5 Best CEFs To Buy For March 2019 (Income Series)

|
Includes: ASG, CHI, FEN, HQH, RMT
by: Financially Free Investor
Summary

For Income investors, closed-end funds (CEFs) are an attractive class of asset with the premise of high distributions and reasonable total return.

In the CEF world, it is hard to separate the wheat from the chaff. It is even harder to figure out which funds may be attractive buys at a given.

We are starting this as a new periodic series, where we will highlight five CEFs that have a solid track record, pay high distributions and are offering "excess" discounts.

We go over our filtering process to select just five from around 500 closed-end funds. The selected five CEFs, as a group, would offer an average distribution rate of 9.16%.

The markets have recovered strongly since the December lows. As active investors, there are different issues that we face during a strong bull market than a free-falling market. During a bear market, we fear if we are investing too early, or what if the markets keep falling after we have invested. During a rising and a strong bull market, while the issues may be different, we still have to worry about the valuations and what if we were buying near the top.

So, what is an income-focused investor who cannot afford to sit in cash, supposed to do? How do we find good candidates to buy in any kind of market? We generally prefer systematic ways by applying broad-based screening criteria to find out good candidates at any given time.

For income investors, closed-end funds, or CEFs, are an attractive class of asset that promise high income generally in the range of 6-10%, broad diversification in terms of types of assets, and market matching total returns in the long term, if selected carefully.

However, CEFs come with their own set of risks that the investors should be aware of. First, the majority of these funds use some level of leverage generally 15-40% that can act both ways. They generally charge high fees, partly due to the leverage, so the quality of management becomes a very important factor. One way to assess the quality of management is to look at their past track record. We should pay particular attention to the returns on their NAVs (net asset values) over the past 3-year, 5-year and preferably 10-year period. The other risk factor is the higher volatility than the broader indexes caused by the leverage.

For stocks, we can use several well-known metrics to figure out if the stock was overvalued or undervalued at a given time. But it is harder to figure out which CEF funds may be attractive buys at a given time. This is what this series of article will do; to attempt to separate the wheat from the chaff.

We are starting this as a new periodic (monthly) series, where we will highlight five CEFs that are relatively cheap, offer "excess" discounts to their NAVs, pay high distributions, and have a solid track record. We also write a monthly series to identify "5 Safe and Cheap DGI" stocks. You can read our most recent such article here.

We go over our filtering process to select just five CEFs from around 500 such funds. The selected five CEFs, as a group, would offer an average distribution rate of 9.16% and offer an average discount of -7.25%.

Please note that these are not recommendations to buy, but should be considered as a starting point for further research.

We start with a fairly simple goal. We want to shortlist five closed-end funds that are relatively cheap, offering good discounts to their NAVs, paying relatively high distributions and have a solid and substantial past track record. We adopt a methodical approach to filter down the 500-plus funds into a small subset.

Goals for the Selection Process

We want to emphasize our goals before we get to the actual selection process.

Here are our primary goals:

  • High income/distributions
  • Long term reasonable return on the NAV
  • Cheaper valuation, determined by the "excess" discount offered compared to their past history

A well-diversified portfolio would probably consist of more than just five CEFs. We think a CEF portfolio can be an important component in the overall portfolio. One should preferably have a DGI portfolio as the foundation, and the CEF portfolio could be used to boost the income level to the desired level. How much is an appropriate allocation to CEFs? It would depend upon an individual investor's personal situation and factors like the size of the portfolio, income needs, risk-appetite or risk-tolerance. However, as always, we recommend you do your due diligence before making any investment decisions.

Selection Process

We have more than 500 CEF funds to choose from, which come from different asset-classes like equity, preferred stocks, mortgage bonds, govt. and corporate bonds, energy MLPs, utilities, and municipal income. Just like in other life situations, even though the broader choice is always good, but it does make it more difficult to make a final selection. The first thing we want to do is to shorten this list of 500 CEFs to a more manageable subset of around 100 funds. We can apply some criteria to shorten our list, but the criteria need to be broad and loose enough to keep all the potentially good candidates. Also, the criteria that we build should revolve around our original goals.

Criteria to Shortlist:

Criteria

Brings down the number of funds to..

Reason for the Criteria

Baseline expense < 2.0% and Avg. Daily Volume > 100,000

Approx. 435 Funds

We do not want funds that charge excessive fees. Also, we want funds that have fair liquidity.

Market-capitalization > 100 Million

Approx. 420 Funds

We do not want funds that are too small.

Track record/ History longer than 10 years (inception date 2007 or earlier)

Approx. 300 Funds

We want funds that have a long track record.

UNII* Balance > -$1.00

Approx. 280 Funds

A large UNII( Undistributed Net Investment Income ) negative balance would indicate that fund is having problems paying its distributions.

Discount/Premium < +5%

Approx. 250 Funds

We do not want to pay too high a premium, in fact, we want bigger discounts.

Since Inception Annualized Return on NAV > 0%

And 5-Year Annualized Return on NAV > -5%

Approx. 230 Funds

We want funds that have a reasonably good past track record in maintaining their NAVs.

Distribution (dividend) Rate > 5%

140 Funds

The current distribution (income) to be reasonably high.

We still have about 140 funds in our list, which is way too long to present here or meaningfully make a selection of five funds.

Narrowing Down to Less Than 50 Funds

To bring down the number of funds to less than 50, we will apply the following criteria:

Excess Discount/Premium:

We certainly like funds that are offering large discounts (not premiums) to their NAVs. But sometimes, we may consider paying near zero or a small premium if the fund is great otherwise. So, what is important is to see the "excess discount/premium" and may not be the absolute value. We want to see the discount (or premium) on a relative basis to their past record say 52-week average.

By subtracting the 52-week avg. discount/premium from the current discount/premium will give us the excess discount/premium. For example, if the fund has the current discount of -5% but the 52-week avg. was +1.5% (premium), the excess discount/premium would be -6.5%.

Excess Discount/Premium = Current Discount/Premium (Minus) 52-Wk Avg. Discount/ Premium

Once we calculate the excess discount/premium, we will apply the filter that we will only choose the funds that have a negative value (or < than 0%). This will ensure that we are paying less than the 52-week average.

After applying this filter, our number comes down to only 34 funds. The list of 34 funds is presented below:

Ticker

DATE

LEVERAGE %

EXPENSE

PREMIUM

Prem/Dis

RTN ON NAV

RATE

Fund

Name

ASG

3/14/1986

0.86%

1.22%

-6.89%

-8.49%

6.50%

7.59%

Liberty All-Star Growth

ETW

9/28/2005

--

1.09%

-4.14%

-7.56%

5.59%

8.98%

EV Tax-Managed Glb B-W Opps.

CHI

6/28/2002

34.58%

1.29%

-3.01%

-4.63%

9.38%

9.32%

Calamos Convertible Opps & Inc.

CHY

5/30/2003

34.54%

1.28%

-1.07%

-3.88%

8.12%

9.23%

Calamos Convertible & High

QQQX

1/30/2007

--

0.93%

1.15%

-3.67%

10.04%

7.67%

Nuveen NASDAQ 100 Dynamic Over.

FEN

6/17/2004

26.12%

1.56%

-5.47%

-3.66%

8.63%

11.28%

First Trust Energy Inc&Growth.

DHY

7/31/1998

35.31%

1.58%

-7.48%

-3.34%

5.59%

9.70%

Credit Suisse High Yield Bond.

EVT

9/30/2003

21.33%

1.14%

-4.66%

-2.84%

8.57%

8.03%

EV Tax Advantaged Dividend Inc.

IGA

10/26/2005

--

0.97%

-9.37%

-2.28%

6.28%

9.09%

Voya Global Adv & Premium Opp

NSL

10/29/1999

39.26%

1.44%

-11.55%

-2.21%

5.84%

7.53%

Nuveen Senior Income

RMT

12/14/1993

9.71%

0.62%

-11.21%

-2.19%

9.78%

9.64%

Royce Micro Cap Trust

HQL

5/8/1992

--

1.19%

-6.78%

-2.09%

9.18%

7.62%

Tekla Life Sciences Investors.

IAF

12/12/1985

--

1.45%

-5.83%

-2.08%

6.82%

11.26%

Aberdeen Australia Equity

TYG

2/27/2004

32.91%

1.80%

-0.29%

-2.08%

7.92%

10.99%

Tortoise Energy Infrastructure

JDD

9/25/2003

32.45%

1.40%

-7.67%

-1.78%

7.33%

9.06%

Nuveen Diversified Div & Inc.

ETG

1/30/2004

24.98%

1.18%

-8.09%

-1.75%

6.81%

8.02%

EV Tax Adv Global Dividend Inc.

FTF

8/27/2003

25.50%

0.77%

-9.16%

-1.72%

5.63%

10.80%

Franklin Limited Duration Inco.

RQI

2/28/2002

24.45%

1.25%

-8.22%

-1.35%

9.18%

7.82%

Cohen & Steers Qty Inc Realty

SCD

2/24/2004

25.80%

1.25%

-11.30%

-1.20%

5.60%

9.75%

LMP Capital & Income.

EOI

10/26/2004

--

1.10%

-2.60%

-1.11%

6.74%

7.58%

EV Enhanced Equity Income

JRO

7/27/2004

38.25%

1.40%

-10.16%

-1.06%

5.72%

7.65%

Nuveen Floating Rate Inc Opps.

GLQ

4/27/2005

40.74%

2.14%

-6.66%

-1.02%

6.06%

10.03%

Clough Global Equity

CIK

3/23/1987

29.93%

0.87%

-10.98%

-1.01%

6.45%

9.00%

Credit Suisse Asset Mgmt

DSU

3/27/1998

31.49%

0.91%

-11.76%

-0.78%

5.52%

7.72%

BlackRock Debt Strategies Fund

JCE

3/27/2007

--

1.02%

-1.77%

-0.78%

7.89%

7.99%

Nuveen Core Equity Alpha

MCR

7/20/1989

19.12%

0.67%

-11.29%

-0.65%

7.10%

8.86%

MFS Charter Income

HQH

4/23/1987

--

1.03%

-9.67%

-0.55%

10.95%

7.98%

Tekla Healthcare Investors

PPT

2/29/1988

--

0.92%

-7.10%

-0.51%

5.99%

8.45%

Putnam Premier Income

ETY

11/27/2006

--

1.07%

-1.65%

-0.42%

6.10%

8.93%

EV Tax-Managed Div Equity Inc.

EAD

2/28/2003

27.04%

0.92%

-12.00%

-0.41%

7.55%

9.23%

Wells Fargo Adv Inc Opp.

SPE

6/8/1993

28.03%

1.90%

-11.77%

-0.40%

5.88%

10.99%

Special Opportunities Fund

GGT

11/15/1994

8.45%

1.48%

2.69%

-0.29%

7.81%

11.43%

Gabelli Multimedia

UTF

3/30/2004

29.33%

1.35%

-7.12%

-0.24%

9.63%

8.01%

Cohen & Steers Infrastructure

AVK

4/30/2003

40.90%

1.27%

-11.68%

-0.13%

5.70%

9.74%

Advent Claymore Conv & Income

Narrowing Down to 15 Funds

Three-Step process:

We will select the top 5 funds based on each of the three criteria.

Excess Discount/Premium:

We sort our list (of 34 funds) on the excess discount/premium in descending order. For this criterion, the lower the value, the better it is. So we select the top 5 funds (most negative values) from this sorted list.

DATE

LEVERAGE %

EXPENSE

PREMIUM

Prem/Dis

RTN ON NAV

RATE

ASG

3/14/1986

0.86%

1.22%

-6.89%

-8.49%

6.50%

7.59%

ETW

9/28/2005

--

1.09%

-4.14%

-7.56%

5.59%

8.98%

CHI

6/28/2002

34.58%

1.29%

-3.01%

-4.63%

9.38%

9.32%

CHY

5/30/2003

34.54%

1.28%

-1.07%

-3.88%

8.12%

9.23%

QQQX

1/30/2007

--

0.93%

1.15%

-3.67%

10.04%

7.67%

High Current Distribution Rate:

We sort our list (of 34 funds) on current distribution rate. We select the top five funds from this sorted list.

DATE

LEVERAGE %

EXPENSE

PREMIUM

Prem/Dis

RTN ON NAV

RATE

GGT

11/15/1994

8.45%

1.48%

2.69%

-0.29%

7.81%

11.43%

FEN

6/17/2004

26.12%

1.56%

-5.47%

-3.66%

8.63%

11.28%

IAF

12/12/1985

--

1.45%

-5.83%

-2.08%

6.82%

11.26%

TYG

2/27/2004

32.91%

1.80%

-0.29%

-2.08%

7.92%

10.99%

SPE

6/8/1993

28.03%

1.90%

-11.77%

-0.40%

5.88%

10.99%

High Return on NAV:

We then sort our list (of 34 funds) on the Since Inception Return on NAV and select the top 5 funds.

DATE

LEVERAGE %

EXPENSE

PREMIUM

Prem/Dis

RTN ON NAV

RATE

HQH

4/23/1987

--

1.03%

-9.67%

-0.55%

10.95%

7.98%

QQQX

1/30/2007

--

0.93%

1.15%

-3.67%

10.04%

7.67%

RMT

12/14/1993

9.71%

0.62%

-11.21%

-2.19%

9.78%

9.64%

UTF

3/30/2004

29.33%

1.35%

-7.12%

-0.24%

9.63%

8.01%

CHI

6/28/2002

34.58%

1.29%

-3.01%

-4.63%

9.38%

9.32%

Now, we have 15 funds total from the above selections. We should see if there are any duplicates from the above selections. In our current list, there is one duplicate, so we remove it, and we are left with 14 funds.

Final Step: Narrowing Down to Just 5 Funds

In our list of 14 funds, we already have the best candidates as probable buys. But, most likely, we are not buying 14 funds in one instance. So, how do we get the best 5 from an already good list?

We will apply weights to four criteria:

  1. Current discount/premium
  2. Excess discount/premium
  3. NAV return since inception
  4. Current distribution rate

Once we have calculated the weights, we combine them to calculate an overall total weight. The sorted list of 14 funds on the combined weight is presented below. The top five funds are highlighted.

DATE

LEVERAGE %

EXPENSE

PREMIUM

Prem/Dis

RTN ON NAV

RATE

Combined Weight

RMT

12/14/1993

9.71%

0.62%

-11.21%

-2.19%

9.78%

9.64%

31.61

ASG

3/14/1986

0.86%

1.22%

-6.89%

-8.49%

6.50%

7.59%

29.47

HQH

4/23/1987

--

1.03%

-9.67%

-0.55%

10.95%

7.98%

28.20

FEN

6/17/2004

26.12%

1.56%

-5.47%

-3.66%

8.63%

11.28%

27.76

CHI

6/28/2002

34.58%

1.29%

-3.01%

-4.63%

9.38%

9.32%

26.34

SPE

6/8/1993

28.03%

1.90%

-11.77%

-0.40%

5.88%

10.99%

26.28

ETW

9/28/2005

--

1.09%

-4.14%

-7.56%

5.59%

8.98%

26.27

UTF

3/30/2004

29.33%

1.35%

-7.12%

-0.24%

9.63%

8.01%

25.00

IAF

12/12/1985

--

1.45%

-5.83%

-2.08%

6.82%

11.26%

24.73

CHY

5/30/2003

34.54%

1.28%

-1.07%

-3.88%

8.12%

9.23%

22.30

TYG

2/27/2004

32.91%

1.80%

-0.29%

-2.08%

7.92%

10.99%

20.29

QQQX

1/30/2007

--

0.93%

1.15%

-3.67%

10.04%

7.67%

20.19

QQQX

1/30/2007

--

0.93%

1.15%

-3.67%

10.04%

7.67%

20.19

GGT

11/15/1994

8.45%

1.48%

2.69%

-0.29%

7.81%

11.43%

15.41

Final List: RMT, ASG, HQH, FEN, CHI

Our final 5 are the top five from the above table. The only thing we have to ensure that our top 5 are from a diverse set of asset classes. For example, if we find two funds representing very similar assets (say MLPs), we will exclude one of them. (Data is as of Feb. 21, 2019.)

Ticker

RMT

ASG

HQH

FEN

CHI

INCEPTION-DATE

12/14/1993

3/14/1986

4/23/1987

6/17/2004

6/28/2002

CATEGORY

Micro Cap

Equity- growth

Healthcare

Energy - MLPs

Income - Bonds

DISTRIBUTION. FREQ.

Quarterly

Quarterly

Quarterly

Quarterly

Monthly

EFFECTIVE LEVERAGE %

9.71%

0.86%

--

26.12%

34.58%

DISTRIBUTION RATE

9.64%

7.59%

7.98%

11.28%

9.32%

BASELINE EXPENSE

0.62%

1.22%

1.03%

1.56%

1.29%

DISCOUNT / PREMIUM

-11.21%

-6.89%

-9.67%

-5.47%

-3.01%

RTN ON NAV

Since inception

9.78%

6.50%

10.95%

8.63%

9.38%

MARKET CAP

$346 MM

$145 MM

$862 MM

$411 MM

$721 MM

UNII BALANCE

($0.01)

($0.25)

$7.14

$2.08

($0.09)

52 WK AVG

-9.02%

1.60%

-9.12%

-1.81%

1.62%

PRICE- 52 WK AVG

$9.40

$5.83

$21.42

$21.78

$11.04

NAV

$9.81

$5.66

$22.74

$21.76

$10.62

Z-SCORE- 3 MONTH

0.3

1.1

0.1

-0.6

0.5

Z-SCORE- 6 MONTH

-0.6

-0.4

0

-0.4

-0.4

Z-SCORE - 1 YEAR

-1

-1.1

-0.4

-1.1

-0.8

1-Year RTN ON NAV

1.36%

7.98%

1.10%

1.89%

5.91%

3-year Annualized RTN ON NAV

16.15%

19.46%

5.38%

10.89%

13.97%

5 YEAR ANNUALIZED RTN ON NAV

4.41%

8.97%

3.60%

-0.09%

4.65%

It goes without saying that CEFs, in general, have some risks that the investor needs to be aware of. They generally use some amount of leverage, which adds to the risk. This leverage also causes higher fees because of the interest expense in addition to the baseline expense. We want to make sure that the leverage is used effectively by the management team - the best way to know this to look at the long term return on the NAV. Secondly, the market prices of CEFs can be more volatile, as they can go from premium pricing to discount pricing (and vice versa) in a relatively short period of time. Especially, during corrections, the market prices can drop much faster than the NAV (the underlying assets). Generally, we should stay away from paying any premiums over the NAV price unless there are some very compelling reasons.

Conclusion

The underlying purpose of this exercise is to find 5 likely best funds for investment at a given point of time, using the screening process. The term "best funds" may be too strong since they are the best only if you believe in the filtering and selection criteria. Also, please note that these selections are dynamic in nature and will change from month to month (or even week to week). That said, we have tried to find funds that have a solid long-term record, offer high distribution rate and are relatively cheaper and offering a better discount/premium in comparison to their 52-week average. Also, we should make sure that the five funds belong to a diverse group in terms of their nature of underlying assets. So we think that this group makes an excellent watch list for further research.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LYB, HCP, HTA, O, OHI, VTR, NNN, STAG, WPC, MAIN, NLY, ARCC, DNP, GOF, PCI, PDI, PFF, RFI, RNP, STK, UTF, EVT, FFC, HQH, KYN, NMZ, NBB, JPS, JPC, JRI, TLT. 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: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. The author is not a financial advisor. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. The stock portfolios presented here are model portfolios for demonstration purposes.