Earlier last week at the Democratic Convention, former President Bill Clinton gave a rousing speech to the Democratic faithful on which party had demonstrated better fiscal responsibility over past Presidential terms. When asked what his secret was to balancing the budget during his Presidency, he said "I always give them a one word answer..Arithmetic!"
No matter what you think of Bill Clinton or whether you are a Democrat or a Republican, you've got to admit the guy can take complicated subjects and make (or spin) them with his down home style of speaking so that they are easier to understand.
In my past articles I've tried to explain to readers which high yielding equity based closed-end funds (CEFs) are paying out more than they take in and which funds refuse to cut spending when they should. In other words, which funds are not balancing their budgets and are fiscally irresponsible. On the other hand, there are plenty of funds that are doing the right thing that trade at significant discounts and have far outperformed these other funds over time. And yet, it's the fiscally irresponsible funds that continue to trade at the highest premium valuations despite these warnings. I don't know what it's going to take for investors to realize the cost over time to hold onto funds that pay out more than they take in, so I thought I would call upon Bill Clinton to explain fiscal irresponsibility in equity CEFs, since in the long run, it could make or save readers a lot of money.
Bill Clinton On Fiscal Responsibility In Equity CEFs
<Bill Clinton walks up to the lectern>
"Thank you! Thank you! You know, equity CEFs are not unlike the fiscal crisis that our cities, states and country find themselves in today. If you spend more money than you take in, I don't care how attractive your public parks, pension plans or other perks are, you're going to run into trouble."
"The first thing I want to show you is this table of all the top fiscally irresponsible equity CEFs which pay out more than they take in. Now take a look here the first column which shows each fund's Net Asset Value (NAV) yield and then compare that to the column next to it which shows the fund's actual total NAV performance year-to-date. I've highlighted in red which fund's NAV's aren't keeping up with their yields and though there are certainly others, these are the ones with the highest NAV yields and will have the hardest time meeting their distributions. Do you think it's a coincidence that many of these funds with the highest NAV yields also have some of the worst NAV total return performances? Let me tell you, it's not. And it's not like this has been going on for just this year. That's what happens when you cut corners and try and fool the public into thinking you can offer something for nothing!"
"You don't have to be a genius to figure out that if you're paying out more than you take in, something has got to give. Now some years, a fund that has a high NAV yield like the Allianz/PIMCO Global StocksPlus & Income fund (PGP), can knock the cover off the ball and easily cover its distribution because the fund uses long S&P 500 derivatives and options, but a lot of these fund's with high NAV yields, particularly the ones over 12%, have no chance of maintaining their yield because they don't have that kind of rocket fuel in their tank. In other words, most funds which use an option-income strategy (shown in blue) are not going to see their NAV's outperform in a strong market so how are they going to maintain their high distributions when their NAVs can't keep up? They can't. Its fiscally irresponsible!"
"Just to prove my point, just in the first week of September, four of these 25 funds in the table above have cut their distributions, three from BlackRock and the latest being the Allianz/PIMCO International & Premium Strategy fund (NAI), which just cut its distribution a whopping 31% on Friday. Heck, I even wrote an article just a week ago identifying which fund's were the worst offenders of overpaying their distributions, and one of those was NAI. You can read that article here."
"Now folks, this ain't rocket science. It's arithmetic! The problem is that some fund families have been doing this for years and investors have been gobbling it up and paying unbelievable premium prices thinking that these funds can somehow maintain their high yields. Take a look at the table below which shows the 3 fiscally irresponsible funds I identified in my article which are also shown in the top 5 highest NAV yields in the table above. They are the Alpine Global Dynamic Dividend fund (AGD), the Wells Fargo Advantage Global Dividend fund (EOD), and the fund I just mentioned, NAI."
"Folks, the last three plus years haven't exactly been a bear market and yet all three of these fund's have lower NAV's today than they did around the market lows in early 2009. Think about that for a second. EOD has gone from a $9.51 NAV at the end of the 1st quarter 2009 down to $8.57 on September 7, 2012. NAI has gone from $11.51 down to $10.61 and AGD has gone from $5.81 to $5.32."
"How many funds do you know that are actually lower in real value now than after one the great bull runs in history? And if you can't grow your NAV over the past three plus years, what hope do you have of growing it if these markets start hitting a top? And if your NAV just keeps eroding even in good times, your deficit is just gonna grow and eventually you're going to have to cut. It's as simple as that. Now I want to show you the flip side and give some kudos to funds that have been fiscally responsible over the same period of time and what the long term benefits can be with balanced budget payouts."
"Referring back to my article above, I also identified 3 funds as shining examples of funds that are doing the right thing and reaping the benefits as a result. They are the Gabelli Healthcare and WellnessRX Trust (GRX), the Calamos Global Dynamic Income fund (CHW) and the Cohen & Steers Infrastructure fund (UTF). Mind you, these are not the only funds that have balanced budgets and in fact, most funds ARE fiscally responsible and are comfortably paying out what they take in since many have already had to make the hard choice and cut their distributions to get their fiscal house in order. But I wanted to give a shout out to these funds because of their heavily discounted valuations and superior NAV performances. All of these funds have NAVs up 14% to 22% YTD through September 7, 2012."
"What I want you to notice is how, unlike the funds which have lost value since the market lows around 3/31/09, these fund's NAVs have all grown substantially even with their distributions. In fact, two of these funds have practically doubled their NAVs since the market lows while the other is up about 50%. Then consider how much better GRX's, CHW's and UTF's total return NAV performance's have been as a result (each fund's bottom right column). Think about it. Would you have rather owned a global stock fund (i.e. a portfolio of US, International & preferred stocks) like UTF, whose NAV is up a stunning 123.4% on a total return basis from the market lows or a similarly allocated global stock fund like EOD, up an abysmal 30.7% including those high payouts?"
"Is it clear now which funds have done a much better job of managing their payouts and are in a position of raising their distributions and which ones have been fiscally irresponsible and are being forced to cut? Finally, consider that GRX is at -13.2% discount, CHW at a -10.7% discount and UTF at a -9.6% discount compared to EOD, AGD and NAI all at premiums with far inferior total return performances and I think you get the picture!"
"So does it make more sense to be fiscally responsible? Absolutely. GRX, CHW & UTF may not look as sexy and attractive with their more modest market yields of 4.5%, 8.9% and 7.9% respectively, but over time, they will be in a much better position to grow their NAVs and raise their distributions as a result. CHW raised its distribution 24% in January, UTF raised its distribution in 2010 and I wouldn't be surprised to see GRX raise its distribution substantially by the end of the year. GRX actually gets the fiscal gold medal award paying out only 3.9% of its NAV annualized and yet has seen its NAV rise over 22% YTD. Do you think maybe it has room to raise?"
"Oh, and I'm not playing partisan politics in which I'm choosing 3 leveraged funds that have outperformed option-income funds during an up market. In fact, let's level the playing field and compare these funds over a longer 5-year period from close to the mark highs at the end of the 3rd quarter, 2007. This period would now include the financial crisis that hit in 2008 and this is where defensive option-income funds like EOD and NAI should have been able to make up lost ground and held up better than leveraged funds. Did they?"
"Nope. Not only have these three funds lost most of their NAV value over the past 5-years by paying out high distributions (including capital gains) that just eroded the life blood of their income...their NAVs, their total NAV performances have been among the worst of all funds in their class, with AGD down a stunning -41.5%. And that's with all those distributions added back. And how have GRX, CHW and UTF performed in comparison?"
"CHW and UTF have much more modest total return NAV losses, which for leveraged funds with mostly global stock portfolios, is pretty darn good considering what happened to the global markets during the financial crisis of 2008. Then look at GRX, a US based leveraged stock fund up a whopping 38% since the market highs back in late 2007. Compare that to the S&P 500 up only 2.3% over the same time period including all dividends and you got to ask yourself, what the heck are investors thinking?"
"Folks, if fiscally irresponsible funds like AGD, EOD and NAI can't keep up with better balanced funds like GRX, CHW and UTF in bad times, i.e. like before the financial crisis hit in 2008, and they fall even further behind in good times, say from market lows in early 2009, then what the heck are these funds doing at premium valuations and why aren't these other funds trading at higher valuations? If you think all of sudden things are going to change for these funds going forward, think again. A stronger market is just going to favor leveraged funds like GRX, CHW and UTF anyway and a weaker market is just going to put more pressure on EOD, AGD and NAI to cut their distributions, which NAI did just this last Friday as I warned it would."
"You know, I said in my September 4th article that I couldn't emphasize enough the quality difference of these six funds. I hope this talk of mine has finally brought this to light and showed all of you the dramatic difference a balanced budget approach can make for equity CEFs. In conclusion, I would encourage you to vote for the fiscally responsible funds, since not only will you be better off financially if history is any guide, you will also be sending a message to the fiscally irresponsible funds that you're not going to take it anymore and they better get their fiscal house in order if they want to remain in office. Thank you and God Bless America."
Author's note: The absolute worst offenders of fiscal irresponsibility in equity CEFs are from the Cornerstone funds. I choose not to write about the Cornerstone funds because unlike every other fund family, they don't maintain a website and it is difficult to get historic information on them. However, a 1 for 2 reverse split back in 2008 for the Cornerstone Total Return fund (CRF) and 1 for 4 reverse stock split for the Cornerstone Strategic Value fund (CLM) should give you an idea of what direction these funds have been headed.
Other news publications that have tried to point out the insane distribution yields that the Cornerstone funds "offer" at the expense of shareholder equity have come from the Wall Street Journal, here, and another from Barron's just this past July here.
Additional disclosure: Short NAI, AGD & EOD