Income investors, in search of yield, are faced with an overwhelming amount of choices in today's markets. One can invest in such a wide variety of financial products that often times certain investments can be overlooked in the avalanche of choices. One such investment vehicle that is often overlooked is the closed end funds (CEFs). There is such a wide variety of these funds that trying to analyze them all would be nearly impossible. Picking the 7 best closed end funds (CEFs) for an income investor is no easy task either but there are some very interesting ones to look at. Income investors can greatly vary in their disciplines and goals, but the common thread is that they are always looking for that competitive, sustainable yield with some type of protection for the initial amount invested. That being the case, below are some great CEFs that might fit the bill but before we hit the list we should focus on some unique CEF elements that one must need to know.
Net Asset Value (NAV)
One characteristic that CEFs have is that their share price is based upon demand. That being the case, one can find the shares can trade well above or below the net asset value of the holdings that make up the fund. It is an unique dynamic for CEFs and one characteristic that must be analyzed before one commits to buying in. Often times CEFs are actively managed, meaning that they can and will be employing all kinds of strategies and unique investing practices. Needless to say that means that holdings are often unknown to the investing public at all times. Therefore there exists the possibility that they will trade in a wide range in regards to the NAV. Income investors will need to determine how the price relates to the NAV before they purchase.
Payouts and Return of Capital (ROC)
Yield is the name of the game for income investors, but the real question is how the yield is derived. When it comes to CEFs an investor wants to make sure that the source of the yield is derived from ordinary income or capital gains as that suggests management is successfully running the fund. Often times management will report that the yields are derived from a return of capital (ROC), which tends to scare some investors. This would be concerning, as the problem could be that the fund is not generating enough to cover distributions so they are dipping into the investment capital. But is this really the case all the time though? The answer is no in that sometimes ROC is not bad. Often time one will find that the CEF is generating its yield via complex option strategies or capital gains. It might take some time for these strategies to come to fruition, so in the meantime the CEF will distribute ROC to keep a consistent revenue stream going for investors. So basically if the CEF is listing a ROC as its source of yield, an income investor should be concerned but further research is necessary to determine if the yield is in jeopardy.
Many CEFs love to juice their yields to shareholders. To accomplish this they will issue preferred shares or even borrow more money and take on debt. This practice is nothing new and if done correctly can make a competitive income stream even more so. On the other hand, if too much leverage is taken on it can expose the fund and its share price to risk. Changes in the interest rates and market conditions will make highly leveraged funds even more volatile. So when income investors complete their due diligence, they need to make sure that the CEF in question has the right amount of leverage in place to fit their risk tolerance and income needs.
Finally comes the management fees. These are the fees that the companies will charge for their expenses to operate the funds. Funds that are actively managed, or highly leveraged, will often times incur high management fees while more passive ones might be lower. Also the term "Management Fees" often time will mean different things to different individuals. Some companies will contend that the fees are only the direct cost for the management and will leave out such items as interest expense. Either way, these fees and expenses will eat into the returns for the funds so it will pay to make sure that the fees are not too high compared with the industry.
So that is enough of the basics, let’s take a look at 7 great CEFs for consideration.
Nuveen Municipal Value Fund (NUV)
NUV is one of my favorite CEFs for this current environment. As long as interest rates are held in check and the world is running to the US dollar then NUV is a nice choice. While the market has remained a volatile place since the late summer, NUV has provided some nice price appreciation with great tax free distributions. Not being leveraged is also a plus. NUV is a closed-ended fixed income mutual fund that invests in the fixed income markets of the United States. The fund also invests some portion of its portfolio in derivative instruments. It invests in undervalued municipal securities and other related income investments, exempt from regular federal income taxes that are rated Baa or BBB or better. It employs fundamental analysis with bottom-up stock picking approach to create its portfolio. The fund benchmarks the performance of its portfolio against the Standard & Poor’s National Municipal Bond Index. Nuveen Municipal Value Fund, Inc. was formed on April 8, 1987 and is domiciled in the United States.
Gabelli Global Gold, Natural Resources and Income Trust (GGN)
Another one of my favorite CEFs is the Gabelli Global Gold, Natural Resources and Income Trust. This is a closed-ended equity fund launched by GAMCO Investors, Inc. and managed by Gabelli Funds, LLC. The fund is not an investment in gold or natural resources as the name might suggest. It is a CEF that happens to be using gold, silver, and natural resource related stocks to derive income off the selling of covered calls and any dividends. The fund makes investments in equity securities of firms operating in gold and natural resources industries including companies in exploration, mining, fabrication, processing, distribution or trading of gold, financing, managing, controlling or operating of companies engaged in gold-related activities. It also invests in companies principally engaged in the exploration, production or distribution of natural resources, such as gas, oil, paper, food and agriculture, forestry products, metals and minerals as well as related transportation companies and equipment manufacturers. When looking at this fund investors are immediately concerned with the ROC issues that are reported. Since the fund does use a covered call income strategy and probably has some capital gains, it is very easy to see how the fund can be using ROC to make a more consistent distribution throughout the year.
The BlackRock Energy and Resources Trust (BGR)
BGR is another popular choice for those income investors looking to capitalize on energy. BGR is a closed-end equity fund that has been around some time as it opened its doors in December 2004. The investment objective of the fund is providing total return through a combination of current income and capital appreciation. The trust will invest at least 80% of its total assets in the equity securities of energy and natural resources companies and equity derivatives with exposure to the energy and natural resources industry. Companies in the energy and natural resources industry include those involved in the exploration, production or distribution of energy or natural resources, such as gas, oil, metals and minerals as well as related transportation companies and equipment manufacturers.
MFS Intermediate Income Trust (MIN)
MIN is an interesting choice for investor in this strange economic climate. The fund invests in the public fixed income markets across the globe. MFS Intermediate Income Trust invests in the securities of companies operating across diversified sectors. The fund primarily invests in short and intermediate-term U.S. Government and foreign sovereign and high-grade securities. It benchmarks the performance of its portfolio against the Barclays Capital Intermediate U.S. Government Bond Index and Intermediate Income Trust Blended Index which is a blended index comprising of 75% Barclays Capital Intermediate U.S. Government Bond Index and 25% of the JPMorgan Global Government Bond Index U.S. The credit quality of the bonds held was decent at 62% of them were rate A or higher. Obviously a move up in interest rates will not bode well for MIN, but currently that does not look like a major threat. The fund, as the name might suggest, will hold bonds that are short to intermediate in maturity dates so that might offer a little protection.
Eaton Vance Tax-Advantaged Global Dividend Income Fund (ETG)
ETG is one of the largest and most popular CEFs in the business and trades on the New York Stock Exchange (NYSE). The Fund’s objective is to provide a high level of after-tax total return, which consists mostly of tax-favored dividend income and capital appreciation. ETG is invested primarily in securities that generated a relatively high level of qualified dividend income, as well as preferred stocks. This CEF operates on a worldwide scale but over half of the holdings are US based. To get the yield to an attractive level, the fund does employ a good deal of leverage but their track record seems to show that they can manage it effectively.
Kayne Anderson MLP Investment Company (KYN)
For a change of pace one would certainly want to look at KYN. KYN is a closed-end fund that invests principally in equity securities of energy-related master limited partnerships (MLPs). KYN's objective is to obtain high after tax total returns for its shareholders. MLPs are publicly traded limited partnerships. Energy-related MLPs own domestic infrastructure assets that are used in the gathering, processing, transportation, storage, refining and distribution of energy-related commodities. One great benefit for KYN is that for tax purposes the distributions are reported on the standard 1099 instead of having to deal with all the K-1s and the special reporting that goes along with them. The downside for KYN is that like other funds it is highly leveraged and at times can trade at a steep premium to NAV.
Alpine Global Premier Properties Fund (AWP)
Our last CEF runs counter intuitive to what the current financial environment is telling investors are working. This CEF will pursue its investment objectives by investing at least 80% of its assets in the equity and, to a lesser extent, debt securities of domestic and foreign issuers, which are principally engaged in the real estate industry or real estate financing or which control significant real estate assets. Under normal circumstances, the Fund expects to invest in the securities of issuers in 10 to 30 countries. Global properties and the related sectors are so out of favor right now that prices for anything related have been beaten down. This CEF is no exception. Fact is that the share price for the CEF is even lower than the NAV by quite a bit. The simple truth is that no one wants exposure to this sector so the CEF will bounce along the bottom. For an income investor this might be appealing as the yield is very competitive and it seems the risks might be limited at this time.
In conclusion, there are many more CEFs that might fit into an income investor’s portfolio. Above is just a brief mention of some of the ones that could make the grade. As always, make sure to do your own analysis to determine that any of these might fit into your portfolio based upon needs and risk tolerance.