In my first article for Seeking Alpha, I laid out my methodology for building a portfolio of Closed-End Funds hedged with inverse ETFs. Based on the comments that I have received on this and subsequent articles, it seems that most investors are concerned about how well the dividend is covered. In this article, I present my Hedged Income CEF Portfolio for these more conservative investors.
My first screen is to measure NAV performance over multiple time periods. My philosophy is that I am outsourcing the stock picking portion of the investment process and I want my money in the hands of a proven winner.
My second screen is to compare the current premium/discount to NAV with the historical average. Trading below the average makes a CEF more attractive as a reversion to the mean is a force that may act on the pricing of the CEF over the long term.
My third screen is to eliminate any funds that have returned capital in the past two years. Dividend coverage must come from investment income and capital gains.
The fourth factor is the weighting of each investment in the portfolio. One of the inputs into weighting is the 6-month Z-Statistic of the premium/discount as calculated by Morningstar. For example, a Z-Stat of -2.00 means that the current premium/discount is observed less than 2.25% of the time. Such a reading would indicate that the investor may want to overweight the fund until the Z-Stat returns to normal.
|Fund||Weight||Yield||Pr/Di||NAV YTD||6mo Z|
Source: Morningstar, as of August 21, 2014 close
I use 3 inverse ETFs for hedging: ProShares 3X Inverse S&P 500 (NYSEARCA:SPXU), Direxion 3X Inverse Russell 2000 (NYSEARCA:TZA) and ProShares 2X Inverse 20+ Year Treasury (NYSEARCA:TBT). More conservative investors may choose not to hedge and just hold cash. But, given the interest rate sensitivity of the portfolio due to heavy exposure to bonds, REITs and utilities, I would suggest carrying the TBT hedge as well.
Tortoise Energy Infrastructure Fund (NYSE:TYG)
This is my pick in the Energy Limited Partnership sector. My more aggressive pick in this space is Salient Midstream (NYSE:SMM), but 100% of its payout this year has been Return of Capital. The other conservative pick in this sector is Cushing Renaissance (NYSE:SZC), which pays 5.6%, but was not picked due to its lower NAV growth statistics.
Brookfield Global Listed Infrastructure Fund (NYSE:INF)
This 5.7% payer trades at a double-digit discount and offers investors global exposure to infrastructure companies like the Italian Snam and the French GDF Suez. The Fund's 3-year anniversary is next week and I plan to offer a deep dive into the Fund at that time.
Reaves Utility Income Fund (NYSEMKT:UTG)
The two other popular picks in the Utility sector are Duff & Phelps Select Income Fund (NYSE:DPG) and Cohen & Steers Infrastructure Fund (NYSE:UTF). DPG and UTF have both been rejected due to paying a growing percentage of their payouts out of Capital.
This portfolio is for investors looking for a basket of CEFs offering monthly income (8 of the 11 pay monthly dividends). The payouts are free of Return of Capital. The added benefit is these Funds also offer capital appreciation as well as a blended 5.1%. In this environment where every investor is expecting the Great Unwind of Quantitative Easing, it is important for income-oriented investors to build a portfolio that offers payouts from investment income, not financial engineering (see CFP). And, don't forget to hedge!
Disclosure: The author is long TYG, SMM, SPXU, TZA, TBT, NHF, JRI.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.