3 Equity Income Closed-End Funds To Consider, And 3 To Avoid

Includes: ETO, EVT, GDV, GUT, HTY, UTG
by: George Spritzer, CFA

This report covers several equity closed-end funds that seek to pay out a high level of qualified dividend income (QDI) to shareholders. Three of the recommended funds seek to own stocks with strong rising dividend levels that allow them to offer attractive yields and are currently available at attractive discounts to net asset value. These funds should benefit if the demand for dividend paying stocks continues in 2012.

I also discuss three equity income funds to avoid, primarily due to excessive valuation.

Three CEFs to Consider

1) Eaton Vance Tax Advantaged Dividend Income Fund (NYSE:EVT)

  • Total Common Assets: 1.31 Billion
  • Expense ratio= 1.20%
  • Leverage: 25.43%
  • Discount= -10.18%
  • Annual Distribution Rate (market price) = 7.99%

Portfolio Overview

Domestic stock


Foreign stock


Preferred Stock


Cash and Other


Investment Strategy: EVT uses a multi-strategy approach toward maximizing dividend returns. Its base strategy is to own stocks with high stable dividends and growth potential. The fund also tries to supplement returns by harvesting dividends in a dividend capture strategy.

Top 5 Equity Holdings

Wells Fargo (NYSE:WFC)


US Bancorp (NYSE:USB)


Conoco Phillips (NYSE:COP)


Intl Business Machines (NYSE:IBM)




2) Eaton Vance Tax Advantaged Global Dividend Opportunities (NYSE:ETO)

    • Total Common Assets: 318.4 Million
    • Leverage: 26.08%
    • Expense Ratio= 1.18%
    • Discount= -11.75%
    • Annual Distribution Rate (market price) = 7.26%

Portfolio Overview

Domestic stock


Foreign stock


Preferred Stock


Cash and Other


Investment Strategy: ETO tries to provide a high level of after-tax return. This return is expected to primarily consist of tax-advantaged dividend income and capital gains. The fund managers consider the potential effects of inflation on shareholder capital. The main difference between ETO and EVT is the extent of exposure to non-U.S. securities, with ETO having more foreign stocks.

Top 5 Equity Holdings

Aflac (NYSE:AFL)


Conoco Phillips


Phillip Morris Intl (NYSE:PM)


Wells Fargo & Co


National Grid PLC (NYSE:NGG)


3) Gabelli Dividend and Income Trust (NYSE:GDV)

  • Total Common Assets: 1.50 Billion
  • Leverage: 23.37%
  • Expense Ratio= 1.53%
  • Discount= -11.1%
  • Annual Distribution Rate (market price) = 5.96%

Investment Strategy: GDV seeks to provide a high level of total return, with an emphasis on dividends and income. Under normal market conditions, the fund invests at least 80% of the portfolio in income producing assets, with at least 50% in dividend paying equities.

In 2011, about half of the distributions were classified as return of capital (NYSE:ROC). Since GDV sells at a healthy discount to net asset value, this can benefit investors in two ways:

  1. capturing some of the discount
  2. receive tax deferred distributions

GDV has a lower earned income yield than the first two funds because it does not invest in preferred stock, has very little international exposure, and does not use dividend capture to enhance earned income.

Top 5 Equity Holdings

Verizon Communications Inc (NYSE:VZ)


Swedish Match AB (SWMA.ST)


Kraft Foods (KFT)


Coca Cola (NYSE:KO)


General Mills (NYSE:GIS)


Three CEFs to Avoid

1) Gabelli Utility Trust (NYSE:GUT)

  • Expense Ratio= 1.44%
  • Premium over NAV= 43.81%
  • Annual Distribution Rate= 7.49%
  • Leverage= 22.36%
  • Annual turnover ratio: 1%

Sometimes it is worthwhile to pay a modest premium over net asset value if you can gain access to very low cost leverage, or if a fund has very low expense ratio. But GUT certainly does not qualify according to these criteria. It has many negative features:

  • The "distribution yield" is mainly return of capital. When a fund is selling at a premium, return of capital is terrible because you only receive the net asset value. It is a form of negative alpha.
  • The 22% leverage is mainly expensive fixed preferred leverage using GUT-A with an interest cost of 5.65% plus management fees. GUT has been earning less than this leverage cost.
  • The management fee of 1.44% is on the high side, especially since the annual turnover rate of the fund is only 1%.
  • The payout yield on the NAV is about 10.8%. This is clearly unsustainable, especially because of the high leverage cost

Even the Board of Trustees of GUT "believes that the premium at which the Fund shares trade relative to net asset value is not likely to be sustainable"

2) Reaves Utility Income (NYSEMKT:UTG)

  • Expense Ratio= 1.27%
  • Premium over NAV= 7.53%
  • Annual Distribution Rate (market price) = 6.97%
  • Leverage= 24.93%
  • Annual turnover ratio: 34%

UTG is actually a pretty decent fund, but when I did the research for this article over the weekend, the premium for UTG had ballooned to over 11%. UTG has access to fairly low cost leverage averaging around 1.35%.

It corrected somewhat on Wednesday, and the premium is now +7.53%. But I still think UTG is somewhat overpriced. The main reason for the overvaluation is the price bounce caused by the Bill Gross recommendation in this year's Barron's Roundtable.

3) John Hancock Tax Advantaged Global Shareholder Yield (NYSE:HTY)

  • Expense Ratio= 1.28%
  • Premium over NAV= 10.21%
  • Annual Distribution Rate (market price) = 9.85%
  • Leverage= 0.0%
  • Annual turnover ratio: 95%

HTY is also a decent fund to buy when it is available at a discount to net asset value, but it is quite overvalued now. It is an unleveraged fund. The distribution rate is quite high, but a good portion of this is return of capital, which causes negative alpha when a fund sells at a premium over NAV.

I believe HTY became overvalued after an article appeared in the popular Daily Wealth newsletter on January 23. This newsletter is read by many investors who may be unfamiliar with closed-end funds and were attracted to the high distribution yield of HTY. Many of the new buyers were likely unaware that more than half of this yield is return of capital.

Disclosure: I am long ETO, ETY.

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