An exchange traded fund comprised of closed-end funds is another alternative for income-seeking investors.
PowerShares CEF Income Composite (PCEF) gives investors the best of both worlds-the simplicity of an ETF with the yield of a basket of CEFs. The portfolio is split into three main sections: investment-grade bond CEFs (42%), equity option income CEFs (27%), and high-yield bond CEFs (18%), with the rest of the portfolio going into unclassified CEFs, reports Steve Pikelny for Morningstar.
"PCEF mostly tracks the S-Network Composite Closed-End Fund Index, though it holds some CEFs not listed in the index. The index covers taxable investment-grade and high-yield bond CEFs as well as option income CEFs. It does not include funds trading at a premium of more than 20% or funds with expense ratios greater than 2.0%," Pikelny wrote.
The high yield of 7.72% for PCEF is a nice reward for investors seeking income, but it does come with some risks. The ETF invests in fixed-income and option-income CEFs, so it lacks broad market exposure in two places-a return of favor for the equity market would lead to capital loss and if CEFs are sold off, discounts would be large, giving way to more capital loss.
Furthermore, the ETFs creation and redemption process is an issue because most of the holdings have thin trading volume. Liquidity restrictions are also a factor, due to low trading volume.
PCEF can be a good option for investors seeking CEF diversification. The guesswork of single stock picking is alleviated and there is more liquidity in the ETF versus a single CEF.
PowerShares CEF Income Composite
Tisha Guerrero contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.