In another article published today, I describe two ways of capturing “alpha” using closed-end funds:
1) Discount Capture
2) Dividend Yield Enhancement
Discount capture is primarily used by active swing traders with a shorter term horizon. With dividend yield enhancement, you are not depending on a change in the discount to net asset value, so this method for capturing “alpha” is useful for buy and hold investors with a longer term trading horizon.
Suppose you own a closed-end fund which distributes 10% of net asset value each year and sells at a 20% discount. Assume a net asset value of $100 and a market price of $80. The $10 annual distribution is 12.5% of market price, so you are earning an extra 2.5% in dividend yield enhancement because of the discount.
Right now, the covered call equity closed-end funds look attractive as a way of capturing both kinds of “alpha”, since the discounts are abnormally wide, and the annual distributions are high.
I have compiled a list of six covered call equity funds where the sum of the discount and annual distribution rate exceeds 25%. Some of these funds benefit from over 200 basis points of dividend yield enhancement. I believe that these coverd call funds have been driven down by tax loss selling and may be due for a nice bounce in January.
I've computed an “adjusted expense ratio” for each fund, which is the expense ratio minus the dividend yield enhancement alpha. All of these covered call funds have a negative adjusted expense ratio.
If these funds were structured as open-end mutual funds, they would sell at NAV and you would have to pay a management fee. But because of the closed-end fund discounts and high distribution payouts, you are essentially getting paid to own them even if the discounts do not narrow.
1- Blackrock Intl. Growth and Income (BGY)
Expense ratio= 1.13%
Annual Distribution Rate (NAV) = 16.79%
Annual Distribution Rate (market price) = 18.99%
Dividend Yield Enhancement alpha= +2.20%
Adjusted Expense Ratio= -1.07%
2- Eaton Vance Tax Managed Global Fund (EXG)
Expense Ratio= 1.05%
Annual Distribution Rate (NAV) = 11.48%
Annual Distribution Rate (market price) = 13.78%
Dividend Yield Enhancement alpha= 2.30%
Adjusted Expense Ratio= -1.25%
3-Eaton Vance Tax Advantaged Dividend Equity Income (ETY)
Expense Ratio= 1.07%
Annual Distribution Rate (NAV) = 10.95%
Annual Distribution Rate (market price) = 13.06%
Dividend Yield Enhancement= 2.11%
Adjusted Expense Ratio= -1.04%
4-Eaton Vance Risk-Managed Diversified Equity Income (ETJ)
Expense Ratio= 1.07%
Annual Distribution Rate (NAV) = 10.11%
Annual Distribution Rate (market price) = 12.23%
Dividend Yield Enhancement alpha= 2.12%
Adjusted Expense Ratio= -1.05%
5-Blackrock Global Opportunities (BOE)
Expense Ratio= 1.10%
Annual Distribution Rate (NAV) = 14.97%
Annual Distribution Rate (market price) = 17.22%
Dividend Yield Enhancement alpha= 2.25%
Adjusted Expense Ratio= -1.15%
6-Eaton Vance Tax-Managed Global Buy-Write Opportunities (ETW)
Expense Ratio= 1.09%
Annual Distribution Rate (NAV) = 9.90%
Annual Distribution Rate (market price) = 11.77%
Dividend Yield Enhancement alpha= 1.87%
Adjusted Expense Ratio= -0.78%