Equity CEFs: More Funds For A Market Rebound

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Includes: GRX, IBB, JTD, XLP, XLV
by: Douglas Albo

Summary

Almost three weeks ago, I went against conventional wisdom and implied the markets might break out to the upside. I received a lot of flack for that position.

However, this has turned out to be the case and though I feel first-quarter earnings may not live up to such lofty expectations, there are still CEFs to buy.

Based on near- and longer-term NAV performances, here are more funds I would be buying at giveaway discounts that should be trading at much higher market prices.

It seemed only yesterday that everyone was bearish and the major market averages were in for something far worse than a -10% correction. But since February 11th when the S&P 500 bottomed at 1,829, the markets have come roaring back with the S&P 500 up 13.0% since then and has even turned positive on the year.

This has surprised many market pundits and though I believe most of the low hanging fruit has already been picked as we head into first-quarter earnings, there are still some great opportunities in equity CEFs that have yet to play catch up. Because as I have said in many articles, including my last one from March 14th, Equity CEFs: Funds For A Market Breakout, CEFs have a way of lagging the market moves but once they get going, they can easily overshoot to the upside or downside, depending on the broader market direction.

One fund that I have owned for a very long time and have been adding to recently is the Nuveen Tax-Advantaged Dividend Growth Fund (NYSE:JTD), $13.58 market price, $15.58 NAV, -12.8% discount, 9.1% current market yield. JTD is a mostly US equity fund whose portfolio is currently about 75% large-cap, dividend-oriented stocks and 25% preferred fixed income securities.

With about 30% leverage, you can get a lot of NAV and market price upside potential when the market is in a rally mode and JTD has historically been very good at taking advantage of these rallies. However, like its sister fund, the Nuveen Tax-Advantaged Total Return Strategy Fund (NYSE:JTA), which I highlighted in my last article here , JTD's market price discount has been on a steady downward slope for the past year plus as shown in this one-year Premium/Discount graph.

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This is highly unfair in my opinion as JTD's NAV total return performance is up 1.4% YTD and better than many equity CEFs that trade at much narrower discounts to even premiums with negative NAV performance YTD. For example, compared to similarly leveraged stock/preferred CEFs like EVT, ETO and ETG from Eaton Vance, JTD is outperforming them all but yet is at a wider -12.8% discount.

For a snapshot of JTD's top holdings, sectors and asset allocation, go to this link, JTD Holdings and Detail. And finally, buying leveraged CEFs at wide discounts during a market breakout can be a win-win for investors as not only can you pick up assets at cents on the dollar with greater upside potential, more importantly you receive a windfall 9.1% current market yield, well above what the fund is responsible for paying with a 7.9% NAV yield.

Though Nuveen slightly lowered JTD's distribution to $0.31/share this last quarter, I much prefer fund managers who are proactive in balancing distributions with a fund's income as opposed to continuing to overpay distributions and seeing NAV deterioration.

You really don't want to know how many CEFs overpay their distributions and yet trade at much higher valuations than say a JTD because of unsustainably high yields. However, in the long run, those funds end up with much worse total return NAV and market price performances despite their higher valuations.

For The Umpteenth Time, Buy GRX

If you want to know what insanity looks like and how completely clueless most CEF investors are, imagine the BEST diversified equity CEF since its inception trading at a multi-year wide -15.1% discount.

The Gabelli Healthcare & WellnessRX Trust (NYSE:GRX), $9.98 market price, $11.76 NAV, -15.1% discount, 5.2% current market yield, has been so dominant on its NAV performance you wonder how investors don't look past its more modest yield and focus more on its total return performance both at NAV and market price. Because if they did, they would realize what they have been missing.

I first mentioned GRX back in early February of 2012 in this article, Gabelli Equity CEFs: Leveraged Funds For A Bull Market, when GRX didn't even have a regular distribution and was stuck in discount purgatory. I even said...

If Gabelli could establish a more even distribution schedule, say quarterly, then I believe GRX would reduce its discount significantly.

Well, so much for that theory. But forgive me for recommending a fund that is up over 100% on its market price since I wrote that article and I have continued to endorse it many times since. Why was I such a strong believer in the fund? Because despite having healthcare in its name, GRX is actually a much more diversified fund than other healthcare CEFs and ETFs with 50% of its leveraged stock portfolio in healthcare/biotechnology stocks and the other 50% in more defensive consumer staple stocks (this is where much of the Wellness and foods portion of the portfolio comes in).

What this means is that GRX is a fund you can take a large position in since not only is the fund more diversified than most healthcare related funds but the fund also is more modestly leveraged at 22% than most other leveraged CEFs. To me, this was a perfect combination to overweight the fund and the following performance comparisons bear that out.

Here are the top equity CEFs I follow sorted by their total return NAV performance since the end of 2011, or roughly a month before I first wrote about GRX. Here you can see which funds have had the best NAV and market price performances since the beginning of 2012. NOTE: I like to use 2012 as a starting point for the current up market cycle since 2011 was a relatively flat year for the markets.

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What I would like for you to notice is that the top CEF NAV total return performances since 2012 are still from healthcare related equity CEFs (first two data columns) with GRX in the 4th position. But then look at how strong GRX's NAV performance has been YTD (next two data columns) compared to the most popular healthcare related CEFs HQH, HQL and BME.. Note: All data is through April 4, 2016.

So even though healthcare CEFs and indeed, healthcare/biotech ETFs, have had a very difficult past year with biotechnology still in a bear market, down -20.0% YTD, as represented by the widely followed iShares NASDAQ biotechnology ETF (NASDAQ:IBB), you wouldn't know it by looking at GRX with an NAV actually up 0.85% YTD. Even the most popular mainstream healthcare sector ETF, XLV, is still down -3.4% YTD including a March dividend.

And I could go back even further to GRX's inception as a spin-off not long before the financial crisis of 2008 to show how GRX's NAV has outperformed all of its benchmark indices (see table below). Then realize this Average Annual Return comparison only goes through December 31, 2015, which means that GRX's NAV has outperformed the healthcare index by even more today.

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Certainly it helps that the consumer staple index ETF (NYSEARCA:XLP) is at an all-time high but isn't that what you want to see from your investments? Or am I to believe that a fund like GRX should be penalized because of its exposure to the healthcare/biotechnology sector, which has been among the weakest over the past year? Or is GRX to be penalized for its exposure to consumer staples, which is at an all-time high and may be overbought?

Would someone please tell me which one it is because I am confused. I always thought outperforming funds should trade at higher valuations, not lower. Now I realize CEF investors like to own funds with big yields but understand total return means all distributions are added back so yield should really be a secondary consideration compared to total return.

Any yet this is how investors have treated GRX's market price, driving it down to a wider and wider discount, as shown in this three-year Premium/Discount chart.

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It is almost beyond belief how CEF investors value these funds. I have often compared GRX with the PIMCO Global StocksPLUS & Income Fund (NYSE:PGP) just to emphasize the valuation differences between the two funds, even though the two funds have little in common other than both using leverage. So while GRX's discount has actually widened over the past few years, PGP's has recently ballooned back up to as high as a 100% market price premium, the highest of all CEFs.

And how would you have done if you had owned these two funds over the past several years? Well if you go back to the table above, you can see that even with this incredible widening disparity of market price valuations, GRX's total return market price performance is still over twice that of PGP's, 107.8% vs. 50.7%, since 2012.

Conclusion

If you want proof that most CEF investors have no insight as to which funds will perform best in the future, all you have to do is look at a fund like GRX which has traded at a double digit discount virtually its entire existence even though it still has been one of the best performing CEFs at both market price and NAV.

So if CEF investors knew that GRX or really any widely discounted CEF would go on to become one of the top performing funds at NAV, wouldn't they have narrowed the discount by now? Of course they would have because selling in the fund would have been dramatically curtailed.

Any new reader is welcome to go back over my articles since early 2011 and see how my recommendations have performed compared to the funds that I have panned. I even wrote two articles, My Article Performances From 2011 and My Article Performances From 2012, to document it. I think you'll find, even today, my success rate is around 95%.

Disclosure: I am/we are long JTD, GRX, HQH, XLV, XLP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.