9 CEF Buys for Income-Oriented Investors

by: Douglas Albo

Eaton Vance Tax-Advantaged Global Dividend Opportunities fund (NYSE:ETO), Eaton Vance Tax-Advantaged Global Dividend Income fund (NYSE:ETG) and Eaton Vance Tax-Advantaged Dividend Income fund (NYSE:EVT) - I was preparing a long, drawn out synopsis of ETO, which has far outperformed any of its correlated indexes, but suffice to say that I believe ETO may raise its dividend soon. This dividend declaration could be in the third week of March or in the next couple months if the market continues its upward momentum. Eaton Vance has taken a lot of flack over the past few months with their lackluster closed-end and mutual fund performances but if one just looked at Eaton Vance's three leveraged stock and fixed-income based CEFs, representing about $3 billion in assets, they have been among the best performers of all funds. The graphs below shows ETO's, ETG's and EVT's market price rise from the market lows in early March 2009 compared to the S&P 500. Keep in mind that these performance percentages do NOT take into account dividends paid monthly, which would make these funds' total return performances even more impressive.

ETO's, ETG's and EVT's NAVs have also appreciated substantially and in ETO's case, the NAV is once again significantly higher ($23.10 as of 3/11/11) than its inception NAV of $19.06 from April of 2004. This strong NAV performance has brought ETO's NAV yield down to where historically, Eaton Vance would consider raising the dividend. In addition, I have found that once a CEF's market price yield approaches 6%, it will have a harder time advancing as its lower yield competes with less riskier yield-oriented securities. The table below shows ETO's dividend changes since inception, three of which occured in the April to May declaration periods.

Though Eaton Vance would typically raise the dividend on all three of their leveraged stock-based CEFs at the same time, this may not happen this go around due to ETO's NAV being so much higher than than ETG's at $15.94 and EVT's at $18.65 and its market price yield being so much lower at 6.47%. All of these funds went public at $20 per share minus a sales credit for an inception NAV of $19.06. ETG would be the least likely to raise its dividend but its strong near term performance, and much higher current yield at 8.36% still make it very attractive in a continued up market cycle. All three of these funds are monthly pay CEFs and will go ex-dividend the fourth week of March.

NOTE: Because of their leveraged portfolios of about 25%, ETO, ETG and EVT can offer greater appreciation potential during strong market cycles but will underperform during difficult market cycles. Many funds attempt to manage this volatility by investing up to 1/3 of the leveraged portfolio in fixed-income securities such as preferred stocks and corporate bonds.

Eaton Vance Tax-Managed Global Buy-Write Opportunities fund (NYSE:ETW) and Eaton Vance Tax-Managed Buy-Write Opportunities fund (NYSE:ETV). Continue to accumulate ahead of their quarterly dividend declaration the third week of March and their ex-dividend date the fourth week of March. Option-income funds such as ETW and ETV continue to see their market prices churn even as their NAVs improve but signs are pointing to the start of their outperformance once again as the markets start to look more volatile and range bound. Though the graphs of most option-income fund's market prices are ugly, the NAV graphs are generally much more positive and as a result, the risk/reward levels of these funds has not been this attractive since the spring of 2009. Most of the Eaton Vance option income funds are in the 9% market price discount range with conservative distribution levels after two rounds of dividend cuts over the past 15 months.

1-Year graph of ETV's market price (blue line) vs. ETV's NAV (red line). (Percentages do not include a roughly 11.5% dividend yield over the past year)

6-month graph of ETW's market price (blue line) vs. ETW's NAV (red line). (Percentages do not include 6-months worth of dividends)

ING Infrastructure, Industrials & Materials fund (NYSE:IDE) and ING Global Equity Dividend and Premium Opportunity fund (NYSE:IGD). I don't know what it is about the ING CEFs but their funds are the most counter-intuitive of all the funds I follow. It seems that the funds that have the best NAV performance, such as IDE, are the ones that have the widest discounts and the ones that have sub-par NAV performance and little NAV upside, such as IRR, seem to get the premium valuations.

Nonetheless, of all the ING CEFs, I would continue to accumulate IDE and IGD. Though I don't expect IDE to raise its dividend this declaration around March 18, a continued up market cycle may put IDE in a position to raise before the end of the year. Though both IDE and IGD are option-income CEFs and thus should offer some NAV downside protection if we go into a more difficult market environment, IGD will be much more defensive since not only does IGD have a larger option coverage on its portfolio, 51% vs IDE's 35%, but IGD also purchases up to 25% put option protection. IGD, at a 2.79% discount to NAV is not exactly cheap compared to IDE at a 9.89% discount and IGD's low NAV and relatively high distribution could be of concern if its NAV performance doesn't pick up, but an 11.1% yield paid monthly is very attractive in this market environment. Both should go ex-dividend around April 1.

1-Year graph of IGD's market price (blue line) vs. IGD's NAV (red line). (Percentages do not include a roughly 11.5% dividend yield over the past year)

NFJ Dividend, Interest & Premium Strategy fund (NYSE:NFJ) - Even after a solid performance year in 2010, especially after raising its dividend from $0.15 to $0.45 a quarter, NFJ is still attractive at a 5.85% discount and 9.81% yield. Who would have thought an option-income fund could raise its dividend and continue to show good NAV growth? Goes ex-dividend March 17.

1-Year graph of NFJ's market price (blue line) vs. NFJ's NAV (red line). (Percentages do not include a roughly 5.5% average yield over the past year)

Eaton Vance Tax-Managed Buy/Write Income fund (NYSE:ETB) - I am adding ETB to this list as it is right around its 52-week low of roughly $13.62 and a 9.25% discount to its $15.02 NAV (as of 3/11/11). This fund usually gets a much higher valuation, typically averaging only a 2.37% discount over the past five years. ETB is very defensive selling 100% index option coverage on its domestic large cap stock portfolio. It is also the smallest of the Eaton Vance option-income funds at only $367 million in assets, meaning it can move up very quickly when investors realize this fund is downright cheap. ETB, like many of the Eaton Vance option income funds, has a mostly large cap domestic stock portfolio. The top 10 holdings are shown below. Goes ex-dividend the last week of April.

1-Year graph of ETB's market price (blue line) vs. ETB's NAV (red line). (Percentages do not include a roughly 11% dividend yield over the past year)

If you believe, as I do, that the equity markets will be more range bound as opposed to the ramp up market we've seen over the last 2-years, then the option-income funds make alot more sense now as their NAVs should start to outperform again. As their income strategy becomes more optimized in a range bound market, we should start to see their market price discounts narrow as investor's rotate into these funds.

Part of my overall income strategy is to own both leveraged and option-income CEFs to take advantage of market direction no matter which way the market trend is. I can only speculate as to the direction of the market but it makes more sense to be prepared no matter which way it goes. The leveraged CEFs will continue to outperform in an up market cycle while the more defensive option-income CEFs should provide some downside protection if the markets start to correct.

For those investors who are even more defensive minded but want to continue to receive income, they can hedge their long CEF portfolio by shorting some of the major broad based index ETFs such as SPY, DIA, QQQQ or EFA (for the MSCI EAFE European index). I would recommend hedging no more than 1/4 to 1/3 of an investor's long portfolio value. For retirement accounts, investors could purchase an inverse index ETF such as SH for the S&P 500, DOG for the Dow Jones Industrial Average, PSQ for the NASDAQ top 100 non-financial stocks (i.e. inverse to the QQQQ) and EFZ for the inverse to the MSCI EAFE European index EFA. I would NOT recommend any of the 2X or 3X inverse ETFs. Note: Many of the major index ETFs such as the SPDR S&P 500 fund (NYSEARCA:SPY) also go ex-dividend in March.

Disclosure: I am long ETW, ETV, ETG, IGD, ETB.

Additional disclosure: Short SPY