Looking Closer At The Closed-End Buy-Write CEFs

 |  Includes: ETB, ETJ, ETW, ETY, EXG, SPY
by: Paulo Santos

I have already shown how the yield on many buy-write CEFs is misleading if quoted directly. However, my own article was - in a way - misleading as well. This happened because just saying that the yields are misleading (which they are) doesn't tell the whole story.

Indeed, what matters is whether over the long term paying such seemingly high yields is having substantial impact on the fund's NAV. And how will we know if the impact is significant? Well, we can compare the CEF's total return (calculated using the NAV plus the distributions that were made) versus some kind of benchmark, such as the S&P, or, for our purposes, a proxy: the SPDR S&P 500 ETF (NYSEARCA:SPY).

Why do we have to make this empirical test? Because not all of the ROC (return of capital) that's reported on the fund's distributions is really ROC, some of it is added NAV that comes from the buy-write strategy. For further explanation, read Douglas Albo's article on the subject, "CEFs and Return of Capital: Is It as Bad as It Sounds?".

So let us take a look at how the following five funds named in my prior article did since their inception, and how SPY compared on a total return basis:

Eaton Vance Tax-Managed BuyWrite Income Fund (NYSE:ETB)

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ETB had the best total return (considering NAV) of all the funds here -- it actually beat SPY's total return since inception even while presenting lower risk. This is an example of a fund that can be part of a conservative income portfolio and which can produce decent returns under many different market scenarios. It still suffers performance-wise when the market goes straight-up, though.

ETB also has the lowest discount to NAV of the 5 funds considered here, at just 10.8% discount, perhaps due both to its better historical performance, and having had just 1 distribution cut a good while ago.

Eaton Vance Risk-Managed Diversified Equity Income Fund (NYSE:ETJ)

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ETJ presents the second-best total return performance (considering NAV), more or less matching SPY since inception, also with lower risk. It's trading at a massive 15.9% discount to NAV today, in spite of that.

Eaton Vance Tax-Managed Diversified Equity Income Fund (NYSE:ETY)

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ETY trades at a 15.2% discount to NAV, more or less in line with the other funds under examination here, except for ETB.

Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (NYSE:ETW)

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ETW had a decent performance in terms of total return (considering NAV), in spite of not matching SPY's total return. The fact is that ETW didn't came far while presenting a lot less risk.

ETW is trading at a 14.7% discount to NAV.

Tax-Managed Global Diversified Equity Income Fund (NYSE:EXG)

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EXG is also trading at a large 15.9% discount to NAV.

Why the discounts?

All the funds considered here have suffered significant distribution cuts. The distributions were clearly too high in the past and that led to significant returns of capital and NAV underperformance. Since the funds apparently yielded so much and then suffered such deep cuts, this might also have thrown off some income investors fearing further cuts. Additionally, as we've shown, 3 of the 5 funds underperformed SPY on a total return basis considering NAV, and all are particularly unsuited for straight up markets. The stock market since 2009 has been quite reliant on Federal Reserve intervention, and when such intervention takes place it produces exactly that kind of market, so the funds might be regarded as unsuited for the kind of upside that's likely to take place (when it does take place).

Also, the complexity of these funds, where yield isn't really yield, and return of capital isn't really return of capital, might also be contributing to the NAV discount.

The NAV discounts, however, are in the past. Former fundholders suffered them. Whoever buys today is favored by those discounts. The discounts also make the distributions seem higher for the present shareholders, while not being as taxing on the fund's NAV. For instance, ETB's 9.64% yield (calculated with the market price) is reduced to 8.6% when calculated with the NAV, so easier for the fund to sustain.


The funds under review have, over the years, lost more NAV than a straight investment on a comparable benchmark would have led to, though they exhibited periods of outperformance and also exhibited lower risk. This confirms that part of the yield paid by these funds was, effectively, return of capital. Looking at total return, however, makes the difference in performance be smaller to the point where we know that the component of income on the yield was significantly higher than reported (and hence, return of capital was smaller).

Even though the yield on these funds is confusing and needs constant attention to reconcile it with the fund's reality, it is my belief that these funds can be decent investments for a defensive income portfolio under some scenarios, especially due to them already incorporating large discounts to NAV. These funds should outperform (on a total return basis) in a down or sideways market, and not lose much to the market in an up-market (unless it goes mostly straight up - such as under quantitative easing periods).

The recent distribution cuts should also have aligned the income these funds can produce more broadly in line with distributions, making further distribution cuts less likely.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.