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

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Includes: CHI, ETW, HQH, IIF, 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.

In this periodic series, we highlight five CEFs that have a solid track record, pay high distributions and are offering "excess" discounts.

We will go over our filtering process to select just five CEFs from around 500 closed-end funds.

The selected five CEFs this month, as a group, are offering an average distribution rate of 9.87% and an average discount of -8.39%.

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, though not all, use some level of leverage usually in the range of 15-40% that can act both ways. They generally charge high fees, partly due to the leverage, so the quality of management becomes an important factor to consider. One way to assess the quality of management is to look at their past long-term track record. We should pay particular attention to the returns on their NAVs (net asset values) over the past 5-year and 10-year period. The other risk factor is the higher volatility than the broader indexes caused by the leverage. Another risk factor may come from asset concentration risk. However, this is easy to mitigate by diversifying into different types of CEFs ranging from equity, equity covered calls, preferred stocks, mortgage bonds, government and corporate bonds, energy MLPs, utilities, and municipal income.

For stocks, we can use several well-known metrics to figure out if the stock was overvalued or undervalued at a given time, even though it is not easy. But it is even harder to figure out the same for CEF funds if they are attractive buys at a given point in time. This is what this series of articles does; to attempt to separate the wheat from the chaff.

Starting last month, we started a new periodic (monthly) series, where we 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 use our multi-step filtering process to select just five CEFs from around 500 available funds. The selected five CEFs this month, as a group, are offering an average distribution rate of 9.87% and offer an average discount of -8.39%. Since this is a monthly series, there will be some selections that may overlap from month to month. For example, three of the selected funds this month also appeared in the list of five last month.

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

Our goals are straightforward and are aligned with most conservative income investors including retirees. 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 in maintaining and growing their NAVs. 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 should 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 should you allocate to CEFs? Each investor needs to answer this question himself/herself based on the personal situation and factors like the size of the portfolio, income needs, risk-appetite or risk-tolerance. 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 at this stage 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. 400 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 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 127 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 average 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 average was +1.5% (premium), the excess discount/premium would be -6.5%.

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

So what is the difference between the 12-month Z-score and this measurement of Excess Discount/Premium? The two measurements are quite similar, maybe with a subtle difference. The 12-month Z-score would indicate how expensive (or cheap) the CEF is in comparison to the 12-months period. Z-score also takes into account the standard deviation of the discount/premium. Our measurement (excess discount/premium) simply compares the current valuation with the last 12-months average.

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 38 funds. The list of 38 funds is presented below:

Ticker

Excess Discount/ Prem

Leverage %

Baseline Expense

Distr. Rate

Current Disc./ Prem

NAV Return Since Inception

Inception Date

Fund Name

ETW

-7.41%

--

1.09%

8.93%

-4.78%

5.72%

9/28/2005

EV Tax-Managed Glb B-W Opps

ASG

-6.15%

0.86%

1.28%

7.19%

-5.76%

6.61%

3/14/1986

Liberty All-Star Growth

CHI

-6.01%

34.58%

1.29%

9.46%

-4.83%

9.40%

6/28/2002

Calamos Convertible Opps & Inc

CHY

-5.70%

34.54%

1.28%

9.40%

-3.21%

8.14%

5/30/2003

Calamos Convertible & High

EFT

-4.37%

35.33%

1.27%

6.32%

-12.99%

5.23%

6/29/2004

EV Floating Rate Income

QQQX

-3.84%

--

0.92%

7.00%

0.45%

10.32%

1/30/2007

Nuveen NASDAQ 100 Dynamic Over

EFR

-3.43%

34.46%

1.30%

6.59%

-12.20%

5.42%

11/24/2003

EV Senior Floating Rate

HQL

-3.25%

--

1.19%

7.71%

-8.30%

9.23%

5/8/1992

Tekla Life Sciences Investors

BGT

-3.05%

29.51%

1.20%

6.07%

-12.60%

5.11%

8/30/2004

BlackRock Floating Rate Inc Tr

ETY

-2.72%

--

1.07%

8.95%

-3.99%

6.29%

11/27/2006

EV Tax-Managed Div Equity Inc

SPXX

-2.68%

--

0.91%

6.85%

0.06%

6.14%

11/23/2005

Nuveen S&P 500 Dynamic Overwri

JFR

-2.52%

37.93%

1.37%

7.66%

-12.37%

5.24%

3/25/2004

Nuveen Floating Rate Income

JRO

-2.49%

37.43%

1.40%

7.82%

-12.10%

5.71%

7/27/2004

Nuveen Floating Rate Inc Opps

JDD

-2.47%

30.61%

1.42%

8.40%

-9.12%

7.36%

9/25/2003

Nuveen Diversified Div & Inc

EOI

-2.08%

--

1.10%

7.50%

-3.36%

6.87%

10/26/2004

EV Enhanced Equity Income

NSL

-1.92%

38.40%

1.44%

7.76%

-11.72%

5.84%

10/29/1999

Nuveen Senior Income

RMT

-1.89%

5.99%

1.07%

8.64%

-11.00%

9.62%

12/14/1993

Royce Micro Cap Trust

EOS

-1.65%

--

1.09%

7.20%

-0.54%

8.11%

1/26/2005

EV Enhanced Equity Income II

ETG

-1.54%

24.98%

1.18%

7.92%

-7.99%

6.93%

1/30/2004

EV Tax Adv Global Dividend Inc

GLQ

-1.53%

40.74%

2.14%

10.62%

-6.90%

6.14%

4/27/2005

Clough Global Equity

CGO

-1.53%

35.69%

1.67%

9.81%

4.00%

7.31%

10/27/2005

Calamos Global Total Return

EVF

-1.42%

35.84%

1.81%

6.44%

-12.89%

5.01%

10/30/1998

EV Senior Income Trust

LGI

-1.31%

13.63%

1.45%

6.90%

-9.70%

6.76%

4/28/2004

Lazard Glb Total Return & Inc

MGU

-1.30%

31.68%

1.75%

7.57%

-15.37%

7.41%

8/26/2005

Macquarie Glb Infrast TR Fund

BDJ

-1.10%

0.00%

0.84%

6.55%

-8.85%

5.35%

8/26/2005

BlackRock Enhanced Equity Div

GDV

-1.06%

23.03%

1.35%

6.20%

-8.24%

7.78%

11/28/2003

Gabelli Dividend & Income

EVT

-1.00%

21.33%

1.14%

7.81%

-2.79%

8.62%

9/30/2003

EV Tax Advantaged Dividend Inc

BOE

-0.86%

--

1.06%

7.07%

-10.83%

5.38%

5/26/2005

BlackRock Enhanced Global Div

USA

-0.62%

0.00%

1.00%

9.82%

-6.72%

8.08%

10/31/1986

Liberty All-Star Equity

FEN

-0.47%

26.12%

1.56%

10.67%

-2.95%

8.79%

6/17/2004

First Trust Energy Inc&Growth

SCD

-0.47%

26.01%

1.25%

9.61%

-10.66%

5.76%

2/24/2004

LMP Capital & Income

IGR

-0.19%

7.77%

1.16%

8.03%

-13.74%

5.15%

2/18/2004

CBRE Clarion Global Real Est I

IIF

-0.14%

--

1.35%

14.35%

-11.85%

9.22%

2/25/1994

MS India Investment

FOF

-0.13%

0.00%

0.96%

8.45%

-5.65%

5.10%

11/20/2006

Cohen & Steers Closed-End Opp

HQH

-0.11%

--

1.03%

7.98%

-9.48%

10.96%

4/23/1987

Tekla Healthcare Investors

RQI

-0.03%

26.43%

1.32%

7.50%

-7.38%

9.37%

2/28/2002

Cohen & Steers Qty Inc Realty

FTF

-0.02%

25.50%

1.22%

10.85%

-7.58%

5.67%

8/27/2003

Franklin Limited Duration Inco

DSU

-0.01%

31.49%

0.91%

7.67%

-11.26%

5.53%

3/27/1998

BlackRock Debt Strategies Fund

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 38 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.

Ticker

Excess Disc./ Prem

Leverage %

Baseline Expense

Distr Rate

Distr Freq

Current Disc./ Prem

NAV Return Since Inception

Inception Date

ETW

-7.41%

--

1.09%

8.93%

M

-4.78%

5.72%

9/28/2005

ASG

-6.15%

0.86%

1.28%

7.19%

Q

-5.76%

6.61%

3/14/1986

CHI

-6.01%

34.58%

1.29%

9.46%

M

-4.83%

9.40%

6/28/2002

CHY

-5.70%

34.54%

1.28%

9.40%

M

-3.21%

8.14%

5/30/2003

EFT

-4.37%

35.33%

1.27%

6.32%

M

-12.99%

5.23%

6/29/2004

High Current Distribution Rate:

We sort our list (of 38 funds) on current distribution rate. We select the top five funds from this sorted list.

Ticker

Excess Disc./ Prem

Leverage %

Baseline Expense

Distr Rate

Distr Freq

Current Disc./ Prem

NAV Return Since Inception

Inception Date

IIF

-0.14%

--

1.35%

14.35%

S

-11.85%

9.22%

2/25/1994

FTF

-0.02%

25.50%

1.22%

10.85%

M

-7.58%

5.67%

8/27/2003

FEN

-0.47%

26.12%

1.56%

10.67%

Q

-2.95%

8.79%

6/17/2004

GLQ

-1.53%

40.74%

2.14%

10.62%

M

-6.90%

6.14%

4/27/2005

USA

-0.62%

0.00%

1.00%

9.82%

Q

-6.72%

8.08%

10/31/1986

High Return on NAV:

We then sort our list (of 38 funds) on the Since Inception Return on NAV and select the top 5 funds.

Ticker

Excess Disc./ Prem

Leverage %

Baseline Expense

Distr Rate

Distr Freq

Current Disc./ Prem

NAV Return Since Inception

Inception Date

HQH

-0.11%

--

1.03%

7.98%

Q

-9.48%

10.96%

4/23/1987

QQQX

-3.84%

--

0.92%

7.00%

Q

0.45%

10.32%

1/30/2007

RMT

-1.89%

5.99%

1.07%

8.64%

Q

-11.00%

9.62%

12/14/1993

CHI

-6.01%

34.58%

1.29%

9.46%

M

-4.83%

9.40%

6/28/2002

RQI

-0.03%

26.43%

1.32%

7.50%

M

-7.38%

9.37%

2/28/2002

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 [CHI], 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. So, how do we get the best 5 from an already good list?

We will apply weights (from 0 to 10) to each of the four criteria:

  • Current distribution rate
  • Current discount/premium
  • Excess discount/premium
  • NAV return since inception

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.

Ticker

Distr. Rate

Current Disc./ Prem

Excess Disc/Prem

NAV Return since Inception

Combined Weight

Distr. Rate

Dis/ Prem

Excess Ret

NAV Ret

RMT

8.64%

-11.00%

-1.89%

9.62%

30.15

8.64

10.00

1.89

9.62

CHI

9.46%

-4.83%

-6.01%

9.40%

29.70

9.46

4.83

6.01

9.40

IIF

14.35%

-11.85%

-0.14%

9.22%

29.36

10.00

10.00

0.14

9.22

HQH

7.98%

-9.48%

-0.11%

10.96%

27.57

7.98

9.48

0.11

10.00

ETW

8.93%

-4.78%

-7.41%

5.72%

26.84

8.93

4.78

7.41

5.72

CHY

9.40%

-3.21%

-5.70%

8.14%

26.45

9.40

3.21

5.70

8.14

EFT

6.32%

-12.99%

-4.37%

5.23%

25.92

6.32

10.00

4.37

5.23

ASG

7.19%

-5.76%

-6.15%

6.61%

25.71

7.19

5.76

6.15

6.61

USA

9.82%

-6.72%

-0.62%

8.08%

25.24

9.82

6.72

0.62

8.08

GLQ

10.62%

-6.90%

-1.53%

6.14%

24.57

10.00

6.90

1.53

6.14

RQI

7.50%

-7.38%

-0.03%

9.37%

24.28

7.50

7.38

0.03

9.37

FTF

10.85%

-7.58%

-0.02%

5.67%

23.27

10.00

7.58

0.02

5.67

FEN

10.67%

-2.95%

-0.47%

8.79%

22.21

10.00

2.95

0.47

8.79

QQQX

7.00%

0.45%

-3.84%

10.32%

20.39

7.00

-0.45

3.84

10.00

Final List

(RMT), (CHI), (IIF), (HQH), (ETW)

Our final 5 are the top five from the above table. The only additional factor that 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 March 29, 2019.)

Ticker

RMT

CHI

IIF

HQH

ETW

AVERAGE of 5 Funds

INCEPTION-DATE

12/14/1993

6/28/2002

2/25/1994

4/23/1987

9/28/2005

CATEGORY

Micro Cap

Income - Bonds

Asia (India)

Health-care

Covered Call

DISTRIBUTION. FREQ.

Quarterly

Monthly

Semi-Annual

Quarterly

Monthly

EFFECTIVE LEVERAGE %

5.99%

34.58%

--

--

--

8.11%

DISTRIBUTION RATE

8.64%

9.46%

14.35%

7.98%

8.93%

9.87%

BASELINE EXPENSE

1.07%

1.29%

1.35%

1.03%

1.09%

1.17%

DISCOUNT / PREMIUM

-11.00%

-4.83%

-11.85%

-9.48%

-4.78%

-8.39%

MARKET CAP

$331 MM

$710 MM

$291 MM

$862 MM

$1048 MM

$648 MM

UNII BALANCE

($0.01)

($0.09)

($0.12)

$7.14

($0.48)

$1.29

52 WK AVG Discount/Premium

-9.11%

1.18%

-11.71%

-9.37%

2.63%

-5.28%

Z-SCORE- 3 MONTH

0

-0.6

-0.08

0.2

-1.2

-0.34

Z-SCORE- 6 MONTH

-0.1

-0.3

0.1

0.3

-1.2

-0.24

Z-SCORE - 1 YEAR

-0.8

-1.0

-0.1

-0.1

-1.8

-0.76

5 YEAR ANNUALIZED RTN ON NAV

3.93%

5.17%

9.49%

6.07%

5.29%

5.99%

10 YEAR ANNUALIZED RTN ON NAV

13.85%

12.46%

12.36%

14.71%

9.42%

12.56%

ANNUALIZED RTN ON NAV Since Inception

9.62%

9.40%

9.22%

10.96%

5.72%

8.98%

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. In the tables above, we have used the baseline expense only. However, three of our selections this month do not use leverage. Also, we want to make sure that the leverage is used effectively by the management team - the best way to know this is to look at the long term returns on the NAV. NAV is the “Net Asset Value” of the fund after counting all expenses and after paying the distributions. So if a fund is paying high distributions and maintaining or growing its NAV over time, it should bode well for its investors. Further, 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 each month, 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 can change from month to month (or even week to week). As you could see, our current list of the month has retained three names from the last month but has replaced two with new names.

Nonetheless, 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 have tried to pay attention not to allow duplicity in asset-classes among the five funds and have selected them from a diverse group. So we believe that this group makes an excellent watch list for further research.

Disclaimer: 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.

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.