A Safe 9.3% Yield from A Leveraged Equity CEF
In my continuing quest to sort through opportunities for high-yield retirement income, I started a look at leveraged equity closed-end funds last week (Retirement Income: Equity Funds Averaging 8.75% Yield). Then I went on to show why in a comparison of the strategies (Retirement Income: Leverage Vs. Option Writing - Which To Choose?). Regardless of the results of that demonstration and my own preferences for the option-writing funds, I want to keep on digging into the leveraged funds for a bit because many of those option-writing funds look to be broadly over-valued right now. Yield-hungry buyers have been flocking to them in recent months. And well they should have, I'll add, as these funds are the place to be in the sort of market we've been seeing for the last year-and-a-half or so. This is something I've been pointing out since at least the beginning of 2015 (Getting The Defense On The Field).
In the opening article, I said I would try to expand on some of more interesting funds and began with the speculative Miller/Howard High Income Equity Fund (NYSE:HIE) (Retirement Income: Own This 11.3% Yielding CEF For 8 Years). Today I'll look at LMP Capital and Income (NYSE:SCD), a fund that is better poised to hold down a place in the core of an income portfolio.
LMP is managed by Clearbridge Investments, Legg Mason's largest equity manager. It holds a broad-based portfolio invested in a range of income-producing securities, including MLPs, US common and preferred stocks, REITs and fixed income.
Here are some key metrics:
There's a lot to like in that list, so let's look at it in detail. As I go through this, I'll discuss the fund in the context of its peer group. I will be referring to the 18 leveraged equity funds considered in this article. I noted at the time that my preference is generally for option-writing CEFs among the equity fund offerings.
Discount. The discount is the second deepest of the 18 leveraged funds in the peer group I looked at last week.
Z-scores show that the discount has given up some ground for the year but the numbers are well within an acceptable range, running less than a standard deviation from the mean values.
All but a handful of funds in the peer group have positive Z-scores, and the ones that are negative have earned that status by their performance stats. SCD's Z-scores fall in the mid- (1 yr) to low- (6 and 3 months) end of the peer group, generally below the better performing funds.
The NAV yield vs. discount plot for the peer group shows SCD in the most favorable position, well below the trend line that funds tend to revert to. That would favor a view that a current buyer will not suffer losses to deeper discounts in the near future.
Distribution. Yield is over 9%, well above the median of 7.9% for its peers. The distribution is high, but not so high as to suggest it will be impossible to maintain. Evidence for that comes from the UNII (undistributed net investment income, the stuff still in the kitty) which is also high. The UNII number is telling us that with half of the year's distributions having been made, the fund is holding another 19% of the anticipated full-year payout. For another indication of the sustainability of the 9.3% yield, note that the fund raised its quarterly distribution 10.7% for the last quarter of 2015 going from $0.28/share to $0.31. The $0.28 had held constant from third quarter 2011 when it was kicked up from $0.15/share.
Some will not like the fact that it pays quarterly rather than monthly, but I tend to find that a trivial point.
Leverage. Leverage is on the low side of the peer group, which ranges from 12.6% to 33.7%.
Summary. I consider SCD a good choice, perhaps the best choice, for a leveraged, domestic general-equity fund. It is positioned well in the category with regard to its valuation. Its portfolio is diversified among high-yield equity holdings. Leverage is modest. It's paying a hefty but not excessive distribution. And that distribution looks solid based on UNII and the 10.7% uptick from the sponsor three quarters ago.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SCD, HIE over the next 72 hours.
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.
Additional disclosure: I am not an investment professional and this article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any security mentioned here is suitable for his or her portfolio.