credit Strategies and 8.12% for JPC Nuveen Preferred. These funds have long track records of not keeping up with their dividends like we talked about yesterday with some of the options-oriented income funds.
As is often the case, the comments on the Barron's article added some good color to the conversation about funds of closed end funds. Maybe, managers specializing in the space can fair a little better is the thinking. There are few fund that own CEFs to see if the idea holds water.
ETFs with dividends reinvested
And not reinvested
There is a bit of a skew to the ETF numbers because the time available to study is much shorter so the numbers show a larger impact from 2022.
The Cohen and Steers Closed End Opportunity Fund (FOF) was the one closed end fund of CEFs that I found, I'm sure there are others though. It's total return CAGR going back to 2007 was +5.29% and price-only was -3.50%. It currently yields 10.55%. The last five years though tell a much different story. Maybe the Barron's commenter was onto something,
The chart is price only. The CAGR is only barely positive but it is keep up with the dividend. I'd say the same if the CAGR was -0.15%. There's no way to know what the fund will do going forward but a flat price after paying 10% for a period of years seems like a good result to me.
Lastly is the Matisse Discounted Closed End Fund Strategy (MDCEX), so a traditional mutual fund. The managers get quoted in every Barron's article about CEFs lately. The fund yields 9%, Portfoliovisualizer tests back to 2013. The total return CAGR has been 7.33% while price only has been -3.99%.
Thinking about these further, I wonder if they should be thought of as "exchange traded income" as we talked about with covered call funds the other day? Let's compare FOF to the Global X S&P 500 Covered Call ETF (XYLD).
Even playing around with different time periods, FOF outperforms on a total return basis (good) but with much more volatility (less good). On a price only basis, the CAGRs for the same period are almost identical and obviously FOF is much more volatile.
Based on the standard deviation for each, adding XYLD seems capable of reducing portfolio volatility but not so with FOF. Again, that probability is not good or bad so much as being about having the correct expectation.
I'll close this out with a way that I think very high yielding, likely to be deteriorating funds can be used. We've looked at this before but there are circumstances for younger retirees where it can make sense to completely deplete a taxable account to pay for expenses while the IRA continues to grow tax deferred (or free for a Roth) regardless of what is decided with Social Security. In this exercise I would not include an emergency fund and some sort of checking account balance.
Taking all ten or whatever percent out as income would certainly not be sustainable for the long term. We've seen in the case of these very high yielders, many of them don't keep up with the dividends they pay but as a means to stretch a taxable account in the context above for an extra couple of years, that is feasible even if far from riskless. The downside would be the money exhausts sooner than hoped for and the person needs to start IRA withdrawals earlier than they expected.
The expense ratio of some of these funds is through the roof. There are fees on the underlying funds plus the management of the fund of funds manager. I'm not going to ever make a meaningful allocation here but I don't think it is insane to allocate 5% or less in one of these funds to add some yield to a diversified portfolio even if it does deteriorate slowly over time. Despite not keeping with the dividends on a price basis for many years, the funds we looked at haven't gone to zero. I would avoid going heavy into these though. Plain vanilla equities are still the thing that goes up the most, most of the time. If a 5% allocation to a fund of CEFs cut in half over the course of a few years, odds are good that the growth from a normal equity portfolio would make that decline in the fund of funds undetectable to the bottom line of the portfolio.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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