Myth Dispelled: Contrasting the Options CEF With Dividend Capture Funds

Includes: AGD, AOD, ETJ
by: Dan Plettner

I recently read text from a “pen name” Seeking Alpha contributor who pitches himself as a Closed-End Fund advocate. That text claimed that ETJ and the Alpine Funds (most notably AOD, AGD) similarly employ an option strategy. With respect to the Seeking Alpha and Closed-End Fund communities, I feel compelled to offer correction. The best way I can improve the accuracy and relevance of Seeking Alpha’s Closed-End Fund content is with my own contributions. Accordingly, I am going to make a conscious effort to contribute content more regularly.

By prospectus all the Alpine Closed End Funds use Dividend Capture Rotation Trading, or more generally “buying dividends”. In effect, the tactic is primarily conducted at AGD and AOD. I am not an advocate of the practice. I do argue that the yield produced has appeared to have an effect on Closed-End Fund market valuations. Such effect may change given the uncertain dividend tax environment. I do own one other Alpine Fund, but not based on expecting distribution increases or benefits from Dividend Capture Rotation Trading.

I do believe in assessing the dynamics that influence Closed-End Fund share prices. Why? Put simply, I believe that Closed-End Fund discounts and premiums are most relevant when they change, and that their changes are anything but random.

Eaton Vance Risk Managed Diversified Fund (NYSE:ETJ) uses an options strategy in its attempt to produce yield. Covered call option premiums when distributed to Closed-End Fund investors are often treated as Return of Capital (“ROC”) for tax purposes and not taxed as dividend income. ROC has different relevance in different situations. In Closed-End Funds, details matter. Let me avoid digressing. Among its actual peers (not the Alpine Funds) ETJ is somewhat unique in that it seeks to mitigate downside risk by also buying protective puts.

Some in the Closed-End Fund space do research seeking to understand what they write about. I respect due diligence and professionalism among my peers whether I share their conviction or not. CEF analyst Jon Maier of Bank of America cited Net Asset Value (“NAV”) erosion resulting from ETJ’s use of protective puts in his assessment of distribution risk. Maier’s recent downgrade corresponded to a significant change in ETJ’s valuation relative to its NAV.

The only similarity between ETJ and the Dividend Capture Alpine Funds, is that work was done by (alternate) people who did research theorizing distribution cuts, and resulting effects on market prices. To date, ETJ's distributions have not been cut. I do believe that if Maier is right and ETJ's distributions are cut soon, neither the cut nor the effect on relative valuation will be nearly as extreme as was the case with AOD and AGD.

ETJ's actual peer group is in my view deserving of much attention given the forward looking uncertainty of dividend tax rates. I have both long and short positions among ETJ's actual peers to the extent my research has resulted in sufficient conviction.

Disclosure: Short AOD. No positions in ETJ or AGD.

I spoke recently about my own assessments in Covestor’s Closed-End Fund webinar. Such positions along with my other portfolio and trading activities are licensed as data to Covestor Ltd. (“Covestor”). Covestor is a Registered Investment Advisor that uses my trading data in effort to replicate my actions for its retail investing clients. Two long positions in covered call funds are licensed to Covestor's Core and ironically, Taxible Income models.

Similarly, my short position in AOD is licensed to Covestor’s Long Short Opportunistic Model. Inquiries relating to Covestor, or originating from Covestor clients and prospective clients must be directed to Covestor Client Services at (877) 873-8830.