Gabelli Equity Trust Preferred B: When Bad Is Good

| About: Gabelli Equity (GAB)

Gabelli Equity Trust (NYSE:GAB) lost 48.89% in 2008 and another 25% year to date in 2009. It has also moved from selling at a premium to its net asset value to an 8% discount to NAV. All of which is joyful news to those of us who live off our investment income.

What is good about a fund losing its shirt in the stock market? The decline has wiped out the fund's store of capital gains, which means there will not be any capital gains distributions until a ton of losses have been transformed into gains. And that is wonderful for those of us who own the fund's preferred stock, Gabelli Equity Trust Preferred D (GAB Pr D or GAB-D, depending upon your quote system).

GAB-D trades regularly, though not in spectacular size, and is not in the least similar to the auction rate preferreds that have trapped many money market investors. It has a $1.46 annual dividend, which is a 6.3% yield at the current price of $23 per share. The credit rating is AAA, as it is for all Closed End Fund preferred stocks. The fund is required to maintain $2 in fund equity for each $1 of preferred stock. The manager has regularly bought back preferred shares on the market to maintain this legally required ratio. This adds to the liquidity of the shares.

6.3% on a AAA security is good, given that long term bank CDs and Treasury Bonds are yielding little more than half that rate. But, even better, since the fund has no more capital gains, most of that yield is in the form of return of capital. Unlike tax exempt income, return of capital is simply not income. It is the return of original capital. So, current buyers get to buy former owners' losses without taking the actual losses themselves. That is sweet.

Currently, 80% of the distribution is in the form of return of capital, and 20% is "investment income." The investment income can be dividends or interest, which will not be determined until the end of the year. The part that is dividends also has a preferential tax rate. All of which means that very little of this dividend is being taxed.

Why Gabelli instead of other closed end fund preferreds? The fact that the manager is a large open end fund manager and it is always possible that there will be movement to open end this closed end dud and merge it with a better performing family member. Why this preferred instead of other Gabelli closed end preferreds? Because the fund invests in highly liquid, large cap stocks that can be sold quickly. It is also well diversified. Some of the other funds are intriguing as funds, but not so much as guarantors of preferreds.

So, in an era when safe, decent rates for income investors are very hard to find, GAB-D stands out as a buy for its safe, high and tax friendly yield.

Stock position: I own GAB-D, I do not own GAB.