ETJ: Noticing a Bogey

A reader asked what I though about the Eaton Vance Risk Managed Diversified Equity Income Fund (ETJ), which is a closed end fund. The reader notes it sells puts and buys puts, along with owning common stocks.

Aside from a violent spasm last October, ETJ has held up well price-wise, dropping 10% in the last year as the S&P 500 has dropped 30%. It seems that most of the time it correlates closely to the broader market. Additionally it yields 10%. On the surface: not too shabby.

These days when I see that type of yield my first inclination is to see how much of the payout was a return of capital. Well, according to this, the dividend for April was $0.45 of which $0.405 was a return of capital and the rest was net income. Ouch. I did not look back at other dividends to see what portion of past payouts were a returning of capital, but maintaining a 10% "yield" is a big bogey for a fund to keep up with. I would not want a lot of exposure to closed end funds who are returning capital to make their payouts.

Comments

[Gruber:]

The question I have is the characterization of income with respect to buy/write funds?

I’m not sure whether the option premium is amortized over the life of the option or recognized when the option expires. If the option premium is recognized at its expiration, for non-GAAP accrual purposes, the fund could payout that accrual in anticipation of the option expiration. That may cause the dividend to be initially characterized as a return of capital until the option expires. Once the option expires, such dividends may be re-characterized as investment income.

I’m not an accountant, but maybe there’s someone out there who can speak to this issue.

Gruber

Jun 24 11:52 PM

[oldman:]

ROC can be income from covered calls and other than dividend or interest income.

Jun 25 02:17 PM

[klarsolo:]

A return of capital is a not a bad thing when you buy a fund at a high discount. Unfortunately ETJ usually trades at a small premium.

Jun 26 10:11 AM

[snoopyjc:]

I just got off the phone with Andrew Moore from Eaton Vance (1-800-262-1122). As "Gruber" suspected above is the truth. Options Premiums are characterized as "Return of Capital", so they aren't just giving you your money back with the dividends!
--joe

Jun 30 04:19 PM