The CEF Firecracker

by: Roger Nusbaum

Yesterday I read this article about a proposed portfolio of closed end funds (CEFs) that were "high income" and "lower risk" for retirees. It was not clear if the CEFs were intend to be the entire portfolio or just a segment of the portfolio; huge difference between the two. It highlighted eight CEFs and if someone wanted to use that many -- or more -- for some small slice of their portfolio, it might not be simple but could contribute to long-term success. Putting the whole thing into a bunch of CEFs regardless of the number of funds is not something I would do.

As we've covered many times over the years, CEFs occasionally freak out and I don't believe that relatively conservative CEFs should be counted on to not freak out. Our one across the board CEF freaked out in June in a way that was relatively worse than during the financial crisis. It has a very conservative history, the NAV only down ticked a little but the market price did freak out. This is why I believe in limited exposure to this product.

The CEF article was about equity-oriented CEFs. The author said he targeted funds that do about as well as the S&P 500 with less volatility and yield about 6% (or more). His screening process came up with eight funds that met his performance, volatility and yield screen. I should note that in my opinion, past trends of performance and volatility need to be discounted heavily. The odds that a bunch of CEFs could consistently return the same at the SPX, with less volatility and three times the yield of the benchmark, seems tough to believe.

I believe there is room for a limited exposure. Occasionally, they go down a lot and it is not a deathblow to endure a decline and take it back up...when the exposure is limited. But the portfolio put forth above, if intended to be the whole thing, feels like a future finding out you had too much at the wrong time situation.