Defensive Equity CEFs At 12% Discounts And 12% Yields

Includes: ETB, ETV, ETW
by: Douglas Albo

I will continue to stress to investors that the best equity closed-end funds (CEFs) for holding NAV value in a down market environment also happen to be some of the funds at the largest discounts among CEFs. Though no fund will escape unscathed in a bear market, option-income funds' NAVs can at least hold up much better than other CEF income strategies and even the broader market ... especially the funds with the largest option-coverages. Here is why these funds make a lot of sense to own even in a difficult market.

  • CEFs at 12% discounts means that their correlated indexes (typically the S&P 500 and/or Nasdaq 100) could drop ANOTHER 13% to 15% before their NAVs would be at par with their current market prices.
  • These funds' five-year average discounts are in the mid single digits making their current 12% discounts excessively wide considering their defensive positioning.
  • Heavily discounted market prices mean windfall dividend yields of 11% to 12% which are sustainable due to their lower NAV yields. These funds receive option premium well in excess of their dividend distributions.
  • CEFs that sell from 90% to 100% option coverage on their portfolios will see much less NAV deterioration than other funds in a down market. Most option-income funds sell only around 50% coverage, which is still more defensive than CEFs that use leverage for their income strategy.
  • On a longer term basis, these funds' NAVs have significantly outperformed the S&P 500 since their inceptions, particularly during the most difficult market periods in 2008 and 2009.

The following funds I would recommend to investors for purchase with the expectation to add to positions if they go to wider discounts. In other words, don't buy all at once. I would also recommend that investors hedge up to one-third of their long positions by shorting any of the major market indices such as the S&P 500 (ticker SPY) or the Nasdaq 100 (ticker ]]QQQ]]). Note: The S&P 500 goes ex-dividend the third week of September and I would wait until after the ex-dividend date or short into market strength. This strategy is no different than what I have used since 2006 which has far outperformed the broader market indices though you have to be disciplined and you have to be patient.* The good news is that you get paid 11% to 12% yields while you wait.

Eaton Vance Tax-Managed Buy/Write Opportunities fund (NYSE:ETV): $11.24 market price, $12.82 NAV. Currently trading at a -12.3% discount, ETV sells 95% option-coverage on its large-cap domestic portfolio, making it very defensive. For the month of September, ETV's NAV is down only 0.77% compared to its correlated indices, the S&P 500 down 4.5% and the NASDAQ down 3.3%. The risk/reward on ETV is higher than any other equity CEF I follow in a difficult market. Offers a current market price yield of 11.8% and goes ex-dividend the third week of September.

Eaton Vance Tax-Managed Global Buy/Write Opportunities fund (NYSE:ETW): $10.25 market price, $11.66 NAV. ETV's sister fund, ETW also offers a high option coverage of 95% and a high current market price yield of 11.8% at a -12.1% discount. ETW is a global fund and thus its NAV performance has not been as strong as ETV's so far this year, but it has still outperformed its correlated market indices which are a combination of domestic and International indexes. Also goes ex-dividend the third week of September.

Note: Both ETV and ETW are quarterly pay funds that included virtually no Return of Capital (ROC) in their June distributions with ETV at 5% ROC and ETW at 0% ROC. Though high ROC in option-income fund's distributions should not necessarily be taken as a negative, and in fact, many fund managers actually look to maximize ROC for tax purposes, many investors consider it a red flag so that is why I point this out.

Eaton Vance Tax-Managed Global Buy/Write Opportunities fund (NYSE:ETB): $11.76 market price, $13.36 NAV. Another purely domestic large-cap stock fund that sells 95% option coverage on its portfolio. ETB has historically been one of the darlings of the Eaton Vance option income funds and was as high as a 15% premium just a year or so ago. Now you can buy ETB at a -12% discount and an 11% yield. For September, ETB's NAV is down only 0.96% compared to its correlated market index, the S&P 500, which is down 4.5%. ETB has one of the best NAV performances since inception and I would challenge any reader or contributor to give me an equity CEF that has performed better since its inception in April 2005. Goes ex-dividend the third week of October.

In a difficult market environment in which defensive funds should be in high demand, these funds are at giveaway discounts compared to many other equity CEFs. Most other high yielding equity CEFs, whether they use an options strategy, a leveraged strategy or a dividend harvest strategy, have significantly greater downside NAV exposure than these 3 funds and many are at close to par to even premiums. That makes no sense, particularly since some will even need to cut their dividends within the next year, in my opinion. Eaton Vance has already rebalanced its option-income fund distributions after two dividend cuts so I don't believe there is any risk of any more adjustments for the foreseeable future.

Option-income funds actually like this volatile up and down market environment in which option premium increases and their income strategy is optimized, i.e. their sold option contracts are more likely to expire worthless. In contrast, their NAVs don't perform as well in strong bull or ramp-up markets which then favors the leveraged strategy funds. If risk-oriented funds can outperform during strong up markets then it should make sense that defensive funds should be outperforming during down market periods. Their NAVs certainly are and so should their market prices.

* Past performance should not be assumed to be indicative of future results.

Disclosure: I am long ETV, ETB, ETW.