Let's Learn About CEFs: Searching For 'CEF Aristocrats'

by: David Van Knapp
Summary

Stocks that raise their dividends regularly are commonplace, and for dividend-growth investors, a record of regular increases is a basic requirement.

CEFs have generally higher yields than stocks, but are there CEFs with records of regularly increasing their payouts?

We hunt for such CEFs. Along the way, we learn a little about CEF screeners and how to use them to search for CEFs with particular characteristics.

This is the second article in a series and experiment in group learning about closed-end funds.

As I stated in the first article in this series (Let’s Learn About CEFs: Getting Started), I come at the task of learning about CEFs from the point of view of a dividend growth investor.

That means I also come with certain biases and expectations:

  • I want income that grows regularly and reliably.
  • I want total returns that are competitive with routine stock investing, such as investing in indexes that track the S&P 500.

I readily accept the proposition that your income can grow not only because your assets raise their dividends, but also because you can use dividends to buy and collect more assets.

Nevertheless, one of my first questions in learning about CEFs is, “Do CEFs consistently raise their dividends or distributions, the way that dividend-growth stocks do?”

In stock investing, a Dividend Aristocrat is a company that has raised its dividend for 25 consecutive years and is in the S&P 500. There are more than 50 such companies.

The official list is maintained by S&P, which also has an index based on their list. There is an ETF (NOBL) based on that index too.

For those unfamiliar with dividend growth stocks, I want to demonstrate what their distributions look like. For the following chart, I have chosen five utilities that are all dividend-growth stocks. The chart shows their payout rates each year for the past 10 years.

You can see the common characteristic: All of the payout lines move up and to the right in stair-step patterns. The steps occur at the time of each company’s annual dividend increase.

All of these companies pay dividends four times per year, and once a year, the payout has been increased. Then the next three payouts are at the new amount, until the following year’s increase.

This is what dividend growth investors become accustomed to and expect (knowing that it won't happen 100% of the time). You can see how this sort of predictability and record of steady increases can be comforting, beyond the sheer math of increasing one’s income and contributing to good total returns.

Are there any CEFs that have patterns like that?

How Consistent are CEF Payouts?

It is already obvious with my limited knowledge of CEFs that a CEF Aristocrat – one that has raised its payouts for 25 consecutive years – probably doesn’t exist.

The reason is that CEF payouts are not consistent in the same way that dividend-growth stock payouts are.

For this article, I have experimented with different ways to get a handle on CEF payouts for purposes of understanding their consistency or lack thereof.

As I stated in the first article, I am focusing for the moment on equity CEFs – funds that mostly own stocks. That’s about a quarter of all CEFs.

Within that group, I decided to take a look at CEFs that own mostly utilities. You may recall that I used DNP Select Income Fund (DNP) as an example in my first article. Around 75% of DNP’s assets are utilities.

The reason I decided to start with utilities is that the utility sector is well known for rising dividend payments. There are 16 utilities that are Dividend Champions – stocks that have raised their dividend for 25 consecutive years. (Champions include stocks not in the S&P 500.)

NextEra Energy, shown in the earlier chart, just ascended this year to that status with its 25th consecutive annual increase. In fact, the five stocks in the earlier chart are the top five holdings of DNP.

The rising-dividend characteristic of utilities would seem to give a leg up to any “utility” CEF in terms of being able to raise its own dividends.

That’s the modest goal here: To look at all of the utility CEFs in existence and examine their payout consistency.

The journey now digresses to answer the question: How does one identify all of the utility-based CEFs? That’s part of a broader area of interest that came up a lot in the comments to the first article: How does one find and research CEFs at all?

Finding Particular Kinds of CEFs

Probably the best-known general resource for researching CEFs is CEF Connect. So I started with their fund screener.

The screener has a simple design that offers four first-level screens. I selected Equity. Then at the next level, they offer choices based on fund strategies, but also on sectors. I selected Utilities.

Here is the result of that screen:

The screener found nine CEFs based on utilities. One of them is Reaves Utility Income (UTG), which was mentioned a lot in the comments to the first article.

But what jumped out at me was that DNP is nowhere to be found in the results.

Let’s try a second screener: The Closed-End Fund Center. Its Fund Selector also allowed me to zero in on utility funds, with these results:

This screener included all nine of the CEFs from CEF Connect, plus it returned two more funds (circled), including DNP, which turns out to be the largest utility fund by asset value. Given its prominence, I am not sure why or how CEF Connect missed it.

Fidelity has a CEF screener, with many variables to choose from and multiple levels of narrowing down funds by characteristics. It took some hunting, but I did find a way to select utility CEFs – by their Morningstar category. These were the results:

Only seven CEFs fit the category, including DNP and UTG.

Closed-End Fund Advisors’ screener returned 10 utilities funds, including DNP and UTG.

The takeaway for me from this search exercise is that in doing your own research, you may want to look at two or three resources, because:

  • Classifications and categories can differ,
  • The way to find the characteristic you want may not be obvious.
  • Searchable characteristics, and the number of levels of screening, are different from screener to screener.
  • Different screeners will return varying results for what seem like identical searches.

How Consistent Are Utility CEF Payouts?

OK, now we can return to the central goal of this article, which is to examine the consistency of utility CEFs’ payouts.

Here is a chart of the 5 largest utility CEFs’ payouts over the past 10 years.

This obviously presents an entirely different picture from the dividend growth stocks shown earlier.

One utility fund (Reaves, UTG) has had some payout increases over the past decade, but they are not annual. They don't inspire my confidence the way many common utility stocks do as to predictability or sustainability.

Another utility CEF (BlackRock, BUI) has had decreases. And the other three have been straight flat.

Clearly, if there is to be such a thing as CEF Aristocrats, we won’t be able to use annual increases as a qualification. But I don’t think we should abandon the idea that consistency and reliability are desirable characteristics.

Remembering that we can provide our own growth via reinvestments, perhaps concepts like reliability should be eased to things like this:

  • No cuts in past 5 years
  • No cuts in past 10 years
  • No cuts in past 13 years (which would bring the Great Recession into the timeframe covered)
  • Payout is higher now than it was 5-10-13 years ago, with no cuts in between

For now, I’m just going to hold the idea of regular dividend increases in abeyance. I’m not expecting to find many CEFs with regular increases (or maybe not any at all).

Obviously, the growth in CEF income will mostly come from reinvesting dividends to purchase more shares, not from reliable, increasing dividends from the funds themselves.

Summary

  • The concept of owning CEFs with reliable, increasing income – which is a baseline requirement and taken for granted in dividend growth investing – probably doesn’t exist with CEFs.
  • We saw variant results from a simple search for utility CEFs using different screeners. You probably want to use multiple screeners when you are looking for CEFs with particular characteristics.
  • A decent goal for CEF income reliability may simply be the absence of cuts over the years. The investor can generate the growth part through reinvestments. Of course, past results don’t guarantee future results, but that’s true throughout investing, not just with CEFs.

Disclosure: I am/we are long LNT, SO. 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.