I was researching closed-end buy-write funds with a view towards recommending them for income portfolios. On the surface, those seemed like nice assets, because:
- They were yielding from 8% to over 10%, with the yield supposedly coming from the buy-write strategy;
- They were trading at significant discounts to NAV (net asset value), of up to 15%.
However, my research led me in a way I was not expecting at the start. Basically, the yields are misleading.
Why are the yields on these funds misleading?
It is rather simple. Because a good part of the yield is not coming from investment gains (is not coming from the buy-write strategy). Instead, it's coming from a distribution of capital.
Let us take for instance the Eaton Vance Tax-Managed BuyWrite Income Fund (ETB). This fund makes quarterly distributions, which have been steady at $0.324 for a while. It would thus seem that the yield on this fund is close to 9.8% per year ($13.25 market price, $1.296 yearly distribution). However, this is highly misleading, because the income the fund is generating is not even close to the $0.324 distribution, indeed, it has been closer to $0.045 per quarter, as per the latest PR describing the April distribution. Below I reproduce the most relevant table from that PR:
What does this mean? It means the real yield on this product is not 9.8%, it's more like 1.4%. Indeed, it seems one can actually believe the yield Yahoo Finance reports (Yahoo Finance reports 1.6%).
And there's another problem
When checking how these funds generate their income, you can come across another problem. These funds have very high operating expenses. Continuing with the ETB fund above, and looking at the most recent report of earnings, you can see $1.042 million in operating expenses. This is on a $379 million fund, annualized it would mean something like an expense ratio approaching 1.1% of the assets the fund holds.
These problems are widespread
The problems described above are widespread; they are not limited to ETB. I checked a few similar funds and here's what I found:
Risk-Managed Diversified Equity Income Fund (ETJ)
Same problem as ETB, the income produced by the fund answers only for 1/10 of the yield, the rest is distribution of capital:
The annualized expense ratio is also similar, at around 1.08% of NAV.
Eaton Vance Tax-Managed Diversified Equity Income Fund (ETY)
Same problem as ETB, the income produced by the fund answers only for 14.3% of the yield, the rest is distribution of capital:
Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (ETW)
Slightly better than the others, but still the income produced by the fund answers for less than 20% of the yield, the rest is distribution of capital:
The annualized expense ratio is also similar, at around 1.07% of NAV.
Tax-Managed Global Diversified Equity Income Fund (EXG)
Also slightly better than the others, but still the income produced by the fund barely exceeds 20% of the yield, the rest is distribution of capital:
(click to enlarge)
The annualized expense ratio is similar, at around 1.04% of NAV.
In short, it's misleading to infer these funds' yields directly from their quarterly distributions.
For any closed-end buy-write fund the above analysis has to be done, to check where the yield is coming from. If the yield is distribution of capital, it should be ignored. All these funds and any other similar ones also run the risk that the distributions will be cut in the future, or if not, the funds will bleed capital and see the operating expense ratios go up even further. In any instance, these funds are misleading.