Income investors with large taxable accounts are consistently focused on maximizing their total return and minimizing the impact of taxes on their nest egg. That means seeking out funds that are sensitive to the type of income they produce and the implications of using capital losses to offset gains.
Exchange-traded funds (ETFs) are one avenue for investors to consider in this pursuit. Many ETFs that track a passive index have low portfolio turnover rates and often pay little to zero capital gains at year-end. These make for a truly inexpensive and effective vehicle for tax-conscious investors that want diversified stock or bond exposure.
Those who may be searching for a more active strategy or one that offers a higher yield may be interested in tax-advantaged closed-end funds (CEFs). These more aggressive funds offer the ability to own a diversified basket of stocks with the ability to employ leverage and more creative portfolio construction methods.
The following are several CEFs that seek to provide both growth and income with a tax-efficient objective.
Eaton Vance Tax-Advantaged Global Dividend Income (NYSE:ETG)
ETG is part of a suite of three Eaton Vance equity-income CEFs that focus on tax-advantaged investment strategies. This fund is designed to offer true global exposure, with approximately 120 underlying holdings and only 50% of the portfolio dedicated to U.S. stocks. The remaining allocations are split among foreign stocks, corporate bonds, and preferred stocks.
The fund has $1.6 billion in market float and sports a current yield of 8.17%. Dividends are paid monthly to shareholders, an attractive feature for income-seeking investors. The fund is currently trading at an 8% discount to its net asset value, which is close to its 3-year average. It is also employing an effective leverage of 25% per the last company disclosure.
Eaton Vance claims to target stocks that pay qualified dividend income and takes the opportunity to harvest capital losses when appropriate. They are also sensitive to managing the sales of highly appreciated positions within the portfolio to try and maximize the use of long-term capital gains when applicable. The goal is a high level of total return (income and capital appreciation) on an after-tax basis.
I currently own ETG for clients of my wealth management firm with dedicated closed-end fund accounts. The combination of tax-efficiency and the access to a world stock allocation are attractive features within a diversified income portfolio. It's my belief that a measure of foreign stock exposure will be a key driver of growth should we see the performance gap narrow between U.S. and international indexes this year.
Gabelli Dividend and Income Trust (NYSE:GDV)
GDV is another popular fund for dividend equity investors that is managed by the famed Mario Gabelli. The objective of the fund is to seek out stocks with high yields and long-term capital appreciation potential. It's also known to have relatively low portfolio turnover, which helps mitigate the impact of short-term capital gains taxes. As of the last reported disclosure, GDV had more than 400 holdings in its diverse portfolio.
This closed-end fund has $2.3 billion under management and currently pays an attractive yield of 6.42%. GDV is employing a leverage ratio of 20%, which is moderate by many equity CEF standards. The fund is also trading at a 9% discount to its net asset value, which is slightly tighter than the 10.85% average over the last three years.
The quality approach to security selection, coupled with a strong management team and modest leverage, make this fund a solid contender among its peer group.
John Hancock Tax-Advantaged Dividend Income Fund (NYSE:HTD)
HTD invests 80% of its assets in dividend paying securities with a strong emphasis on the high yield utility sector. The portfolio includes a diverse array of common stocks, preferred stocks, and interest rate swaps when appropriate.
I like that the portfolio managers recognize the need to control interest rate risk within HTD considering the sensitivity of the core holdings. The willingness to manage this dynamic is a key reason this fund piqued my interest as a truly differentiated active strategy.
The fund currently pays a distribution rate of 6.78% and income is paid monthly to shareholders. It's also trading at just a 3% discount to its net asset value, which is on the high side of the three-year average of 9%. That narrow discount is likely a warning sign that the price of HTD has been driven a little faster than historical norms and may be higher risk for new money at this juncture.
Nevertheless, this portfolio should be one to watch for those who are interested in a high yield equity income CEF with a strong track record and active philosophy.
The Bottom Line
As a closed-end fund portfolio manager, I always caution investors against the danger of purchasing funds based on one-dimensional factors like yield of tax-efficiency. Every fund should be evaluated for the merits of its portfolio strategy, distribution plan, costs, and comingling with other holdings in your accounts.
Furthermore, it's extremely important to consider how a closed-end fund is trading relative to its net asset value and prior historical trends. If a fund is at an abnormal premium or very tight discount, it may be better to wait for a correction rather than jump head first into the frothy waters.
These vehicles offer many advantages over traditional ETFs and mutual funds. Yet, they must also be carefully managed because of the significant risks of sentiment turning the tides on the current price trend.
Disclosure: I am/we are long ETG, HTD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.