Seeking Alpha

The 8% Income Portfolio: Why It Deserves A Place In Your Retirement Strategy

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Includes: ARCC, AWF, BBN, BND, CEFL, CHY, DNP, EFA, ET, GBAB, GOF, HQH, HYB, IIF, KYN, MAIN, NBB, NLY, NMZ, PCI, PDI, PFF, RFI, RNP, STK, UTF, VTI
by: Financially Free Investor
Summary

We discuss why a high-income CEF-based portfolio may deserve a place in your overall portfolio strategy.

To justify our thesis, we performed some extensive back testing using CEF-based portfolios all the way from the year 1995. The results were not disappointing.

Our own ‘8% CEF Income’ portfolio completes five years on Oct. 17, with initial positions built over the first two years. We will review the progress.

Usually, many people associate closed-end funds with high risk, high fees, and high leverage. Some would argue that they have no place in a conservative or retirement portfolio. We tend to differ. We believe that in spite of their obvious risks if used the right way, they can provide high-income, moderate risk and at the same time, provide market-matching returns. Even so, at times, their market prices can be volatile, certainly more than some of the dividend stocks. So, we do not advocate a very large allocation to CEFs, but 20%-25% could be appropriate for most investors. It's not about all in or nothing - it's about the right proportions. Appropriateness and the right amount of exposure to a specific type of investment usually depend on several factors, including an individual’s goals, risk tolerance, and personal situation.

We will go over both the benefits and the associated risks of investing in a high-income portfolio strategy. However, we believe that there are more positives than downsides, and that’s why it deserves a place in your overall strategy. Sure, if you have a very large investment pool and your income needs do not exceed 3%-4% of your investment capital, there may not be a need at all to go for a higher income portfolio. But that's not the case for so many other investors who have to draw enough income from a much smaller investment pool. So, how much risk are we talking about? Our back testing shows that risks with a properly planned high-income portfolio are no greater than the S&P 500, in fact, they are much less.

We will run several back-testing examples to provide you a glimpse of benefits vs. risks in comparison to the broader market index. If used in the right proportions in terms of allocation, a CEF portfolio may provide higher income, lower risk, and the longevity to an income-focused portfolio. In the end, we will provide some updates on our nearly five-years-old model portfolio, "The 8% Income CEF Portfolio," as a continuation of regular series here on SA.

Back-Test: (10-CEF Portfolio)

Starting year: 1995 (January 1995)

Invest over ten years: 10 years ($10,000 a year)

Total investment: $100,000

Ending year: August 2019

Income withdrawn: 6% with 2.5% increase every year.

Benchmark (for comparison): S&P 500

Why 1995 as the beginning year?

By selecting 1995 as the beginning year, we would be making purchases at increasingly higher prices, especially in 1997-1999. But the subsequent bear market from 2001 to 2003 would even out our cost basis. By selecting the period from 1995 to 2019, we were able to include two full-blown bear markets and two bull-market periods.

CEF selection

We selected 10 CEFs that were introduced in 1994 or earlier. Selecting CEFs with such a long history is a little tough since a lot of popular CEFs today did not exist before 2004 or 2005. Moreover, we wanted to make sure that each CEF belonged to a different asset class. First, we will include 10 CEFs that we felt had a reasonable history and proven management. Later on, to remove the selection bias, we created a second group by replacing six funds that had a good record by other funds that did not have a very good performance record. These six funds have had a meager 5% return (including distributions) since their inception. Let’s say we were not good at picking the winners and so ended up picking an average set of funds, some good, some bad and a few average ones.

Let’s see how our two groups of funds did from 1995 to 2019 in comparison to S&P500.

Table: The First Group of 10 CEFs (Group-1)

Ticker

Name

Allocation

Inception

Date

NAV Return Since Incep.

BTO

John Hancock Financial Opportunities Fu

10.00%

8/18/1994

11.05%

HQH

Tekla Healthcare Investors

10.00%

4/23/1987

10.55%

AWF

AllianceBernstein Global High Income Fund

10.00%

7/28/1993

10.54%

PFO

Flaherty And Crumrine Preferred and Income

10.00%

2/13/1992

8.57%*

RFI

Cohen & Steers Total Return Realty Fund

10.00%

9/27/1993

10.34%

HYB

New America High Income Fund

10.00%

2/26/1988

9.75%

MSD

Morgan Stanley Emerging Markets Debt Fund

10.00%

7/23/1993

9.23%

GAB

Gabelli Equity Trust

10.00%

8/21/1986

9.98%*

PEO

Adams Natural Resources Fund

10.00%

1/30/1929

7.28%*

MYF

Blackrock MuniYield Investment Fund

10.00%

2/28/1992

6.44%

Average

9.37%

*The return is on price (since inception) as NAV return was not available.

The Second Group of 10 CEFs: Group-2

As stated earlier, we created this second group by replacing six funds in the first group that had a good record with funds that did not have a very good performance record. These six new funds have had only a 5%-6% return (including distributions) since their inception (over 25-35 year period). Let’s assume we were not very good at picking the good funds at the time and so ended up picking up an average (or below average) set of funds, some good, some bad and a few average ones.

TABLE: Group-2

Ticker

Name

Allocation

Inception

Date

NAV Return Since Incep.

BTO

John Hancock Financial Opportunities Fu

10.00%

8/18/1994

11.05%

HQH

Tekla Healthcare Investors

10.00%

4/23/1987

10.55%

FCO

Aberdeen Global Income Fund

10.00%

2/28/1992

5.99%

PDT

John Hancock Premium Dividend Fund

10.00%

12/21/1989

8.13%

RFI

Cohen & Steers Total Return Realty Fund

10.00%

9/27/1993

10.34%

CIK

Credit Suisse Asset Management Inc Fund

10.00%

3/23/1987

6.57%

JEQ

Aberdeen Japan Equity Fund

10.00%

7/24/1992

1.94%

EEA

European Equity Fund

10.00%

7/23/1986

5.19%

PEO

Adams Natural Resources Fund

10.00%

1/30/1929

7.28%*

MFT

Blackrock MuniYield Investment Quality Fund

10.00%

10/30/1992

6.15%

Average

7.31%

*The return is on price (since inception) as NAV return was not available.

The Third Group of 10 CEFs: Group-3

Let’s assume we further water down the quality of our CEFs. As we see BTO and HQH were the star performers in Group-1 and Group-2. Lets replace them with very mediocre CEFs namely PPR and HIO.

TABLE: Group-3

Ticker

Name

Allocation

Date

NAV Return Since Incep.

PPR

Voya Prime Rate Trust

10.00%

5/12/1988

4.50%

HIO

Western Asset High Income Opportunity Fund

10.00%

10/22/1993

5.71%

FCO

Aberdeen Global Income Fund

10.00%

2/28/1992

5.99%

PDT

John Hancock Premium Dividend Fund

10.00%

12/21/1989

8.13%

RFI

Cohen & Steers Total Return Realty Fund

10.00%

9/27/1993

10.34%

CIK

Credit Suisse Asset Management Income F

10.00%

3/23/1987

6.57%

JEQ

Aberdeen Japan Equity Fund

10.00%

7/24/1992

1.94%

EEA

European Equity Fund

10.00%

7/23/1986

5.19%

PEO

Adams Natural Resources Fund*

10.00%

1/30/1929

7.28%*

MFT

Blackrock MuniYield Investment QualityF

10.00%

10/30/1992

6.15%

Average

6.18%

*The return is on price (since inception) as NAV return was not available.

Portfolio Performance from Jan. 1995 to Aug. 2019

Assumptions:

  • We invested $10,000 every year from 1995 to 2004 (first trading day, every January).
  • Over 10 years, the total original investment amounted to $100,000.
  • We would withdraw 6% income from this portfolio (every year at the year-end) on the invested capital and take an increase of 2.5% per year for inflation adjustment.
  • The beginning date is January 1st, 1995. The end date is Aug. 31st, 2019.

Performance Comparison of the 10-CEF portfolios with S&P 500:

From Jan. 1995-Aug. 2019

Group-1

Group-2

S&P500

Group-3

Total Original Investment (Invested over 10 years from 1995 to 2004)

$100,000

$100,000

$100,000

$100,000

Total Income Withdrawn

$153,730

$153,730

$153,730

$153,730

Net Investment Value (Sept. 1st., 2019) - when income withdrawn

$277,615

$161,981

$93,727

$89,581

Net Investment Value (Sept 1st., 2019) - If income was NOT withdrawn

$677,278

$504,482

$447,337

$397,466

Compounded (annualized) Return (in addition to income)*

5.24%

2.44%

-0.32%

-0.55%

Compounded (annualized) Return (If no income was withdrawn)*

10.04%

8.43%

7.78%

7.14%

*Annualized returns were calculated based on 20 years (not 25 years) since the investment was made over ten years.

**Performance of S&P500 has been taken from the Vanguard 500 Index fund.

Group-1 Portfolio Return and Income Calculations:

Group-2 Portfolio Return and Income Calculations:

S&P 500 Return and Income Calculations:

Group-3 Portfolio Return and Income Calculations:

Over nearly 25 years, our Group-1 10-CEF portfolio performed very well, provided inflation-adjusted 6% income every year and still provided nearly 5.25% compounded return in terms of capital appreciation. Group-2 also did OK and a lot better than the S&P 500. However, if you had put the same amount in S&P 500, after taking inflation-adjusted 6% income every year, S&P 500 did not perform nearly as well and ended up providing negative appreciation in the capital. Group-3 performed slightly inferior to the S&P 500.

We do agree that there's some element of selection bias irrespective of what kind of CEFs we picked. That said, we picked CEFs from every asset class, including energy and natural resources, which we all know have done quite poorly in the last few years. Especially, Group-2 and Group-3 are filled with a majority of mediocre CEFs.

In our view, the success of 10-CEF portfolios (Group-1 and Group-2) boils down to the following factors:

  • Wide diversification among varied asset classes - some of them have low correlation with the stocks. Investment over long periods (in a staggered manner). By doing so, even though we bought at the very peak prices during 1996-1999, but we also bought at the bottom during the recession of 2001-2003.
  • For Group-1, some credit goes to the selection of CEFs that have a good track record maintaining their NAVs. We need to be careful to be selective about which CEFs we buy into. Not all are equal in terms of quality.
  • Selected CEFs should have yields over 6%-8% and possibly have positive UNII (Undistributed Net Investment Income). This may not apply to some categories of CEFs.

Our "8% Income CEF" Portfolio: 5 years in the making

We started this model portfolio in October 2014, and since then, we have published several periodic updates on SA. At the start, this portfolio had twin goals - first, to provide 8% income (by way of dividends and distributions), and secondly, provide some capital appreciation over the long term. For income-seeking investors, 8% income will allow a withdrawal rate of up to 6% and leave 2% for growth.

Author’s Note: This model portfolio is part of our “High Income DIY Portfolios” SA Marketplace service. For more details, please see at the top of the article, just below our logo.

Comparable Performance to the S&P 500 with Less Volatility:

The chart below shows the performance of the 8% CEF Portfolio with the S&P 500 during the volatile period of January 2018 to year-to-date 2019. The movement of the portfolio is similar to the S&P 500 but with much less volatility. The reasons are two fold. First, we have 10%-15% cash in the portfolio that keeps the volatility down and provides an opportunity to buy at lower prices. Secondly, the constant flow of over 8% distributions into the portfolio lowers the volatility. For instance, we had a correction of nearly 20% during December 2018, but the CEF portfolio dipped only about 11% during that time. Then as the markets recovered, the portfolio recovered very strongly as well.

True to its name, this portfolio continues to generate high income, thus meeting its primary goal. Even though the total return of the portfolio is important to many folks, it's a secondary goal to us since we know that the stock market never moves in a straight line. There will be ups and downs along the way, as shown by the above chart. In fact, we should take advantage of lower prices when there are substantial discounts available. From time to time, we put additional cash to work when the price of a security is low, or the overall market is taking a beating. We provide real-time updates to the members of our HIDIY marketplace service.

Some Background:

Here's some brief background for the new readers. A total amount of $100,000 was initially allocated to the portfolio, and another $100,000 was contributed in the next 12 months ($8,333 in 12 installments). No more fresh money was added thereafter.

Cash added/contributed:

Initial Investment 10/17/2014:

$100,000

From Nov. 1st, 2014

until Oct 1st, 2015

$100,000

12 installments of $8333.33

TOTAL Contribution

(Cost basis)

$200,000

The primary goal of this portfolio was providing a durable income stream in good times and bad. The investment strategy was to utilize CEFs (closed-end funds), which generally use some amount of leverage to generate high distributions. To start with, initially, we had chosen to invest in as many as 13 funds (11 CEFs, one ETN and one ETF) to provide us broad diversification, high distributions, and exposure to different types of assets such as equity, bonds/credit securities, utility, infrastructure, energy MLPs, preferred income, floating-rate income, technology sector, healthcare, etc. Subsequently, during the following years, we have added a few more funds and four individual company stocks to the portfolio from the BDC/mREIT/MLP sectors. However, these individual stocks form only about 11% of the portfolio size.

Portfolio Composition:

Here's the current portfolio consisting of 21 securities, four individual company stocks, and 17 funds:

Fund/Stock Name

SYMBOL

Fund's composition

1

DNP Select Income (NYSE: DNP)

DNP

Utility (80%)

2

Kayne Anderson MLP (NYSE: KYN)

KYN

(MLP - Master Limited Partnership)

3

Guggenheim Strategic Opp Fund (NYSE: GOF)

GOF

Equity CEF fund

4

Columbia Seligman Premium Tech Growth (NYSE: STK)

STK

Equity CEF fund

5

Nuveen Muni High Inc Opp (NYSEMKT: NMZ)

NMZ

Muni Tax-Free ( Tax-free yield)

6

PIMCO Dynamic Credit Income (NYSE: PCI)

PCI

Global Income, including corporate debt, mortgage-related and other asset-backed securities

7

PIMCO DYNAMIC INCOME FD (NYSE: PDI)

PDI

Debt obligations and other income-producing securities

8

ISHARES US PREFERRED STOCK ** ETF **

(NYSEARCA: PFF)

PFF

Preferreds 90% (This is an ETF, not CEF)

9

COHEN & STEERS TOTAL RETURN REALITY Fund (NYSE: RFI)

RFI

REIT (Real Estate) CEF

10

COHEN & STEERS REIT & Preferred Income Fund (NYSE: RNP)

RNP

Preferred is 48%, 50% REIT

11

Cohen & Steers Infrastructure (NYSE: UTF)

UTF

Utility+Infrastructure (50% is International)

12

UBS ETRACS Monthly Pay 2xLeveraged ETN (NYSEARCA: CEFL)

CEFL

Exchange-Traded Note (based on the index of CEFs)

13

Tekla Healthcare Investors ( HQH)

HQH

Healthcare/Biotechnology

14

Annaly Capital Management, Inc (NYSE: NLY)

NLY

mREIT

15

Main Street Capital Corp (NYSE: MAIN)

MAIN

BDC (Business Development Co)

16

Ares Capital Corp ( ARCC)

ARCC

BDC

17.

Morgan Stanley India Investment Fund ( IIF)

IIF

Emerging Mkt Equity – India specific

18.

Calamos Convertible & High Income Fund ( CHY)

CHY

Convertible and Debt Securities

19

New America High Income Fund (HYB)

HYB

High Income - Leveraged

20.

Energy Transfer LP (ET)

ET

MLP - Partnership

21

AllianceBernstein Global High Inc (AWF)

AWF

Global Income

MAIN, NLY, and ARCC: Three Individual Stocks

MAIN, NLY, and ARCC are the only three individual company securities in this portfolio which are not funds (every other security is a fund). MAIN and ARCC are in the BDC sector, whereas NLY is an mREIT. ARCC was added in 2017. All three put together form only about 10% of the portfolio value.

CEFL:

This is an ETN (exchange-traded note) sponsored by UBS ETRACS and is linked to the 2x leveraged performance of the underlying "ISE High Income Index." We have not invested any new money in this security since mid 2015. If you were to look at it only from the price-performance point of view, you would find its performance to be disappointing. But that's just half the picture. Since this is a 2x leveraged product and provides hefty dividends normally in the range of 17%-20%, after adding the dividends, it has performed reasonably well, providing positive returns on the invested capital when we include the dividends compared to a loss without including dividends. Even though it has performed well for our portfolio, this is still a high-risk security - that’s why we have limited our position to roughly 2.5% of the portfolio size. That said, we intend to hold our current position and may add more at an opportune time. We like to caution that there are additional risks that come with an ETN product which the investor should be aware of. They are widely discussed in many other articles on the SA forum.

HQH:

Tekla Healthcare is the only fund from the healthcare sector in our portfolio. The fund has a good record. Even though the fund has struggled in recent times, the long-term future looks bright, given the tailwinds to the healthcare sector.

PFF:

PFF is an ETF (not a CEF) and uses no leverage. It has roughly $15 billion in assets and provides a broad and diversified portfolio of preferred securities. The fund caps any single issuer’s weight at 10%, to limit concentration risk. PFF charges a competitive fee.

DNP, UTF:

These two funds overlap each other to some extent. DNP invests in the utility sector, whereas UTF invests both in utility and infrastructure sectors.

GOF:

The fund invests in the US government and agency issued fixed income debt and senior equity securities, corporate bonds, mortgage, and asset-backed securities. It also utilizes an options strategy. The fund carries a premium most of the time and currently yields 11.5%.

STK:

STK is an equity CEF and invests primarily in the technology sector. The fund currently yields 10.8%. The fund deploys an options strategy, most of the distributions come from capital gains. The fund is somewhat risky but also can provide high growth in good times. Due to the large appreciation since we invested, and some recent buys, the fund is just about 6% of our portfolio.

RFI, RNP:

Both RNP and RFI are from the Cohen & Steers fund family and have some overlap in the types of securities they invest in. RNP is a sort of hybrid fund, which invests roughly 50% in real estate (REITs) and the balance 50% in preferred and debt securities. It also provides some exposure to international preferred securities as an added benefit.

RFI is invested in equities of real estate securities. It also invests roughly 15% in the preferred securities issued by the real estate companies.

Both funds have a solid history, provide decent yields and relatively low expense ratio. RFI does not use leverage, whereas RNP uses roughly 25% leverage.

PCI and PDI:

These are the two PIMCO funds in our portfolio. The funds are quite similar in terms of their assets and objectives. Both funds have large exposure to mortgage debt. Due to a strong recovery in the housing market and steep fall in mortgage delinquencies, this asset class is likely to keep performing well into the future. We own both as they are equally strong performers.

KYN, ET:

KYN is our fund for the MLP sector. The past few years have been tough for the sector. KYN provides exposure to some of the best companies in the MLP sector without the headache of K-1 (partnership) tax treatment.

We added ET (Energy Transfer) to the portfolio this year, our first partnership that issues K-1. The price and dividends were too attractive to pass up.

NMZ:

NMZ is the diversified Municipal fund from Nuveen’s family. This fund is tax exempt and should be used in a taxable account. If the portfolio was maintained in a tax-deferred account, we could replace NMZ by BlackRock Taxable Muni Fund (NYSE: BBN), Guggenheim Taxable Muni Fund (GBAB), or Nuveen Build America Bond (NBB).

IIF:

This is an emerging market, country-specific equity fund focused on India. The fund uses zero leverage, and the fee is reasonable. Since this is country specific, we will limit our allocation not to exceed 2.5% of the portfolio.

CHY:

The fund invests in convertible securities (45%), debt securities (40%) and preferred securities (6%). The fund is sponsored by Calamos Advisors. It provides monthly distributions and uses a leverage of about 33%.

Sector Allocation:

Position-wise Holdings:

Income Distribution Chart:

Sale/Purchases made since January 2019:

We made some opportunistic buys in the year 2019, reducing our cash reserve and increasing the income.

Symbol

Buy/Sell and

Date

Shares and

Price

Amount

CHI

Buy

04/16/2019

285

$10.50

$2,992.50

IIF

Buy

04/16/2019

141

$21.15

$2,982.15

NLY

Buy

06/14/2019

220

$9.08

$1,997.60

ET

Buy

7/29/2019

207

$14.45

$2991.15

HYB

Buy

8/9/2019

350

8.57

$2999.50

AWF

Buy

9/20/2019

251

11.95

$2999.45

Dividends:

Total dividend earned in 2019 (Jan-Sept): $14,444

Total dividends earned until the end of 2018: $64,162

Total dividends earned since portfolio inception: $78,606 ($64,162+$14,444)

(This includes $1,382 from securities already sold.)

The projected dividend for the full year 2019 is $21,500. The current yield-on-cost (YOC) is 10.75%. If you were to invest today in this portfolio, you would still get an attractive yield of 7.25%. The current cash reserve of $28,730 represents just under 10% of the portfolio.

Security-wise dividends:

Symbol

Total until 3 rd QTR. 2019

Dividend since portfolio inception until 2018

Total Dividend As of Now

Symbol

Total until 3 rd QTR. 2019

Dividend since portfolio inception until 2018

Total Dividend As of Now

ARCC

421.6

679.4

1101

NLY

690.8

2745

3435.8

CEFL

783.86

5702.09

6485.95

NMZ

724.47

3304.58

4029.05

CHI

114

0

114

PCI

1506.75

6385.33

7892.08

DNP

763.12

3998.06

4761.18

PDI

1076.58

6601.45

7678.03

GOF

1355.4

4752.63

6108.03

PFF

621.71

3227.71

3849.42

HQH

1074.2

1429.52

2503.72

RFI

765.89

4331.63

5097.52

IIF

0

0

0

RNP

823.76

4111.74

4935.5

KYN

965.52

4249.71

5215.23

STK

1221

4134.32

5355.32

MAIN

660.38

2762.32

3422.7

UTF

874.96

4364.51

5239.47

ET

0

0

0

HYB

0

0

0

AWF

0

0

0

Total dividend since inception = $78,606 (64,162 + 14,444)

Performance:

The tables below show the portfolio, first sorted on "Ticker" followed by sorted on "Total Return."

Also, here is the current portfolio (sorted on Ticker) as of 09/30/2019:

Ticker

Price 9/30/2019

Held

Value

Weight

Total Cost

Gain/Loss

Gain/Loss

Total Value Incl. Divi.

(Incl. Divi.)

ARCC

18.64

340

6,335.90

2.13

5,488.59

847.31

15.44

7,436.90

35.50%

AWF

11.99

251

3,009.49

1.01

2,999.45

10.04

0.33

3,009.49

0.33%

CEFL

14.12

491.61

6,941.52

2.33

10,003.31

-3,061.79

-30.61

13,427.47

34.23%

CHI

10.41

285

2,966.85

1

2,992.50

-25.65

-0.86

3,080.85

2.95%

DNP

12.86

1,467.55

18,872.63

6.33

15,000.22

3,872.41

25.82

23,633.81

57.56%

ET

13.08

207

2,707.56

0.91

2,991.15

-283.59

-9.48

2,707.56

-9.48%

GOF

19.34

827

15,994.18

5.37

14,987.72

1,006.46

6.72

22,102.21

47.47%

HQH

18.34

820

15,038.80

5.05

17,957.18

-2,918.38

-16.25

17,542.52

-2.31%

HYB

8.83

350

3,090.50

1.04

2,999.50

91

3.03

3,090.50

3.03%

IIF

18.95

141

2,671.95

0.9

2,982.15

-310.2

-10.4

2,671.95

-10.40%

KYN

14.46

894

12,927.24

4.34

16,560.63

-3,633.39

-21.94

18,142.47

9.55%

MAIN

43.21

356

15,382.76

5.16

10,010.36

5,372.40

53.67

18,805.46

87.86%

NLY

8.8

946

8,324.80

2.79

9,492.83

-1,168.03

-12.3

11,760.60

23.89%

NMZ

14.28

1,368.22

19,538.20

6.56

17,771.28

1,766.92

9.94

23,567.25

32.61%

PCI

24.48

1,000.26

24,486.41

8.22

21,004.00

3,482.41

16.58

32,378.49

54.15%

PDI

32.54

542.49

17,652.46

5.92

15,996.53

1,655.94

10.35

25,330.49

58.35%

PFF

37.53

459.35

17,239.33

5.79

17,831.06

-591.73

-3.32

21,088.75

18.27%

RFI

14.79

1,205.74

17,832.87

5.98

14,991.42

2,841.44

18.95

22,930.39

52.96%

RNP

24.61

830.43

20,436.81

6.86

15,009.22

5,427.59

36.16

25,372.31

69.04%

STK

21.1

880

18,568.00

6.23

15,558.66

3,009.34

19.34

23,923.32

53.76%

UTF

27.24

705.62

19,221.14

6.45

14,826.60

4,394.54

29.64

24,460.61

64.98%

CASH$

1

28,730.67

28,730.67

9.64

CEF Portfolio

297,970.07

100

Here's the same portfolio (sorted on Total-Performance) as of 09/30/2019:

Ticker

Price 9/30/2019

Held

Value

Weight

Total Cost

Gain/Loss

Gain/Loss

Total Value Incl. Divi.

(Incl. Divi.)

MAIN

43.21

356

15,382.76

5.16

10,010.36

5,372.40

53.67

18,805.46

87.86%

RNP

24.61

830.43

20,436.81

6.86

15,009.22

5,427.59

36.16

25,372.31

69.04%

UTF

27.24

705.62

19,221.14

6.45

14,826.60

4,394.54

29.64

24,460.61

64.98%

PDI

32.54

542.49

17,652.46

5. 92

15,996.53

1,655.94

10.35

25,330.49

58.35%

DNP

12.86

1,467.55

18,872.63

6.33

15,000.22

3,872.41

25.82

23,633.81

57.56%

PCI

24.48

1,000.26

24,486.41

8.22

21,004.00

3,482.41

16.58

32,378.49

54.15%

STK

21.1

880

18,568.00

6.23

15,558.66

3,009.34

19.34

23,923.32

53.76%

RFI

14.79

1,205.74

17,832.87

5.98

14,991.42

2,841.44

18.95

22,930.39

52.96%

GOF

19.34

827

15,994.18

5.37

14,987.72

1,006.46

6.72

22,102.21

47.47%

ARCC

18.64

340

6,335.90

2.13

5,488.59

847.31

15.44

7,436.90

35.50%

CEFL

14.12

491.61

6,941.52

2.33

10,003.31

-3,061.79

-30.61

13,427.47

34.23%

NMZ

14.28

1,368.22

19,538.20

6.56

17,771.28

1,766.92

9.94

23,567.25

32.61%

NLY

8.8

946

8,324.80

2.79

9,492.83

-1,168.03

-12.3

11,760.60

23.89%

PFF

37.53

459.35

17,239.33

5.79

17,831.06

-591.73

-3.32

21,088.75

18.27%

KYN

14.46

894

12,927.24

4.34

16,560.63

-3,633.39

-21.94

18,142.47

9.55%

HYB

8.83

350

3,090.50

1.04

2,999.50

91

3.03

3,090.50

3.03%

CHI

10.41

285

2,966.85

1

2,992.50

-25.65

-0.86

3,080.85

2.95%

AWF

11.99

251

3,009.49

1.01

2,999.45

10.04

0.33

3,009.49

0.33%

HQH

18.34

820

15,038.80

5.05

17,957.18

-2,918.38

-16.25

17,542.52

-2.31%

ET

13.08

207

2,707.56

0.91

2,991.15

-283.59

-9.48

2,707.56

-9.48%

IIF

18.95

141

2,671.95

0.9

2,982.15

-310.2

-10.4

2,671.95

-10.40%

CASH$

1

28,730.67

28,730.67

9.64

CEF Portfolio

297,970.07

100

1

Sold during the period (Jan 2019 – Sept. 2019)

$0

2

New investments made during the period (Jan 2019 – Sept. 2019)

$16,962.10

3

Net new money invested (2 -1)

$16,962

4

Net Cash deployed so far (including redeployed dividends) (231,600+7972)

$248,562

5

Total Dividends collected (from Oct 17, 2014, until Sept. 30, 2019)

$78,606

6

Net Cash position (06930/2019)

$28,731

7

Cost basis (09/30/2019)

$200,000

8

Portfolio balance (as of 09/30/2019)

$297,970

9

Net profit/Loss (incl. dividends)

(09/30/2019)

$97,970

10

Return on original invested capital (88,057/200,000)

+48.98%

11.

Net Gain/Loss % for the Portfolio YTD including the dividends, and cash-reserve

(since December 31st, 2019 until 09/30/2019)

12/31/2018: 243,545, 09/30/2019: 297,970

+22.34%

11-A.

Net Gain/Loss % YTD (excluding the CASH Reserve)

+25.55%

12.

Net Gain/Loss in S&P500 YTD (since January 1st, 2019 until Sept. 2019)

+18.87%

Performance Comparison with Benchmark:

Here are our two original goals:

1

Earn a current income of 8% and preserve capital.

2

Provide roughly 2% or more capital appreciation over the long term.

As such, this portfolio is meeting its primary goal of earning an 8% income. For performance comparison, we have been using the traditional Stock/Bond portfolio as a benchmark. Thus far, the portfolio has done very well against the Stock/Bond portfolio. In a nutshell, here's how we have fared so far against our goals:

We earned an income of $14,444 during the year 2019. The full-year dividend should be nearly $21,500. The total of dividends/distributions, since inception, stands at $78,606. The current yield on cost is at 10.75%. The projected yield on the current portfolio value (including the cash-reserve of 10%) is at 7.25%.

Capital preservation: The portfolio value moves along with the markets, and currently, it's showing nice gains. But we have to look at it on a long-term basis. Including dividends, the portfolio is up by 48% as of 09/30/2019. Morningstar portfolio calculates a little over 10.47% annualized return for this portfolio since inception. It's even better at 11.7% if we were to exclude the cash reserve.

Our benchmark for this portfolio is not the S&P 500, but a traditional stocks/bonds portfolio (40/20/40 Stocks/International Stocks/Bond allocation). We will assume that similar amounts were contributed on the same dates, and similar amounts were deployed. We will compare our Income-centric portfolio with a hypothetical stock/bond portfolio with 40/20/40 allocation to Vanguard Total Stock Market ETF (VTI), iShares MSCI EAFE - International (EFA), and (Vanguard Total Bond Market ETF (BND).

Table: Comparison with Stock/Bond Portfolio

As of 10/01/2019

8% Income portfolio

60:40 Stock/Bond portfolio

Cost Basis

$200,000

$200,000

Total Portfolio Value

$297,970

$260,425

Net Dividends Earned

$78,606

$22,554

Risks with CEFs Investing

It goes without saying that CEFs, in general, have some additional risks that the investor needs to be aware of.

Leverage and high fees:

They generally use some amount of leverage, which adds to the risk. The leverage can be hugely beneficial in good times but can be detrimental during tough times. The leverage also causes higher fees because of the interest expense in addition to the baseline expense. If a fund is using significant leverage, 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.

Volatility:

Due to leverage, 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. Especially during corrections, the market prices can drop much faster than the NAV (the underlying assets). Investors who do not have an appetite for higher volatility should generally stay away from CEFs or at least avoid the leveraged CEFs.

Premium over NAVs:

CEFs have market prices that are different from their NAVs (Net Asset Values). They can trade either at discounts or at premiums to their NAVs. Generally, we should stay away from paying any significant premiums over the NAV prices unless there are some very compelling reasons.

Asset-specific risk:

Another risk factor may come from asset concentration risk. Many funds may hold similar underlying assets. 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.

Closing Remarks

We believe this portfolio presents a viable alternative to an all-stock or a balanced stock-bond portfolio. However, it should be used as part of a broader strategy and allocation model. One of the great benefits of this portfolio is the constant stream of high income that it generates, and one does not need to sell shares to withdraw income. It appears that in good times (bull market), this portfolio, after including the dividends, should at least match or beat the broader market performance. However, more importantly, during tougher times, the cash dividends would help protect the downside considerably, as is evident from back-testing models.

We have tried to demonstrate through our back-testing and the current model portfolio that this 8% model will likely perform better than an index fund like the S&P 500, especially if we were to withdraw high levels of income consistently. So, we believe this portfolio would have a special appeal to income-seeking investors.

Please note that this portfolio will not protect the investor from a broader market crash or correction. To avoid getting caught in a situation like 2008, an investor should invest gradually over a period of time, adding equal sums of money every time, which would hopefully smoothen the ride.

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, PRU, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, ARCC, AWF, CHI, DNP, EVT, FFC, GOF, HCP, HQH, HTA, IIF, JPC, JPS, JRI, KYN, MAIN, NBB, NLY, NNN, O, OHI, PCI, PDI, PFF, RFI, RNP, STAG, STK, UTF, VTR, WPC, 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: 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. 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. Any stock portfolio or strategy presented here is only for demonstration purposes.