Equity CEFs: Searching For The Right Balance Of Income And Appreciation Funds, Part I

by: Douglas Albo

Through 11 months in 2012, the total return market price performances of equity based high yielding Closed-End funds (CEFs) have been pretty good. I wouldn't call it great since many funds continue to trade at low valuations as reflected by their historic premium/discount levels but certainly better than 2011 when most funds closed at their widest discounts since the bear market bottomed in the spring of 2009.

Total return is the key metric for equity based CEFs since their high yields play such a large role in their total return performance. As a result, the biggest challenge is to try and find the right balance of funds to take advantage of both yield and appreciation potential, since together they make up the total return of these funds both on a market price and a Net Asset Value (NAV) basis.

One of the great features of equity CEFs is that they really come in two flavors, one for an up market and one for a flat to trendless market. They may all offer high yields, but one income strategy generally works better dependent on the market environment we are in. I'm not going to get into a lot of detail here about these income strategies, but you can read about them in one of my first articles I wrote here on Seeking Alpha back on January 6th, 2011. Here is the article, and one of the first things you'll notice is that my tables have improved a lot since then!

Here are three spreadsheet tables I update every two weeks which sort the YTD total return market price performances, shown in table 1; the total return Net Asset Value performances, shown in table 2; and the difference between the two, shown in table 3. I can only fit so many funds in a screen shot (about half of the total number of high yielding equity CEFs I follow) so if you are interested in seeing all the funds in the 3 tables in an Excel spreadsheet format, please go to my Capital Income Management website (link shown at left) and click on the "2012 Equity CEF Performance Spreadsheet And Analysis" subscription request.

The first two tables sort funds which have outperformed (shown in green) and underperformed (shown in red) the S&P 500 which is up 14.9% YTD through November 30th, 2012. I use the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) for comparison since unlike most quoted S&P 500 returns, SPY includes dividends and this makes for a more accurate comparison. Keep in mind however that many of these funds would not necessarily use the S&P 500 index as their benchmark since many of the funds include global stocks and/or fixed-income securities. Still, I wanted to use a common and recognized index to base performance against. Note: Total return performance is defined as all distributions and dividends added back but not reinvested.

The last table sorts funds whose NAV performances have outpaced their market price performances, i.e. funds with the highest negative spread have seen their market prices lag their NAV prices the most. This cutoff can be more subjective and I consider funds which have up to a 5% difference between their market price performance over their NAV performance to be essentially in balance though obviously, the more negative the number the more the fund might be considered undervalued. Though not shown due to screen shot space limitations, there are about 30 funds which are shown in red and may, and I stress may, have their market prices getting ahead of their NAVs, i.e. over 5%.

Funds in all three tables are also color coded by income strategy as shown below. I also highlight in red funds which may have excessive premium valuations (10%+), excessive NAV Yields (12%+) and high expense ratios (2%+) in columns to the right.

Earlier this year, I recommended to investors to overweight the leveraged funds such as the Gabelli fund (NYSE:GAB), the Gabelli Healthcare & Wellness fund (NYSE:GRX), the Calamos Global Dynamic Income fund (NASDAQ:CHW), the Calamos Strategic Total Return fund (NASDAQ:CSQ), the Eaton Vance Tax-Advantaged Dividend Income fund (NYSE:EVT) and the Cohen & Steers Infrastructure fund (NYSE:UTF), all of which I expected to have a better year in 2012 than the option-income funds, which I recommended in 2011. By and large, this has turned out to be the case as the leveraged funds (shown in orange) make up most of the top tier funds in the first two tables.

Now some of these funds actually use a combination of income strategies, i.e. option-income, leverage and dividend harvest. However, in general, leveraged funds will outperform both on an NAV and market price basis during strong up markets whereas option-income funds will generally outperform during flat to trendless up and down markets, like in 2011. Though no funds like bear markets, option-income funds' NAVs will still hold up far better in down market conditions than any of the other fund income strategies. Of course, CEF market prices are subject to investor emotions and market sentiment and this can often result in funds that might be considered undervalued or overvalued compared to how their NAVs are performing.

This is what I want to get into next, identifying which funds offer the best yield and appreciation potential based on varying market environments heading into 2013, however due to the length of this article, I will come back with a Part II of this series.

Disclaimer: Information included in these tables comes from sources believed reliable and I have assembled this information based on extensive research and analysis, however no guarantee can be made as to the absolute accuracy of all of the data.

Disclosure: I am long GRX, CHW, EVT, UTF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.