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A CEF Portfolio Designed for Capital Appreciation

|Includes:Alpine Total Dynamic Dividend Fund (AOD), BIF, DCS, EXG, FCO, IIF, MTP-OLD, SNF, UTF

CEFDisc10™ is a closed-end fund (NYSEMKT:CEF) stock portfolio designed to generate better than average stock price appreciation (capital appreciation) in the CEF market sector with a secondary emphasis on current yield.  (Note: CEFDisc10™ is neither currently a financial product nor an investment service. It is presented here and by reference for informational purposes only.)

The CEFDisc10™[1] is intended as a companion to two other CEF10™ portfolios:

1.    CEFBig10™[2] designed to provide investors a diversified CEF portfolio generating a frequently recurring, attractive current yield with the potential of capital appreciation (taxable total-return);

2.    CEFMuni10™[3] designed for investors seeking an attractive federally tax-exempted income yield on a monthly basis (tax-exempt income).

Designed for Capital Appreciation? Warren Buffett noted he likes to buy stocks for “pennies” on the dollar”. The CEF market segment is one of the few stock market segments where an investor can buy a stock at a highly visible discount to its underlying net asset value (NYSE:NAV).  

A Powerful Phenomenon: The attraction to buying CEFs at a discount is based on a very powerful statistical phenomenon called “regression toward the mean”. Simply put, a recurring variable, such as a CEF stock’s premium/discount, over time will tend to move closer to its average given a similar set of conditions. This is why many CEF investors recommend buying a CEF stock when it’s trading at a discount and selling it when it’s trading at a premium.

The Whole Story: Unfortunately, most CEFs don’t gravitate to par (stock price equals NAV). For various reasons, beyond the scope of this conversation, CEFs on average have a tendency to trade at a discount. The CEF market segment historically has traded at a discount.

Current to Historical Average Discount: In an article “Widening CEF Discounts May Indicate Better Future Performance[4]” (7/20/10), some empirical evidence was offered to support the supposition that there is a gravitation phenomenon as it relates to current and historical average discounts on a relative basis.  

CEFs that have an extreme current premium/discount that is nominally lower than their four quarter rolling average seem to experienced better stock price performance in the post 3 and 6 month periods than those with extreme nominally higher spreads.

Portfolio Construction: The CEFDisc10™ is designed to own 10 stocks that have experienced widening discount spreads in hopes that in a 3 to 6 month period such stock prices will generate better price performance relative to its peers as the price gravitates back towards its mean discount.

Portfolio Rules: The 10 stocks purchased in the portfolio will be subject to the following criteria:

1.    $50 million or greater in market capitalization;

2.    Trading at a discount at the time of inclusion (avoid owning CEFs with large premiums that are rapidly contracting do to a distribution cut or corporate event);

3.    Stocks will be subject to a “stop loss” of 115% of Eqcome CEF  Index;

4.    Portfolio recalibrated at month-end or early if price objectives are achieved.

The CEFDisc10™ portfolio can be found on my website. All three CEF10™ portfolios are currently neither currently financial products nor services. They are presented here and by reference for informational purposes only.

Caveats: There are many situations where a CEF’s stock price could gravitate back towards its historical premium/discount after a statistically significant divergence and still not generate capital appreciation. This would be the case if there was a significant change in the CEF’s NAV.

Given the recent establishment of the CEFDisc10™ (July, ’10), it is considered in a beta test phase. I would not recommend that investors purchase shares in the CEFDisc10™ until a definitive track record has been established consistent with the stated objectives. Interested investors may want to watch the weekly progress of the portfolio to see if its underlying construction is both valid and reliable.

As always, consult your personal financial advisor prior to making any investment decision as equity investments of this nature can be subject to both a loss of income and principle.

Joe Eqcome (Disclosure: owns and is accumulating stocks in the CEFDisc10 portfolio for purposes of alignment of interest and commitment to the underlying premise.)


owns and is accumulating stocks in the CEFDisc10 portfolio for purposes of alignment of interest and commitment to the underlying premise