Timing the Addition of a CEF to Your Portfolio

 |  About: AllianceBernstein Income Fund (ACG)
by: Gary Gordon

What if I told you that there's an exchange-traded investment that has averaged 8% annual distributions (paid monthly) throughout the current decade? What if I also told you that this closed-end fund (CEF) typically trades at about a 5% discount to its net asset value, but that it currently trades at a 10% discount.? Would you be intrigued?

Let's take the discussion one step further. What if this fund seeks current income that's, first and foremost, consistent with the preservation of capital? And what if it primarily invests in U.S. Government obligations like treasuries? Would the low level of traditional risk now be worth an 8% annualized return paid out monthly?

What if the fund in question has a 20-year track record of compounding at 9%? And what if the price of this fund had stayed in and around an $8 price target for the last 5 years, before the dramatic Q4 2008 financial crisis sent the price down to $6.50? Would a probable 15% appreciation make the current 9.25% yield even more attractive?

What if the fund has total net assets in excess of $3 billion, making it one of the largest fixed income CEFs in existence? And what if 88% of the debt in the portfolio is A-rated? Would these factors make the investment even more enticing? It would for me!

Let's review, restate and recalibrate:

  1. This particular closed-end fund invests in U.S. government debt, mostly treasuries. Eighty-eight percent of the debt comes with an A rating. Clearly, the credit risk seems quite low.
  2. With a beta of .45, this fund has less than 1/2 the risk of the U.S. equity market. Yet it is producing equity-like historical returns at 9% compounded. Obviously, this is a desirable risk-reward relationship.
  3. This exchange-traded vehicle is trading at a 10% discount to the actual assets it holds. Moreover, it is trading at a 15% discount to its long-standing price point. Undoubtedly, the strong potential for capital appreciation may be added to the undeniable consistency of 8% annual (0.67% monthly) distributions.

In truth, I typically shy away from CEFs. They lack the transparency of ETFs/ETNs where one knows exactly what's inside. CEFs are also more expensive... a lot more expensive.

Nevertheless, there are exceptions... and the Alliance Bernstein Income Fund (NYSE:ACG) is one of them. Even with an obscenely high 2.2% in net expenses (ETFs often run at about 0.5%), ACG is in the right place (troubled economy) at the right time (maximum fear).

The Alliance Bernstein Income Fund (ACG) has the liquidity of exchange-traded assets. So you can sell for a profit and/or use a trailing stop-loss to further mitigate risk. ACG is also large enough that the price execution is favorable for those who are concerned about an investment's bid/ask spread.

Tax-efficiency isn't a concern here either. ACG's turnover rate is about 13%.

Most importantly, the economic environment favors debt obligations... especially those that will be paid! This is a fund that'll be paying in spite of the credit crisis.

Best of all, a current yield of 9.2% gives you "sleep-ability" until credit is flowing freely. And at that future point, funds like the Alliance Bernstein Income Fund (ACG) will be trading 15% higher.

Again, CEFs rarely make the kind of sense that ETFs do. CEF costs are exorbitant. And you're counting on a fund manager to outperform a benchmark with reasonable risk... a feat that is rarely accomplished.

In this case, however, you have a yield that's greater than 7%. And it's not coming with the kind of risk that 7%+ yields are famous for. There's limited leverage (if any). And, the fund is trading at a price discount to its actual net asset value.

I would probably sell this CEF if I had pocketed a handsome 22%-25% in capital appreciation alone. And I'd put a stop-loss of 10%-12%, should the credit crisis become more incorrigible.

Yet, as long as you've got a low-risk asset that is producing at least 7.5% in cash flow, as long as you're not looking to lock in a gain or protect against an obscene loss, the Alliance Bernstein Income Fund's yield has all of the makings of a meal ticket.

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ACG cef 1 year

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