Assessing Closed-end Call Writing Funds (CEF: MCN)

Roger Nusbaum submits: There is an article in Barron's about closed end call writing funds [summarized here]. The article was negative. As a group, the funds have not done well but are doing a little better lately. The conclusion that is made in the article about these funds being a bad way to go may turn out to be right or wrong. I have written about these funds a lot in the past and I believe in the concept.

However, at every step along the way I have disclosed that these only make up 5%-10% of the fixed income portion of my client accounts. The means a client with 60% equities and 40% bonds would, at most, have 4% of his total portfolio in one of these.

If the fund I use, Madison Claymore (MCN), which luckily for me has done relatively well, should somehow cut in half, I would look dumb which is a lot better than if I had financially damaged someone by owning too much in the hunt for yield.

MCN 1-yr chart:

Comments

[Internet2k4]

If the concern is that the CEF unsustainably cannibalizes its NAV in covering calls, that doesn't seem to be happening with MCN - according to ETF Connect the July 04 inception NAV was $14.30 and today it's $14.75 - and the other CEFs in the table are a mixed bag in sustaining or growing the IPO NAV. What has disappeared in all of them is the IPO price premium to NAV, as the Barrons article observes.

[Chamois16]

I believe the assumption about mandatory erosion of NAV is wrong. Call options are written on only a percentage of portfolio assets (usually 35-60%) and not all are exercised. While NAV growth in rising markets is truncated by the strategy, it is not eliminated.

OEF had a problem with this strategy, because it was not professionally done using institutionally-traded OTC options, which have higher premiums. I think the better CEF in this category, which also use puts to alleviate downside risk, are showing, at least to date, to be a different breed of product. We won't know for sure until yearend when distributions are recharacterized.

[leojbourne]

Writing covered calls on stable stocks can generate nearly 1% per month if calls are sold at relative high points on a chart. While it is true that upside potential is curtailed, buy-and-hold investors in large cap stocks shouldn't care. If a stock is called away, there may be capital gains, but that same stock can be repurchased later with the proceeds on a dip. With low beta stocks, writing covered calls is essentially underwriting the speculation of others. I don't see how the passthrough of covered call premiums to CEF shareholders reduces the NAV, since NAV is based on stock holdings and proceeds of sales. Writing in-the-money (ITM) covered calls could indeed reduce NAV, but this would be a poor strategy, since in a rising market there is greater return on slightly out-of-the-money (OTM) calls. In a falling market, writing ITM calls will not stop erosion of NAV in terms of holdings, but will offset it through distribution of cash from premiums. So the strategy seems ok to me. However, since several others have commented on NAV erosion from CEF covered call writing, I must be missing something.