- The second quarter has a history of being the weakest quarter of the year for the averages, particularly May and June.
- Closed-end high-yield funds offer 8% dividend income and the potential for just as much return in the form of share price appreciation if they move closer to their NAVs.
- Closed-end funds offer a much better alternative to more commonly used income producing ETFs.
The first quarter has come to a close and the market looks very nervous. There has been a similar pattern to the trading days the past couple of weeks. The averages open higher, make their highs for the day before 11:00 AM EST, and then sell off until the close. Market breadth has not been good and the market does not look very strong.
At the beginning of March, many were hoping that the losses seen in January were a correction and the market was poised to take another leg upward. The markets tested the all-time highs in the first half of March and have just been hovering around them since. This type of trading activity looks more like the market running out of steam instead of gearing up for another rally higher.
The Dow Jones Industrial Average (NYSEARCA:DIA) still has to fill the gap created on March 17, 2014. When it does, do not be surprised to see the lows of the year tested.
The second quarter has been the worst performing quarter for the US markets in three of the past four years. The average losses for the S&P 500 (NYSEARCA:SPY) in those three years was nearly 6%. May and June have been particularly bad months, and the markets could see significant weakness in these months of 2014.
A new low for the year by the S&P 500 has the potential to lead to an acceleration of selling in May and June which are historically two of the worst months for the averages. A 6% loss from current levels could very quickly turn into a 10%-15% move to the downside.
Closed-End High-Yield Funds offer investors an opportunity to take advantage of a possible pullback in the averages without shorting the market. Last week I examined the 37 domestic taxable high-yield bond funds. I have analyzed the most recent portfolio statistics provided by the 91 global taxable income closed-end bond funds in search of the funds offering the best value for investors.
The search parameters for the global funds differ from what was used for the domestic funds. The objective however is the same; the potential for double-digit returns on investment.
- Trading at a minimum 8% discount to the fund's net asset value.
- Minimum distribution rate of at least 8% of the fund's current price.
To ensure the quality of the first two parameters, the figures of the first two parameters are put under further scrutiny. The sustainability of the fund's distribution rate is examined along with shares' ability to trade at or above the fund's net asset value.
- The fund has maintained its distribution rate for at least the past two years.
- The fund has traded at or above its net asset value within the past two years.
- Portfolio leverage is less than 30%.
- The average duration of the fund's portfolio holdings is less than 7 years.
Five Funds made the cut.
Western Asset Emerging Markets Debt Fund (NYSE:ESD) boasts the highest credit rating of its holdings; however, it also has the longest average duration for its holdings. Western Asset Global High Income Fund Inc. (NYSE:EHI) holdings have a little shorter average duration, 4.4 years vs. 6.6 years for ESD and all of the holdings in EHI have credit ratings CCC or better. This may explain why shares are trading closer to the fund's net asset value.
Stone Harbor Emerging Markets I (NYSE:EDF) primarily hold debt from emerging markets which hurts the credit quality of the fund's holdings. The riskier investments are rewarded with a yield of 11.67%. Alpine Total Dynamic Dividend F (NYSE:AOD) holds common stocks to produce its stream of dividend income. I would not expect shares to move closer to the fund's net asset value as quickly as others if the market does pullback, however it is already trading at much higher discount relative to its peers.
MFS Intermediate Income Trust C (NYSE:MIN) did not really make the cut because the fund has lowered its dividend in the past two years and it is currently trading at a discount of only 7.64%. The fund has lowered its distribution about 10% over the past two years. It is worth noting that the dividend rate is 60% greater than it was seven years ago. The fund has a very low average duration of 3.2 years and spectacular credit quality of its holdings with 99% having at least a BBB rating.
The cushion that the fund's low duration and superb credit quality will supply should there be a sudden spike in interest rates is worth the risk if any further cuts to the distribution rate. The fund's distribution rate is 9.23%, the fund could lower its distribution rate another 10% and the yield would still be greater than 8% on shares.
Closed-End High-Yield Funds are not as well-known as their ETF counterparts; however, they have a lot more to offer investors who take the time to do the research and discover them. MIN and EHI have much better credit quality ratings than iShares iBoxx $ High Yield Corporate Bonds (NYSEARCA:HYG) fund, yet both are currently yielding 50% more than HYG. EDF give investors exposure to emerging markets and pay more than 2.5X more in monthly distributions as iShares JPMorgan USD Emerging Markets Bond (NYSEARCA:EMB) or PowerShares Emerging Markets Sovereign Debt (NYSEARCA:PCY). 74% of the portfolio holdings of ESD are rated BBB or better. Perhaps not as high quality as iShares 7-10 Year Treasury Bond (NYSEARCA:IEF), but the yield is nearly 5X greater and the average duration of ESD's holdings is shorter.
These funds offer investors two sources of return on their investments, from the income provided by the fund's distributions and the potential for share price appreciation if shares return to trading closer to their respective net asset values. These are not exactly the most exciting investments an investor could own, but during periods of uncertainty in the markets excitement can be dangerous for portfolios.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.