Best And Worst Equity CEFs In A Dangerous Market

by: Douglas Albo

I continue to be amazed at what investors in equity based high-yielding closed-end funds (CEFs) continue to buy and sell at the first sign of a market rally or sell-off. With the Dow Jones down 400 points one day and up 200 the next, the volatility of the markets makes for a dangerous environment, so investors really need to understand which fund's Net Asset Values (NAVs) will hold up best if we go into another market sell-off and which ones are vulnerable to further deterioration.

First, the CEFs with NAVs that will hold up best. I have no idea what investors are thinking about when they sell funds like the Nuveen Equity Premium Opportunity fund (JSN), or the Eaton Vance Tax-Managed Buy/Write Opportunity fund (NYSE:ETV) or the Eaton Vance Tax-Managed Buy/Write Income fund (NYSE:ETB) at the first sign of a market downturn. But here's a clue ... these funds actually want the market to go down right now.

The reason why funds like JSN, ETV and ETB - and throw in others like ETW, JLA and JPZ - want the market to go down right now is because they all sell between 94% and 100% index options against their large-cap equity portfolios. And so far during this options cycle, the September rotation contracts have already gone up pretty significantly in value. In other words, these fund's NAVs are even MORE defensive than usual because any major pullback in the market will offset portfolio depreciation with appreciation in their short index options. The real negative would be if the markets continue up over the next few weeks, then these funds' NAVs won't capture that upside. But for these funds' market prices to sell off more than less defensive funds when the markets look like they are about to roll over is just ridiculous. Here are the most defensive funds that I recommend. All information is as of August 31, 2011.

Nuveen Equity Premium Opportunity fund (JSN)

Market Price: $11.66
NAV Price: $12.73
Discount/Premium: -8.41%
Income Strategy: Option-income (100% option coverage)
Market Price Yield: 10.81% (quarterly pay)
NAV Price Yield: 9.9%
YTD NAV Performance: -0.22%

In addition to JSN, Nuveen's other 100% option covered CEF's are JLA and JPZ. All have had superior NAV performance YTD (all down less than 1%) and all go ex-dividend the second week of September.

Eaton Vance Tax-Managed Buy/Write Income fund (ETB)

Market Price: $12.10
NAV Price: $13.49
Discount/Premium: -10.3%
Income Strategy: Option-income (95% option coverage)
Market Price Yield: 10.71% (quarterly pay)
NAV Price Yield: 9.61%
YTD NAV Performance: -3.78

Eaton Vance Tax-Managed Buy/Write Opportunity fund (ETV)

Market Price: $11.52
NAV Price: $12.92
Discount/Premium: -10.84%
Income Strategy: Option-Income (95% option coverage)
Market Price Yield: 11.54% (quarterly pay)
NAV Price Yield: 10.29%
YTD NAV Performance: -4.06%

ETV also has a sister fund, ETW, which is global and sells a similar option coverage. For those concerned about Return of Capital (ROC), both funds had virtually NO return of capital in their June distribution with ETV at 5.2% ROC and ETW at 0% ROC. Both go ex-dividend the third week of September.

Just so that we're clear, I am not recommending funds that have had historically poor NAV performance, particularly during difficult market periods. Here is ETV's quarterly NAV total return (including dividends) since inception compared to its correlated index, the S&P 500 ETF (NYSEARCA:SPY).

Click to enlarge

I have shown time and time again that these funds' NAVs are performing much better than investors believe. So why do these funds sell off at the first sign of a market pullback? Here's a fund with a NAV that has outperformed its correlated index since inception, is much more defensive if we go back into a market sell-off, with a market price at a -10.84% discount to its NAV and offers a sustainable 11.54% market price yield. It is ludicrous that investors would sell this and other defensive funds first when there are so many other equity CEFs that are much more vulnerable to a market sell-off.

Let's go over a couple of those funds.

Alpine Global Dynamic Dividend fund (NYSE:AGD)

Market Price: $6.41
NAV Price: $6.01
Discount/Premium: 6.48%
Income Strategy: Dividend Harvest
Market Price Yield: 11.23% (monthly pay)
NAV Price Yield: 11.96%
YTD NAV Performance: -9.6%

I'll be honest with you. Why anyone would buy this fund other than for a trade is beyond me. Just what does a NAV crash from $19 since inception to $6 tell you about its history? Just what does a -9.6% YTD NAV performance (including dividends) tell you about its shorter term performance? That is the worst of all equity CEFs I follow. And finally, just what evidence has been shown by AGD or even its sister fund, AOD, that they are anything but amortizing their NAV while offering a high dividend yield? And if they are amortizing funds, then why would anyone pay a premium for this fund when you can buy funds at significant discounts with the same dividend yield? Frankly, I would need a much higher market price yield to own a fund with these terrible fundamentals and that would put AGD at a significant discount, in my opinion.

Eaton Vance Tax-Advantaged Global Dividend Income fund (NYSE:ETG)

Market Price: $13.87
NAV Price: $14.52
Discount/Premium: -4.48%
Income Strategy: Leveraged
Market Price Yield: 8.87% (monthly pay)
NAV Price Yield: 8.47%
YTD NAV Performance: 0.05%

First of all, I like the Eaton Vance leveraged equity CEFs ETG, EVT and ETO in a strong market environment. The problem with ETG is that we're not in that ramp up market environment anymore and ETG was just about at a premium valuation a couple days ago. Compare a premium valuation to its sister funds EVT and ETO at -9.6% and -10.6% discount levels respectively and ETG is relatively overvalued. Now ETG has had excellent NAV performance YTD but that won't matter if we go into a market sell-off again. In fact, rarely do you see the Eaton Vance leveraged funds at narrower discounts than their option-income fund counterparts. But that's the situation we are in right now.

The equity markets, as reflected by the Dow Jones Average, S&P 500 and Nasdaq, have had a nice recovery from the early August lows. However, I am concerned about the market stalling out here and and at least giving back some of its recovery gains. If that happens, then you'll want to own funds that are more defensive and are at significant discounts to their NAVs.

Disclosure: I am long ETV, ETB, ETW, EVT, JSN.

Additional disclosure: Short ETG, SPY