Closed end funds (CEFs) are some of the most unique and misunderstood investment vehicles in the markets. Built within these funds are characteristics that make them difficult to understand, yet advantageous enough to be classified as an outstanding assets within an income portfolio. For 2011 investors had to suffer through a tumultuous year with many ups and downs in the market. The volatility of these markets also took their toll on the CEF world. Income investors held tight as the markets swooned and rebounded time and time again. In the end there were a number of great CEFs that not only held their ground, but also made money in the process for those willing to hold them through 2011. Listed below are some the best funds for 2011 that income investors should closely examine to see if they might be right for one’s portfolio as we move into 2012.
Reaves Utility Income Fund (UTG)
UTG is one of those funds that you wish you were able to clone. The investment objective of the Fund is to provide a high level of after-tax total return consisting primarily of tax-advantaged dividend income and capital appreciation. It intends to invest at least 80% of its total assets in dividend-paying common and preferred stocks and debt instruments of companies within the utility industry. Up to 20% of the Fund may be invested in the securities of other industries.
The fund pays a monthly dividend that computes to an annual yield of 6%. But what had investors excited was that at the end of 2011 the Fund also declared a special distribution of $0.332 per share. The special distribution was being paid in addition to the Fund’s regular monthly dividend. Of the $0.332 per share $0.287 represents short-term capital gain and $0.045 represents long-term capital gain. For calendar 2011 the total of distributions per share was $1.812 or a 7% yield.
The fund does come with its share of risks though. Currently the fund has a rather high leverage rate and a lofty expense ratio and management fees. The fund also sells at a premium to net asset value, so anyone new buying in should make sure to consider this before the purchase. Despite all of this, the fund has been a true winner for income investors, and should continue to do well in 2012.
Nuveen Municipal Value Fund (NUV)
Moving away from the utility sector, we find one CEF that had a great year for income investors. That investment is Nuveen Municipal Value Fund, and it has been a dream for income investor looking for that tax free distribution. While the market remained a volatile place in 2011, NUV has provided some nice price appreciation with great tax free distributions. This CEF 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.
For 2011 the CEF started with a price of $9.19 and ended the year with a closing price of $9.80. That makes for a return of 6.6% before any distributions are calculated into the mix. NUV paid a distribution rate $0.53 per share, so its 2011 yield was 5.7%. Make sure to take into account that this distribution should be free from federal income tax, so when comparing it to other taxable investments it becomes very impressive.
Finally, let it be understood that there are many other municipal CEF that pay much higher yields that were not addressed here. The reason NUV was selected was that unlike these higher yielding CEFs, NUV is not a leveraged fund. Leverage typically magnifies the total return of a fund's portfolio, whether that return is positive or negative. Therefore NUV should be much less volatile if and when interest rates begin to rise.
John Hancock Tax Advantaged Dividend Income Fund (HTD)
Moving on to a different type of CEF, we come across the John Hancock Tax Advantaged Dividend Income Fund. This closed-ended equity mutual fund was launched by John Hancock Funds, LLC. It is co-managed by John Hancock Advisers, LLC, John Hancock Asset Management, and Analytic Investors, Inc. The fund invests in public equity markets of the United States. It seeks to invest in the stocks of companies operating across the diversified sectors. The fund also invests in preferred stocks and employs options strategies to generate income. The fund benchmarks the performance of its portfolio against the Merrill Lynch Preferred Stock DRD Eligible Index. John Hancock Tax Advantaged Dividend Income Fund was formed on February 27, 2004 and is domiciled in the United States.
For 2011, any income investor that was holding this CEF had a great year. The CEF started the year at a price of $15.05 and ending the year with a price of $17.34. That makes for a 15.22% return on the share price alone. The fund generated $1.14 per share, which means that it yielded 7.57% based upon the beginning price in 2011.
Currently the fund has a rather high leverage rate that is well over 30%. As mentioned before, the high amount of leverage can quickly turn against the fund, but so far management has done rather well at managing that risk. The fund also now sells at a discount to NAV of about 6.4% which will be attractive to any new investors. HTD did very well in 2011, and looks to continue its good fortune in 2012 with a bit of luck.
John Hancock Preferred Income Fund II (HPF)
Staying in the same family, but with a different investment philosophy, we turn to the John Hancock Preferred Income Fund II. This investment is a closed-ended equity mutual fund launched by John Hancock Funds, LLC. It is co-managed by John Hancock Advisers, LLC and John Hancock Asset Management. The fund invests in public equity markets of the United States. It seeks to invest in the stocks of companies operating across many diversified sectors. The fund invests in the preferred stocks and other preferred securities, including convertible preferred securities or other fixed income securities rated investment grade or higher by Moody or S&P. It benchmarks the performance of its portfolio against the Merrill Lynch Preferred Stock Hybrid Securities Index and Lehman Brothers US Aggregate Bond Index. John Hancock Preferred Income Fund II was formed on November 29, 2002 and is domiciled in the United States.
From the beginning to the end of 2011 the fund has appreciated just over 12% in price. In addition to that the fund generated over $1.62 cash distributions per share for the year. That calculates to an 8.7% yield if one would have picked up this great fund at the beginning of the year. The fund is leveraged like the above, but its rate is rather high at over 35%. The good news is that the fund sells rather close to its net asset value, and at the time of this writing is at a 2.8% premium. There is no denying that this fund has been a winner for income investors. If interest rates remain at historic lows, then HPF should have another good year into 2012.
Kayne Anderson Energy Development (KED)
Moving on to yet another sector, we find another CEF that has done rather well in 2011. When reviewing the list of commodity/energy related CEFs, it is easy to find examples with great distribution yields. It gets much tougher trying to find examples that had any price appreciation during 2011. KED is one prime example of a CEF that did just that.
Kayne Anderson Energy Development Company is a principal investment firm specializing in energy investments. The firm prefers to invest in midstream energy companies. It seeks to invest between $10 million and $75 million, and typically invests in non-traded companies through equity and debt instruments. That being the case, this philosophy is what carries over to their CEF. KED invests principally in debt and equity securities of privately-held energy-related master limited partnerships (MLPs), publicly-traded MLPs, and other energy companies. Energy-related MLPs own domestic infrastructure assets that are used in the gathering, processing, transportation, storage, refining and distribution of energy-related commodities. KED's objective is to generate both current income and capital appreciation for its shareholders.
From the beginning to the end of 2011 the fund has appreciated 15.96% in price. In addition to that, the fund generated over $1.37 cash distributions per share for the year. That calculates to a 7.42% yield if one would have picked up KED at the beginning of 2011. The fund is leveraged and current reports have that number at about 21%. Currently the fund sells at a small discount of 3.6% when compared to its net asset value. The only issue is that their annual expense ratios are rather high, but that did not seem to have had any adverse affects upon their performance in 2011. Once again this fund was a winner for income investors in 2011. Odds are that KED should continue to perform in 2012 as long as the current investing environment does not take any dramatic turn.
Cohen & Steers Reit and Preferred Income Fund (RNP)
Still keeping in the diversification mode, we find RNP. RNP is a closed-ended balanced mutual fund that was launched by Cohen & Steers Inc. The fund invests in the public equity and fixed income markets of the United States. It seeks to invest in the stocks of companies operating in the real estate sector, including real estate investment trusts. For its equity portfolio, the CEF employs a fundamental analysis to create its portfolio with a focus on growth potential, earnings estimates, and the quality of management. For its fixed income portfolio, the fund typically invests in debt and preferred securities of companies operating across diversified sectors. It employs a fundamental analysis to create its fixed income portfolio with a focus on the issuer’s creditworthiness, corporate and capital structure, placement of the preferred or debt securities within that structure, momentum and other exogenous signals, and relative value versus other income security classes.
From the beginning to the end of 2011 the fund has decreased 1.74% in price. Actually that is not so bad considering how well the real estate markets behaved in 2011. The good news is that the fund generated over $1.20 cash distributions per share for the year. That calculates to an 8.3% yield if one would have picked up RNP at the beginning of 2011. The fund is leveraged and currently that number is over 30%. The fund sells at discount of 4.6% when compared to its net asset value, so that should make new investors happy. The annual expense ratios come in at 1.87%, so they fall in line with the average. This is our first fund presented here that did not have any price appreciation in 2011, but the yield distribution more than made up for it. In 2012 RNP should remain about the same as long as interest rates are still held in check and market volatility does not return in any meaningful way to bring the whole sector down.
Kayne Anderson MLP Investment (KYN)
Our last, but not least, CEF that had a good 2011 was 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. Energy-related MLPs own domestic infrastructure assets that are used in the gathering, processing, transportation, storage, refining and distribution of energy-related commodities.
Some advantages for KYN are that for tax purposes they issue a Form 1099, as opposed to the K-1s that are usually issued by MLPs. Another plus is that an investment in KYN provides the investor with access to private investment opportunities which are usually not available to retail investors.
From the beginning to the end of 2011 the fund had a very modest increase of less than 1% in price. When compared to the vast universe of CEF’s, that return is actually pretty good. KYN’s good news was that for 2011 the fund distributed $1.99 in distributions per share. If you were lucky enough to buy at the beginning of the year for the price of $30.15, then your yield would have been a cool 6.6%.
The fund, like most, is also leveraged well above the 30% mark. The fund sells at a premium of 5.8%, which is actually pretty good. Some points during the year, one will find KYN well into the double digits for premium, so anything under that is an interesting turn of events. The annual expense ratios are rather high, but that is the price that one pays while investing in the CEF world. In summary, KYN has always been one of the great funds, and for 2012 it should continue to be a success.
In conclusion, there are many great CEFs that did very well in 2011. In the list above I tried to provide a diverse population of CEFs, and not just focus on one sector or type that did well overall for the 2011 calendar year. Needless to say, CEFs are not for every investor and one needs to take the time to pick the right one for their portfolio. If done correctly, CEFs can make wonderful additions to any income investor’s holdings and add that extra boost in cash flow.