Are there still good values among high yielding equity based closed-end funds (CEFs) after this market run? Yes...but they are getting harder to find and this article is as much about identifying overvalued funds as it is about finding undervalued ones.
So how do you find which funds may be undervalued and which ones may be overvalued? The following tables sort virtually all the high yielding (i.e. generally 6% or higher) equity based (i.e. portfolios over 50% stocks) available to investors by their NAV total return performances from January 1, 2012. Funds in green have seen their NAVs either outperform or at least keep up with the S&P 500, as reflected by the SPDR S&P 500 Trust ETF (SPY). SPY, including dividends added back, is up 22.98% since January 1, 2012 so any fund that has had a total return NAV performance over 17% I have shown in green in the NAV total return column. Note: Most quoted S&P 500 returns do not include dividends but in my analysis, they do.
The funds are further color coded by their income strategy. Blue for option-income, orange for leveraged, olive green for dividend harvest and black for other. As you might expect, leveraged funds dominate the top performers while the most defensive option-income funds and sector specific funds that had underperforming sectors, bring up the rear.
The first table shows the top NAV performers over the past 13 months, from January 1, 2012.
The next table shows the bottom NAV performers over the past year and a month.
These two tables show the majority of the 80 or so equity based CEFs I follow. From these two tables I can then identify which funds may be undervalued or overvalued by next sorting the difference between a fund's total return NAV performance and a fund's total return market price performance. This is shown in the % Difference Between NAV/Market Price column and fund' which have a positive percentage difference that have seen their market prices outperform their NAVs and funds which have a negative percentage difference that have seen their market prices underperform their NAVs.
Logically, the more a fund's market price has underperformed its NAV, the greater the potential that the market price may play catch-up, all else being equal. But then you have to adjust that potential based on a number of factors such as a fund's current discount/premium level, a fund's NAV and market yield, whether or not the fund has raised or lowered its distribution or the potential for the fund to raise or lower its distribution. And then finally, a fund's income strategy can make a huge difference since income strategies excel in different market environments.
The Most Undervalued Equity CEFs
So from a first sorting by NAV total return performance (first table above), I then sorted by the % Difference Between NAV/Market Price column so that any fund with less than a 5% difference between its market price performance and NAV performance gets a green in that column. So now here is the updated table...
If a fund is green in the Total Return NAV Performance (column #1 of the data columns) and green in the % Difference Between NAV/Market Price (column #3), we can then further eliminate funds based on their premium/discount valuations as well as other criteria as noted above. The end result is a list of 12 equity CEFs that qualify, based on my criteria and analysis, as the most undervalued equity CEFs. And here they are...
The Most Overvalued Equity CEFs
Just because a fund may be at a high premium valuation doesn't necessarily mean the fund is overvalued. The PIMCO Global StocksPlus & Income fund (PGP) may have a 45% market price premium, but the fund's total return NAV performance of 55% over the last 13 months offsets that a lot. I would never recommend the fund at this valuation and I wrote negatively on PGP last July when it was at an even higher 82.6% premium, but for those investors who can stomach the volatility, PGP may be worth that premium since it would be very difficult to replicate the fund's income strategy.
No...the most overvalued funds, in my opinion, are the ones that have high valuations, underperforming NAVs and yet don't have the NAV upside potential like a PGP to justify that high valuation. So to find the most overvalued funds, I first sorted the funds whose NAVs underperformed the S&P 500 by more than 6% (shown in red in the second table above). Once I had those funds red-flagged, then I sorted the funds by the % Difference Between NAV/Market Price. Funds whose market prices outperformed their NAVs by more than 5% are shown in red below (not all funds were able to be shown).
And then after eliminating the funds which had superior NAV performance (shown in green in column #1 of the data columns) as well as funds that were already discounted over -6%, you're left with eight funds that I have identified as the most overvalued funds of all...
What you'll notice with the most overvalued funds is that they tend to have some of the highest NAV and market price yields of all equity CEFs. This is because investors will often chase these high yields and end up bidding these funds up to premium price levels, ignoring the fact that such high yields often lead to NAV underperformance in good times and severe NAV erosion (destructive Return of Capital) in bad times.
And if a fund cannot support its high NAV and market price yields, then a cut in its distribution is all but inevitable. Four of these funds have already cut their distributions over the past year and I wouldn't be surprised to see one or more cut over the next six months as well. According to my analysis, the Gabelli Natural Resources, Gold & Income fund (GNT) and the Seligman Premium Technology Growth fund (STK) are the most in danger of a distribution cut, particularly if the gold and technology sectors they invest in underperform.
On the hand, funds with low NAV yields and superior NAV total return performances may be in a position to raise their distributions. I wrote just such an article a couple weeks ago addressing that very subject, which you can read here, Other Funds Raise. As it turned out, many of the funds I identified had already raised and several others could still raise in 2013.
What you'll notice in that article is that there are funds that made the list in this article as well. They include the Gabelli Dividend & Income Trust (GDV) and the Cohen & Steers Infrastructure fund (UTF). Others from this list that could also raise include the Allianz/PIMCO Equity & Convertible Income fund (NIE) and the John Hancock Tax-Advantaged Dividend Income fund (HTD).
Now, of course, a fund's income strategy may all of a sudden fall out of favor or a fund's sector portfolio of stocks may all of a sudden come into favor. If that happens, then the likelihood of a distribution raise or cut is diminished. But what I'm going on here is all of these fund's historical NAV performances and historical valuations come up with my undervalued and overvalued list.
I mean, who wouldn't come to the conclusion that the John Hancock Tax-Advantaged Dividend Income fund, ticker HTD, is severely undervalued compared to the John Hancock Tax-Advantaged Global Shareholder Yield fund (HTY) in this market environment? HTD has a leveraged portfolio of stocks and preferred securities whereas HTY has a mostly global stock portfolio and uses an option-income strategy.
When you compare total return NAV and market price performances over time, particularly in a strong market environment, it's not even close. HTD's NAV is up an astounding 182% since the market lows in March of 2009 while HTY's NAV is up only 55%. See both fund's quarterly NAV total return performances below...
And yet it's HTY that trades at a 7.2% premium with an underperforming NAV (see overvalued funds above) while HTD trades at a -8.1% discount (see undervalued funds above). HTD also pays monthly vs. HTY which pays quarterly.
This is an example of what my analysis can show and I'll be back in six months to see how my undervalued vs. overvalued funds performed.