A Poor Man's CEF Portfolio That Performs

by: Joe Eqcome

The Eqcome CEF Big 10 Portfolio is a simple, inexpensive and self-directed way for retail investors to own a diversified CEF portfolio representative of this market segment. The portfolio consists of 10 CEF stocks. Each stock represents one of the largest within the 10 major CEF fund types (see chart below) and has been in continuous operation since Oct ‘04. The CEF Big 10 portfolio was off 3.9% during the period versus the S&P 500 (NYSEARCA:SPY) off 11.8% and Claymore CEF Index off 37.9%.

Investment Management Underperformance: Seventy percent of large cap fund managers failed to beat the S&P 500; 85.5% of small cap managers failed to beat S&P 600 (small cap); 80% of bond fund managers failed to beat benchmarks (excluding High Yield) (WSJ 4/22/09). It makes you wonder, for what purpose are we paying investment managers? The privilege to lose our money!

Basis of Comparison: As to what stocks are included in the S&P indices, the selection process is determined by the Standard & Poor’s Index Committee (“Committee"). This Committee has full discretion as to what stocks are to be added. The Committee examines five main criteria when looking for Index candidates: trading analysis, liquidity, ownership, fundamental analysis, market capitalization, and sector representation. Therefore, inclusion in an S&P index is akin to selection of stocks by an investment committee with very strict investment guidelines—and is not rule based.

Eqcome CEF Big 10 Portfolio: It might be instructive to apply a similar process to building a Poor Man’s CEF Investable Portfolio. One of the key criterions was to limit the portfolio to 10 stocks making it investable for retail investors. To meet the diversification criterion, one CEF stock was selected for each of the 10 key CEF fund types. Other criteria included a combination of large assets size within its fund type, sufficient trading volume and a continuous operating history for purposes of historical performance measurements. Below is a list of CEF stocks that meet those criteria.

Based upon 100 shares of each of the CEF stocks listed, The Eqcome CEF Big 10 Portfolio can be purchased for less than $10,000 (As of 5/27/09 the cost was $9,262.) Assuming you’d pay $10 per trade at a discount broker, the 10 stocks would cost you $100.00 in the aggregate to own. That would represent an initial cost of 1.1% of the value of the portfolio. This would compare to a 1.5% average CEF management fee. The good news is that you would only have to pay commissions once on the stocks initially purchased. Over a 3 year holding period your IRR would be 1.2% higher than an annual fee-based portfolio. (This assumes an annual 5% stock price appreciation.)

Portfolio Performance Vs CEF Index: The chart below is a comparison of the Eqcome Big 10 CEF Portfolio (unweighted) versus that of the Claymore CEF Index on a daily basis indexed to October 27th, 2004. The prices used for Eqcome Big 10 CEF was adjusted for distribution and splits. The Claymore CEF index is a cap weighted index and distributions are adjusted on a quarterly basis.

The gap between the Eqcome Big 10 and the Claymore Index may be a function of Claymore's exclusion of CEFs with non-taxable income of greater than 50%. This would exclude most muni funds which have performed well as of late.

Data related to the Eqcome CEF Big 10 Portfolio is continuously updated and available at Joe Eqcome’s website under the tab “CEFBig10”. (An Investor may prefer to substitute an individual stock for each of the fund types or own more of one fund type than another.)

Disclosure: Author owns all CEFs in the CEF Big 10 Portfolio