Is High-Yield a Danger Sign or Opportunity in Closed-End Funds?
In a discussion of high-yielding CEFs, I referred to studies that show the highest-yield correlates with total performance for stocks. But the highest-yielding stocks are not the best-performing stocks. Stocks in the highest quintile of dividend yield consistently underperform those of the second quintile which have lower, but still-high yields.
Here’s one chart showing how often US dividend-paying stocks beat the S&P 500 by quintile of dividend yield by decade, from 1930 to 2016.
And here is the average of each decade from 1930 to 2016.
I suggested that the same relationship may apply to closed-end funds, but I knew of no data to support or negate that opinion.
To test that hypothesis, one needs historical data on yield. This is not something that is readily available to those of us who do not have access to historical databases of closed-end funds. But as it happens, I began saving data on a regular basis from the site, cefanalyzer, when it was still running. Cefanalyzer was the most complete database for a vast range of metrics for closed-end funds. Unfortunately, the site no longer exists having been discontinued by its creator. I didn’t start saving cefanalyzer data until August 2016, and then only for a few categories. A category I do have beginning August 27, 2016, is taxable income. I decided to see how yield for the funds in the category correlates with total return through June 12, 2018, a period of just under 22 months.
Obviously, this cannot be a definitive analysis. It is a small snapshot based on the data readily available to me. But it does provide some insight into how performance varies with yield for taxable-income closed-end funds.
Market yield ranged from 3.21% to 21.33%. I divided the 121 funds into quintiles by market yield. The quintile boundaries are:
Oxford Lane Capital Corp. (OXLC) led the group with a 21.33% yield, followed by Eagle Point Credit Company (ECC) at 13.80%, PIMCO High Income Fund (PHK) at 12.46%, AGIC Convertible & Income II (NCZ) at 11.66%, and Virtus Global Multi-Sector (VGI) at 11.76%. It’s an interesting side note that four of the five rank among the top-five yielding taxable-income funds today: OXLC (15.25%), ECC (13.37%), PHK (12.60%, and NCZ (11.44%).
Six of the 121 funds no longer exist, so there are 115 funds that have a performance record through this week. Here is the average total return for each quintile of market yield in August 2016.
As we see, funds in the highest quintile for market yield strongly outperformed the lower-yielding quintiles. The top-yielding funds have beaten the next highest yielders by almost double.
This next chart shows each of the 114 funds to illustrate the range of returns from the funds comprising each market yield quintile.
The top quintile has the greatest range in return with two of the funds, AllianzGI Divers Income & Convertible (ACV) and PIMCO Corporate & Income Opportunity (PTY), turning in total performance records greater than 50% for the 22 months. Both were paying over 10% in August 2016. ACV was a fairly new fund at the start time for this analysis, having an inception date of March 2015. Both have a considerable component of their market gains coming from changes in their premiums/discounts since August 2016. ACV's discount moved from -11.33% to its current -1.26% and PTY has gone from 10.83% to 29.3%. They now have market yields in the mid-8% range (ACV, 8.56% and PTY, 8.24%).
The top quintile’s single loser was PIMCO Global StocksPLUS (NYSE:PGP) which suffered two distribution cuts since August 2016 and is now yielding 9.6% (down from 10.6%). In PGP’s case, the loss is entirely a consequence of a massive decline in the fund’s premium. It was over 100% (that’s not a typo, it had a 106% premium) in August 2016 and is now at 43%.
These three funds illustrate an important point about CEFs that contributes to the differences we see in the returns by yield quintile for the CEFs as compared to stocks. For CEFs, high-yield drives reduced discounts or higher premiums, which in turn add considerable gains to the fund’s market returns. But when high yields come with high premiums, as they often do, the impact of distribution cuts on those premiums can take an immediate toll on returns to shareholders. Losses to market valuation changes (deepening discounts or falling premiums) are a strong risk factor, especially for high-premium funds these losses are all but inevitable when the high yields are not sustained by the portfolio's investment income.
It’s difficult to extrapolate from this limited data set, but these results suggest that one need not be apprehensive about funds with high yields simply on that basis. The widely-repeated cautions on yield-chasing do not seem to apply. For this small snapshot in time, there is evidence that high yield is a premium factor. What matters, unsurprisingly, is the individual funds themselves: the quality of their management, the appropriateness of their strategies, the stability of their distributions, and their potential for changes in discount/premium valuations.
For interested readers, here are the primary data on market yield for the start date in August 2016 and the funds’ total returns through June 12, 2018. I’ve highlighted the top and bottom five values in each column.
Disclosure: I am/we are long OXLC. 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.
Additional disclosure: I am also long several of the funds listed in the appendix table but not discussed directly in the article.
I am not an investment professional and nothing I write here should be taken as professional advice. Everyone's personal situation is unique. It is the role of finance professionals to provide advice in the contexts of an individual's personal situation. What may be right for my investment goals and risk tolerances may well be quite wrong for someone else. Do your own due diligence. Consult with professionals on your own needs, objectives and tax circumstances before you invest. I do not give advice and ask that readers refrain from asking for it.