CEFL Is Worth Considering With A 17.1% Dividend Yield

| About: UBS ETRACS (CEFL)
This article is now exclusive for PRO subscribers.

Summary

CEFL has a 17.1% yield on annualized monthly compounded basis.

Considerable uncertainty and risks exist, but the high yield offers ample compensation for the risks.

CEFL may be useful for those wishing to diversify fixed-income portfolios with some equity exposure.

Less uncertainty regarding Federal Reserve appointments exists, but tax-related uncertainty still exists.

Performance of CEFL

For the one-year period ending November 24, 2017, the UBS ETRACS Monthly Pay 2x Leveraged Closed-End Fund ETN (NYSEARCA:CEFL) returned 27.73% based on a purchase on November 25, 2016, at the closing price of $16.31, the November 24, 2017, price of $18.02 and the reinvestment of dividends through to November 2017. It does not include my projected December 2017 monthly dividend of $0.2549. This exceeds the total return on the S&P 500 (NYSEARCA:SPY) of 19.91% over the same period, also with reinvestment of dividends. CEFL is based on an index of higher-yielding closed-end exchange-traded funds. While typically called dividends, the monthly payments from CEFL are technically distributions of interest payments on the ETN note based on the dividends paid by the underlying closed-end funds, pursuant to the terms of the indenture. There is an unleveraged ETF that is based on the same index, the YieldShares High Income ETF (NYSEARCA:YYY)

Since the price of CEFL is only modestly higher than it was a year ago, it was mainly the high dividends that generated the 27.73% return. The substantial 58.41% total return performance of CEFL over the last two years ending on November 24, 2017, is also due primarily to the high dividends. This is almost twice the total return on SPY over the same period, also with reinvestment of dividends.

Analysis of the December 2017 CEFL Dividend Projection

As I indicated in CEFL Still Attractive With 16% Dividend Yield, Despite Coming February Dividend Shock, there has been a significant change in the composition of the index as a result of the rebalancing that occurred in the beginning of 2017. On balance, the dividend yield on the closed-end funds that comprise the index is somewhat lower than prior to the rebalancing.

Since 27 of the 30 high dividend closed-end funds that comprise the index upon which CEFL and YYY are based pay monthly dividends, there is a minor seasonal factor involved with the CEFL dividend. In some months, some of the quarterly payers have ex-dividend dates and that boosts the next months' dividends. Only the Morgan Stanley Emerging Markets Domestic Debt Fund (NYSE:EDD), Templeton Emerging Markets Income Fund (NYSE:TEI) and Liberty All-Star Equity Fund (NYSE:USA) now pay quarterly dividends. USA has an ex-date in November 2017 thus it will contribute to the December 2017 monthly dividend.

The only change in the dividends paid by closed-end funds that comprise the index upon which CEFL is based was that USA increased its quarterly dividend to $0.17 from the prior $0.13. The ex-dates of all of the components can be seen in the table below along with the weights, prices, ratio of price to net asset value, dividends and contributions to the index. As of this writing, Alpine Total Dynamic Dividend Fund (AOD) has not yet declared its monthly dividend with an ex-date in November 2017. I have assumed in the calculation of the December 2017 dividend that it will be the same as the previous monthly dividend shown below.

Equity and Fixed-Income Market Considerations and Risks

The classic risks that investors have faced since the end of World War II have been more or less related to the Federal Reserve. One risk has been that of an inverted yield curve. Every inverted yield curve has resulted in a period of economic weakness. In hindsight, many claim that by raising short-term interest rates high enough to cause an inverted yield curve, the Federal Reserve erred, since that was the cause of the subsequent recession. The other classic risk is that which occurs when the Federal Reserve acts to punish what it perceives as bad government policy, by raising rates.

From the late 1970s until arguably 2007, the Federal Reserve, at times, used monetary policy to dissuade politicians from what the Federal Reserve considered profligate fiscal policy. The term "bond market vigilantes" referred to financial market participants who voted with their money against the inflationary impacts of government policy. However, it was the Federal Reserve that took on the major role of punishing politicians when it considered fiscal policy too inflationary or just that debt was excessive.

The present composition of the Federal Reserve Open Market Committee is probably disinclined to engage in any punishment unless there is actually significantly above target inflation and it is clear that such inflation can be directly attributed to actions of politicians. There also may be some shift away from the perception that higher interest rates are both inevitable and desirable among some policy makers and market participants. Some Federal Reserve officials have insinuated that the current target rate for federal funds is not that far from where it will ultimately be under normal neutral conditions.

The focus of many market participants is now on the impending tax bill. More clarity has appeared regarding tax policy since the Congressional Republicans have passed their version of the tax bill and a tax bill has come out of the Senate committee. As the Senate will allow amendments to the bill from the floor, there is likely to be changes in the final version and there is still even some doubt as to whether anything will be enacted. However, unless the debate shifts from focus on how many middle-class taxpayers actually will pay more or less under the Republican tax bill to the undeniable fact that there will be a massive shift in the tax burden from the rich and onto the middle class, it is extremely likely that a Republican tax bill will be enacted.

There are many different ways to categorize households as between those that are middle class and those that are rich. Likewise, there are a number of ways to measure how a change in the tax code impacts various sectors in the economy. There are also different methodologies used to calculate what percentage of federal taxes is paid by middle class households as compared to the rich. However, by any conceivable way of delineating the middle class from the rich, and measuring the impact of changes in the tax code, any tax bill enacted this year or next will be the most massive shift ever, in the tax burden away from the rich and thus onto the middle class.

While critics of the Republican bills correctly call it war on the middle class, a more accurate critique would be to call it war on wage earners. Middle-class households that do not primarily live on wages or pensions but rather derive their income from dividends, profits or inheritances will come out ahead. Likewise, those whose very high incomes come solely from wages will do worse. It is likely that many of those who now are paid salaries will try to reorganize themselves so that their salaries are now pass-through business income, which is to be taxed at a much lower rate than wages, salaries or pensions.

As was seen in Kansas, where the rate paid by pass-through entities was reduced so that it was advantageous for those collecting salaries to reorganize themselves into pass-through entities, many highly paid individuals did so. Bill Self, the state's highest paid employee, does not pay state income tax on millions he earns as the University's men's basketball coach since he uses a Limited Liability Corporation to be compensated for his services rather than a salary.

Various Republican officials have asserted that the new tax bill will put procedures in place to make sure that all person service income such as wages, salaries or pensions will be taxed at the higher rate. This procedure would involve determining for all pass-through entities what "reasonable salaries" are for the owners of the pass-through entities. It is mind-boggling to consider how many more Internal Revenue auditors will be needed to make those "reasonable salaries" determinations for the millions of pass-through entities. So much for a simpler tax code.

Whether it is labeled a war on the middle class or a war on wage earners, it will be a mostly a massive shift of the tax burden from the wealthy and on to everyone else. Shifting the tax burden away from the rich and onto the middle class will eventually reduce economic growth. The question is how much harm will be done by the tax bill and how long it will take for the economic weakness to manifest itself. Related to this is the chance that one of the two classic risks to investors emanating from Federal Reserve action described above will occur before the eventual economic weakness manifests itself. Both of the scenarios of classic risks to the securities markets from Federal Reserve action last only until economic weakness is obvious to such an extent that the Federal Reserve changes course and reduces interest rates.

The latest versions of the tax bills increase the likelihood that negative impacts are likely to be seen sooner rather than later. This could be beneficial to securities that are sensitive to Federal Reserve action, as the economic weakness could dissuade the Federal Reserve from raising interest rates. However, the final version is not yet known.

Previously, the mechanism by which shifts in the tax burden away from the rich and thus onto the middle class eventually resulted in financial crises involved overinvestment. It is not just a coincidence that tax cuts for the rich have preceded both the 1929 depression and the 2007 financial crisis. The Revenue Acts of 1926 and 1928 worked exactly as the Republican Congresses that pushed them through promised. The dramatic reductions in taxes on the upper income brackets and estates of the wealthy did indeed result in increases in savings and investment. However, overinvestment (by 1929 there were over 600 automobile manufacturing companies in America) caused the depression that made the rich, and most everyone else, ultimately much poorer. Likewise, overinvestment, after the Bush tax cuts shifted the tax burden away from the rich and thus onto the middle class, resulted in overinvestment, especially in both residential and commercial real estate. The effects of the resulting financial crisis are still being felt.

As was described in A Depression With Benefits: The Macro Case For mREITs:

In free-market capitalism, capital generates income for the owners of the capital which in turn is used to create additional capital. This is very good. Sometimes, it can be actually too good. As capital continues to accumulate, its owners find it more and more difficult to deploy it efficiently. The business sector generally must interact with the household sector by selling goods and services or lending to them. When capital accumulates too rapidly, the productive capacity of the business sector can outpace the ability of the household sector to absorb the increasing production.

The capitalists, or if you prefer, job creators use their increasing wealth and income to reinvest, thus increasing the productive capacity of the business they own. They also lend their accumulated wealth to other business as well as other entities after they have exhausted opportunities within business they own. As they seek to deploy ever more capital, excess factories, housing and shopping centers are built and more and more dubious loans are made. This is overinvestment. As one banker described the events leading up to 2008 - First the banks lent all they could to those who could pay them back and then they started to lend to those could not pay them back. As cash poured into banks in ever increasing amounts, caution was thrown to the wind. For a while consumers can use credit to buy more goods and services than their incomes can sustain. Ultimately, the overinvestment results in a financial crisis that causes unemployment, reductions in factory utilization and bankruptcies all of which reduce the value of investments.

This time we may have a much shorter overinvestment period and go almost directly to the financial crisis period. This could occur if disruptions to specific sectors precipitate a financial crisis. There is now a significant possibility that disruptions to specific sectors in the economy could be more important than the negative macroeconomic impacts of the Republican tax bill. Eliminating the Obamacare individual mandate, as is currently in the Senate version, would cause there to be 13 million less people with health insurance. Uninsured people spend less on healthcare than those with insurance. Most studies indicate a 25% difference. Thus, fewer insured people will result in less spending on healthcare than would have been the case otherwise. Other than the direct impact on GDP from lower expenditures, there could be financial distress as some firms in the healthcare become unable to pay their debts.

The risks of defaults stemming from weakness in the housing-related sectors probably exceed that of healthcare. The homebuilders are correct in their complaints that most of the tax advantages of home ownership will be eliminated in all of the Republican tax bills. The Senate version now eliminates deductions for state and local taxes, including real estate taxes. The House version allows deduction for real estate taxes up to $10,000. As the homebuilders point out, many more middle- and low-income people will no longer itemize, since the standard deduction has increased, and many other deductions will be reduced or eliminated. Additionally, a lower limit on mortgage interest deduction for new home purchases reduces tax advantages of home ownership.

Thus, as the home-builders now argue, only a few relatively wealthy households that still itemize will get any benefit from the $10,000 real estate tax deduction. For those wealthy households, a $10,000 deduction is not likely to be a major factor when deciding whether to buy a home. The net result could be a significant negative impact on home prices. As we saw in 2007, a decline in real estate prices can easily spillover to the financial sector.

As I said in With A 23.4% Dividend Yield Credit Suisse X-Links Monthly Pay 2xLeveraged Mortgage REIT ETN REML Now More Attractive:

Another potential disruption from the Republican tax bill also stems from the reduction or eliminations of deductions for state and local taxes. As with the real estate impact, the impacts on the finances state and local will vary widely for different regions and locations. There are some jurisdictions that will be severely impacted the reduction or eliminations of deductions for state and local taxes. New York and California are the obvious examples.

Take the example that would be the case if the deduction for real estate taxes were limited to $10,000. There would likely be people in New York and California who were paying $5,000 in property taxes and $5,000 in state and local income taxes. These people would now pay more federal income taxes as compared with someone in a state with no state and local income taxes, who pays $10,000 in property taxes, assume both have the same incomes and itemize. This could cause shifts in businesses out of the states with high state and local income taxes.

The most significant impact could be felt in New York City. In theory, New York and New York City in particular, could reduce income taxes and make up the difference by raising property taxes. This would make sense since New York City residents pay one of the highest state and local income taxes in the nation. Additionally, in terms of tax as percent of market value, New York City residents pay one of the lowest property taxes in the nation.

The flight of businesses from New York City could prompt the government to see the advantage of real estate taxes as compared to income taxes, in that real estate cannot be relocated to another tax jurisdiction. However, given the immense power of the real estate interests in New York City, a much more likely scenario would be that as tenants fled New York City, in response to the tax bill, the real estate interests in New York City would force the government to reduce real estate taxes and make up the difference by raising local income taxes. This scenario or something similar might be played out in various other high-tax localities.

In addition to the various degrees of financial distress and defaults possible from disruption caused by the Republican tax bill, which could cause the Federal Reserve set short-term interest rates lower than what markets are now assuming, there could be other favorable impacts on the bond market. Long-term fixed income securities could also benefit from lower issuance of corporate bonds. Lower corporate income taxes reduce the tax benefits from debt and could give corporations additional funds to pay down debt.

The quandary for investors can be described as someone who has seen the first and last page of a book, but does not know either how long the book is or what happened between the first and last pages. We know that a massive transfer to the rich will happen. We know that the middle class has a much higher marginal propensity to consume than the rich. We know that initially the rich, or if you rather the job creators, use their additional after-tax income to invest. This extra investment could initially boost securities prices. The higher prices for securities could enable investments to occur that might have otherwise been undertaken. These can range from factories, shopping centers and housing. It is during that period that the possibility of the classic Federal Reserve related risks is most severe. What we don't know is the path that equity prices and interest rates will take between the enactment of the tax shift and the eventual financial crisis or similar event occurs. At that point in time, the massive excess supply of loanable funds as compared to demand for loans will push risk-free short-term interest rates down to near the lower bound, as was the case during the depression of 1930s in Japan for decades and in America since 2008.

The length, path and magnitude of a tax-shift induced cycle is particularly important to investors in leveraged instruments, such as high yield 2X leveraged ETNs. No two overinvestment cycles are identical. This time the picture is cloudier since most of the shift in the tax burden from the wealthy to the middle class will be via reductions in business taxes. Reducing taxes on corporations would not increase economic activity. A profit-maximizing corporation will make decisions relating to the level of production, wages and prices that maximize after-tax profit. Since corporate income taxes are a percentage of pre-tax profits, the level of output, wages and prices that maximize pre-tax profits are also the same levels that maximize after-tax profits. This was explained in Get 16.8% Dividend Yield, And Diversify Some ETN Interest Risk. However, that does not mean that changing corporate taxes, other than the rate, cannot impact economic activity.

Allowing immediate expensing of capital expenditures or even just allowing vastly increased accelerated depreciation could bring forward capital expenditures that would have otherwise have taken place in the future. This would be particularly powerful if the immediate expensing or extra accelerated depreciation was set to only last for a specified period. Allowing immediate expensing of capital expenditures could even cause projects that would otherwise be not accepted on a net-present value analysis, and be undertaken as a result of now having expected internal rates of return exceeding the hurdle rate.

There is also a "geographical Laffer Curve effect" when different taxing jurisdictions cause activity to shift from higher tax jurisdictions to those with lower taxes. Generally, this is more pronounced the closer the different jurisdictions are. People driving from New York to New Jersey to pay less sales taxes when they shop are an example. Lower corporate taxes in the U.S. could shift some activity from other countries. Allowing repatriation of corporate profits now nominally held in other countries or just eliminating taxes on foreign earnings could boost the value of shares in multinational corporations. Most major profitable multinationals have ample access to capital regardless of where their cash is located. Thus, very few multinational corporations are not undertaking any projects because of where their cash is located.

The general consensus is that any tax bill will be favorable for the equity markets while the inability to pass any new tax legislation would result in lower economic activity that could favor fixed-income rather than equity. In the short run that might seem correct, if only because so many market participants appear to believe it to be true.

Leveraged High-Yield ETNs and the Rationale for Holding All of Them

Many thought that the 2016 election results would usher in a period of higher interest rates. Rates have risen somewhat since the election. However, 2x Leveraged ETNs that I follow have done very well since the election. Those are in addition to CEFL, the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA:MORL) and the UBS ETRACS 2xLeveraged Long Wells Fargo Business Development Company ETN (NYSEARCA:BDCL).

As I explained in the article 30% Yielding MORL, MORT And The mREITs: A Real World Application And Test Of Modern Portfolio Theory, a security or a portfolio of securities is more efficient than another asset if it has a higher expected return than the other asset but no more risk, or has the same expected return but less risk.

I was originally drawn to 2x leveraged high-yield ETNs as a vehicle to take advantage of my macroeconomic outlook that interest rates would stay much lower for much longer than many market participants believed. MORL was the first one I considered since low interest rates would benefit the leveraged mREITs that comprise the index upon which MORL is based as well as amplifying MORL's dividend via the 2X leverage. In A Depression With Benefits: The Macro Case For mREITs, I explained my view that interest rates were not likely to rise in the intermediate future and the mREITs were a good way to benefit, if my outlook proved correct. Furthermore, MORL would provide a very high yield, in excess of 20%, because of its 2X leverage which involved implicitly borrowing at the three-month LIBOR rate. This would generate a large positive carry.

After UBS came out with CEFL, a 2x leveraged high-yield closed-end fund ETN, I pointed out in 17.8%-Yielding CEFL - Diversification On Top Of Diversification, Or Fees On Top Of Fees? that those investors who have significant portions of their portfolios in mREITs and in particular a leveraged baskets of mREITs such as MORL could particularly benefit from diversifying into an instrument that was correlated to the S&P 500, as mREITs were not very correlated to SPY.

In my article, BDCL: The Third Leg Of The High-Yielding Leveraged ETN Stool, I said that BDCL is highly correlated to the overall market, but may be a very good diversifier for investors seeking high income who are now heavily invested in interest rate sensitive instruments. All leveraged ETNs have interest-rate risk since their dividends fluctuate inversely with the borrowing costs implicit in their leveraged structure. However, MORL has much greater exposure to interest rates than CEFL, and CEFL has more interest rate risk than BDCL. In the continuum from mostly interest rate risk to mostly equity market risk, MORL is the most interest rate sensitive and BDCL is the most equity market sensitive. CEFL is between the two and has some interest rate risk and some equity market risk.

The reason for the difference in relative sensitivity to interest rate and equity market risk amount in the three 2x leveraged high-yield ETNs is due to the composition of the indexes upon which they are based. MORL is based on an index of mREITs. Interest rates impact mREITs in two ways. Higher long-term rates are a two-edged sword for leveraged mREITs like Annaly Capital Management, Inc. (NYSE:NLY). Higher long-term rates reduce the value of their mortgage portfolio and thus the book value of the shares. The other side of the two-edged sword is that higher long-term rates and lower prices of mortgage securities provide an opportunity for mREITs to reinvest the monthly principal payments they receive in higher yielding mortgage securities. A highly leveraged mREIT with, say, 9 to 1 leverage and CPR of 11% would be generating new cash available for reinvestment from prepayments of principal each year approximately equal to the entire equity of the mREIT.

CEFL is based on an index of higher-yielding closed-end exchange-traded funds. Some of the closed-end exchange-traded funds contain common stocks, usually the high dividend paying variety. Many of the closed-end funds in the index that CEFL is based on contain high-yield bonds. These junk bonds are considered to have some equity-like characteristics. However, to the extent that those bonds are longer-term obligations with fixed coupon rates, they are impacted by declines in the overall bond market like that which has occurred since the election. In contrast, it is highly unlikely that any of the business development companies that comprise the index upon which BDCL is based would hold any longer-term obligations with fixed coupon rates. The only debt securities that business development companies would normally hold in the course of their business would be loans to the companies that the business development companies have invested in. Those debt instruments would usually be convertible into equity and have adjustable interest rates. Thus, they would tend not to be hurt by higher interest rates.

Since CEFL yields not that much less than MORL, this suggests that a portfolio consisting of both MORL and CEFL would have close to the yield of a portfolio with only MORL but considerably less risk. My article explained why adding BDCL to such a portfolio could result in a more efficient risk/return profile. The post-election performance of three UBS ETRACS Monthly Pay 2xLeveraged ETNs, MORL, CEFL and BDCL, illustrates the advantages of diversification. All three have very high yields. However, a portfolio consisting of all three would have almost as much yield as a portfolio consisting only of any single one but considerably less risk.

Conclusions and Recommendations

I am still cautiously bullish on CEFL despite the price increases over the past year. CEFL is one of the few instruments that provide a very high yield and some ability to benefit from a rising stock market. However, some of the factors that made me bullish previously are not as pronounced as before. Both of the classic economic risks relating to possible Federal Reserve action would be negative for CEFL. The yield on CEFL is not as high as it has been, and thus, is not now as attractive relative to junk bonds or some other high-yield 2X leveraged ETNs. Additionally, closed-end funds typically trade at either discounts or premiums to book value. On balance, there is a slight bias towards discounts. Because of significant changes in the composition of the index, comparisons of aggregate discounts to book value from previous years may not be very meaningful. Using data available as of November 26, 2017, the average discount to book value of the 30 high dividend closed-end funds that comprise the index upon which CEFL and its unleveraged version YYY is based was 7.46%. This is more than the 6.3% on November 2, 2017. However, it is near the lower end of its range and that suggests caution. As of January 27, 2017, it was 9.28%. As of December 28, 2016, before the rebalancing, it was 9.5%. It was 6.9% on July 28, 2016. This compares to the record 13.8% discount to book value for CEFL on September 18, 2015. Much of the price increase in CEFL since then has been due to the reduction on the discount to book value that the components were trading at.

Some of the dividends paid by the components of CEFL include return of capital. That can be a source of concern. Because of significant changes in the composition of the index, comparisons of the shares of dividends from return of capital to previous levels may not be very meaningful. Data available as of November 21, 2017, indicated that only 9.8% of the CEFL dividend consisted of return of capital. My calculation using available data as of December 28, 2016, before the rebalancing indicated that 17% of the CEFL dividend consisted of return of capital. It had been even higher in previous months.

The risks posed by the prospects of protectionism or a really bad choice to replace Janet Yellen have faded in the eyes of many market participants; however, they cannot be ignored. The new tax law could initially cause a boost to the stock market. Lowering corporate taxes would increase earnings. To the extent that concerns regarding the federal deficit are either discarded or explained away with fantasy dynamic scoring, the fixed-income markets could suffer. Eventually, the shift in the tax burden from the rich to the middle class will result in a recession. The question is how long it will take. It took about four years for the Bush tax cuts to damage the economy enough to cause the 2007 financial crisis. A longer-term holder might want to hold a greater weight in fixed-income related ETNs like MORL based on the belief that the Trump tax policies will eventually depress the economy and force the Federal Reserve to lower rates. Alternatively, someone might want to assign higher weights in their portfolios to relatively more equity related ETNs like CEFL and BDCL if they thought that stocks would be more likely to rise when corporate taxes are cut.

If one was an extreme optimist in terms of the stock market, they might hold out hope that the trade bluster, disputes over tax policy and the now abandoned Border Adjustment Tax proposal might just be the crisis that enables the USA to replace much or all of the income tax with a value added tax. There would be tremendous benefits of doing so. That would be the ultimate example of turning lemons into lemonade. The alternatives of protectionism and possible worse scenarios are horrendous. See: Value Added Tax: A Way Out Of The Trade War Train Wreck?

The uncertainty of policy especially tax policy suggests large fat-tail risks in both directions in the equity market. This would lead investors, who have a significant portion of their portfolios in CEFL, to consider adding MORL to hedge against the risk of much weaker economic growth and BDCL to get the potential gain from much stronger economic growth. This would enable them to maintain the income in the high teens that CEFL now delivers. Likewise, MORL investors might want to consider adding CEFL or BDCL in order to hedge the against a high real growth scenario.

When choosing between CEFL, BDCL and MORL. There are a number of considerations. Even though the average discount to book value for the closed-end funds in the index upon which CEFL is based on has declined from earlier extreme levels, it still is significant. As I discussed in MORL's 19.9% Dividend Yield Has Produced Triple Digit Total Returns, But New Risks Have Arisen, the average discount to book value for the mREITs in the index upon which MORL is based on has recently declined so much that it has now disappeared and has turned into a premium. Thus, in terms of relative value as measured by average discount to book value for the components in the index, CEFL looks better than MORL. The discounts to book value are not available on a timely basis for BDCL.

The yields on all of the high-yielding 2x leveraged ETNs like CEFL are still compelling. However, the uncertainty regarding economic policy means that significant event risks exist in addition to the risks inherent with the ETNs use of leverage. This is in addition to the leverage employed by many of the components that make up the indices upon which these ETNs are based. I am diversifying the large proportion of MORL in my portfolio with some CEFL and BDCL since there is a small possibility of much stronger economic growth than I expect. That enacting the new tax bill will, at minimum, create a greater perception on the part of many market participants of much stronger economic growth should be considered by shorter-term investors. If something catastrophic were to occur, it would be expected that the stock market would decline sharply, but MORL could do better as investors seek the safety of agency mortgage-backed securities and the Federal Reserve lowers interest rates.

There is also a specific risk relating to CEFL in that a once per year rebalancing will occur at the beginning of 2018. Previously, there was some concern that the rebalancing could lead to front-running arbitrage opportunities which could negatively impact holders of CEFL. Changes in the timing of the rebalancing procedure were put in place by those who manage the index upon which CEFL is based which should eliminate front-running arbitrage opportunities. However, there is an inherent uncertainty that results from the possibility of significant changes in the composition of the index upon which CEFL is based.

In view of the uncertainty and risks. Active traders might consider waiting until discounts to book value for CEFL components return to more attractive levels or wait until the Federal Reserve and tax policy pictures become more clear. However, a lesson we can learn from the last few years is that waiting for price declines in high-yielding instruments like CEFL can backfire, as the large dividends forgone by waiting exceeds the savings from a lower purchase price.

My calculation projects a December 2017 CEFL dividend of $0.2546. The implied annualized dividends based on the last three months would be $2.8454. This is a 15.9% simple annualized yield with CEFL priced at $17.88. On a monthly compounded annualized basis, it is 17.1%. With a yield around 17%, without any reinvestment of dividends, you get back your initial investment in about six years and still have your original investment shares intact. If someone thought that over the next five years, equity markets and interest rates would remain relatively stable, and thus CEFL would continue to yield 17.1% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $220,449 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $17,100 initial annual rate to $37,758 annually.

Table I. CEFL Components

Name

Ticker

Weight

Price

NAV

price/NAV

ex-div

dividend

frequency

contribution

Eaton Vance T/a Gl Dvd Incm

ETG

4.73

17.09

18.09

0.9447

11/21/2017

0.1025

m

0.0101

Alpine Total Dynamic Dividend

AOD

4.68

9.03

9.95

0.9075

10/23/2017

0.0575

m

0.0106

Liberty All Star Equity Fund

USA

4.65

6

6.66

0.9009

11/16/2017

0.17

q

0.0470

Calamos Strat Tot Return Fd

CSQ

4.64

12.12

12.73

0.9521

11/9/2017

0.0825

m

0.0113

PIMCO Dynamic Credit Income Fund

PCI

4.46

22.46

23.63

0.9505

11/10/2017

0.1641

m

0.0116

Calamos Convertible Opp&inc

CHI

4.44

11.46

11.31

1.0133

11/9/2017

0.095

m

0.0131

BlackRock Multi-Sector Income

BIT

4.41

18.08

19.9

0.9085

11/14/2017

0.1167

m

0.0102

DoubleLine Income Solutions

DSL

4.39

20.13

21.62

0.9311

11/15/2017

0.15

m

0.0117

Morgan Stanley Emerging Markets Domestic Debt Fund

EDD

4.27

7.71

8.74

0.8822

9/28/2017

0.15

q

Blackstone/GSO Strategic Credit Fund

BGB

4.12

15.65

16.9

0.9260

11/21/2017

0.105

m

0.0099

BlackRock Corporate High Yield Fund

HYT

4.05

10.93

12.2

0.8959

11/14/2017

0.07

m

0.0092

Wells Fargo Advantage Income Opportunities Fund

EAD

4.02

8.38

9.27

0.9040

11/14/2017

0.0564

m

0.0096

BlackRock Credit Allocation Income Trust

BTZ

4.01

13.22

14.8

0.8932

11/14/2017

0.067

m

0.0072

First Trust Intermediate Duration Prf.& Income Fd

FPF

3.98

24.71

25.03

0.9872

11/1/2017

0.1525

m

0.0088

Prudential Global Short Duration High Yield Fund

GHY

3.96

14.45

16.33

0.8849

11/16/2017

0.09

m

0.0088

Cohen & Steers Quality Income Realty Fund Inc

RQI

3.94

12.54

13.8

0.9087

11/14/2017

0.08

m

0.0090

John Hancock T/a Dvd Income

HTD

3.76

25.55

26.11

0.9786

11/10/2017

0.138

m

0.0072

Eaton Vance Limited Duration Income Fund

EVV

3.35

13.56

15.02

0.9028

11/10/2017

0.0806

m

0.0071

Wells Fargo Advantage Multi Sector Income Fund

ERC

3.12

12.91

14.19

0.9098

11/14/2017

0.1077

m

0.0093

Western Asset High Income Fund II

HIX

2.88

6.921

7.73

0.8953

11/22/2017

0.049

m

0.0073

AllianceBernstein Global High Income Fund Inc

AWF

2.71

12.57

13.86

0.9069

11/2/2017

0.0699

m

0.0054

Templeton Emerg Mkts Inc Fd

TEI

2.58

11.48

13.02

0.8817

9/27/2017

0.1119

q

Prudential Short Duration High Yield Fd

ISD

2.22

14.75

16.52

0.8929

11/16/2017

0.0925

m

0.0050

Nuveen Pfd Sec Income Fd

JPS

2.07

10.21

10.35

0.9865

11/14/2017

0.062

m

0.0045

Western Asset High Income Op

HIO

2.06

4.961

5.62

0.8827

11/24/2017

0.029

m

0.0043

First Trust High Income Long/short Fund

FSD

1.7

16.26

18.01

0.9028

11/1/2017

0.1272

m

0.0047

Nuveen Preferred Income Opportunities Fund

JPC

1.57

10.42

10.73

0.9711

11/14/2017

0.065

m

0.0035

Nuveen Credit Strategies Income Fund

JQC

1.19

8.11

9.04

0.8971

11/14/2017

0.0475

m

0.0025

AllianzGI Convertible & Income Fund

NCV

1.17

6.96

6.61

1.0530

11/10/2017

0.065

m

0.0039

BlackRock Debt Strategies Fund Inc

DSU

0.89

11.54

12.68

0.9101

11/14/2017

0.0685

m

0.0019

Disclosure: I am/we are long CEFL, MORL, BDCL, AGNC.

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.