Eaton Vance Enhanced Equity Income Fund II (NYSE:EOS) is a buy for steady monthly income and a secondary goal of capital appreciation. EOS is 7.85% of The Good Business Portfolio (see my article on 2019 4th quarter earnings and performance review for the complete portfolio list). The fund tries to model the Russell 1000 that is high in the Information Technology percentage at 38.87% with EOS being 1.65% higher than the index, and the health care sector at 16.16% with EOS being 1.42% less than the index percentage. The EOS fund invests in Large Cap and Mid Cap companies and would be a good addition to a portfolio needing more diversification in this category and wants a high tech component.
EOS fundamentals are reviewed in the following topics.
- Yearly income percentage and total return
- Company allocation
- Covered calls
- Distributions
- Conclusion
Yearly Income Percentage and Total Return
Being in retirement, my goal is to have a steady monthly income without the swings of dividends that are paid on a quarterly or yearly basis. The fund's yearly distribution of 7.52% ($0.0988 per month) return in today's low-interest-rate environment is fantastic.
I calculated the total return of EOS over a four-year-plus two-month period, starting with January 1, 2016, until Year to date 2020 - i.e., 50 months in total. I chose this time frame since it included the great year of 2017 and 2019 and other years that had a fair and bad performance. EOS outperformed the Dow average by 11.93%. For the 50 months, the Dow's total return was 41.59%, and EOS beat it at 52.52%. EOS does well in an upmarket, but had trouble in 2016, in the manic-depressive market of that year. The recent market correction last week has created a buying opportunity for EOS, which now sells for a discount of 3.13%, which before the recent correction, was selling at a premium of nearly 5%. The economy is moving up going forward, which is good for EOS with its covered call approach to dampen the swings of the market.
Investment | Total Return for 50 Months | The difference from Dow Baseline | Yearly Distribution |
EOS | 53.52% | 11.93% | 7.52% |
DOW Baseline | 41.59% | -- | -- |
The EOS price took a downward spike in late 2018 as did the market but came back with the market by 14.72% in early 2019. The five-year price chart below shows the valuation swings of the EOS portfolio while paying out a steady monthly income throughout the year. The latest correction gives a good buying opportunity for this good income CEF.
Data by YCharts
Company Allocation
The Eaton Vance website gives a full list of the companies and percentages of each in the fund portfolios for the latest quarter. The table below gives the top ten companies for the fund and their percentage in the fund. Using price chart data, I calculated the total return of the EOS top 10 companies out of approximate 65 that the fund owns. All ten outperformed against the Dow average total return of 41.59% over the 50-month test period. The total percentage of the top ten companies in the fund is shown at the bottom of the table. So overall, the fund has great companies in its portfolio, with the top 10 producing a total return above the Dow average over my 50-month test period.
Company | Percentage |
In Portfolio | |
Alphabet Inc. Cl C (GOOG) | 8.02% |
Amazon (AMZN) | 7.60% |
6.37% | |
5.17% | |
SalesForce (CRM) | 3.26% |
Adobe Systems (ADBE) | 3.16% |
Qualcomm Inc. (QCOM) | 2.78 |
Facebook (FB) | 2.56 |
Apple (OTC:APPL) | 2.09 |
PayPal Holdings (PYPL) | 2.00 |
Total 43.01%
Source: Eaton Vance web site
Covered Calls
The fund sells covered calls for income and downside protection. EOS sells covered calls against 47% of its company positions, with an average duration of 30 days and 3.4% out of the money. Covered calls provide the EOS fund portfolio some downside risk protection and extra income to smooth out the normal market gyrations. The management, in using covered calls, has the time to use covered call exit methods if the market price goes against them. For EOS, selling covered calls on individual company positions provides a steady income that does well in total return in a strong upmarket and gives some downside protection in weaker markets.
Distributions
Each month, the fund issues a statement saying which part of the distributions comes from short-term capital gains, long-term capital gains, investment income, and the return of capital. It is best to have EOS in a tax-deferred account so that you do not have to handle the tax calculations for the different categories of the distribution, and most of the income is taxable. The EOS distribution for December 2019 had the cumulative distributions for 2019 at 0.0% investment income, 0.0% short-term capital gains, 100% long-term capital gains, and 0% return of capital. Short-term and long-term gains are normally a significant part of the EOS distribution. Year to date distributions has been a return of capital, which is not indicative of EOS yearly performance. The fund does well in a strong upmarket and follows the market in an average market. The fund managers advise against drawing any performance conclusions from the distribution breakdown, but I feel the high long term capital gains distribution shows the strength of the fund companies it owns. They do manage the fund payouts to try and keep the monthly payment constant. The payout distribution increased in January 2019 by 13%, showing the fund managers want to keep the distribution a strong reflection of the good companies they own.
Conclusion
EOS is a good income vehicle in a tax-deferred account. It gives a high monthly distribution, which is steady and beats the Dow averages over the test period of 50 months. It also provides someone like me, who generally picks his own companies, an easy means of buying a diversified portfolio of large-cap and mid-cap tech companies without having to research each of them in detail. EOS is a good complement to individual company positions. The fund follows the market in an average market and does well in a strong upmarket. EOS also provides steady income, with fund price muted both on the upside and downside swings by the covered calls. EOS also sells for a discount of 3.12% (February 28 close). EOS is 7.85% of The Good Business Portfolio and will be trimmed when EOS hits 9% of the portfolio. We are now in a strong down correction, and now would be a good time to start building a position in EOS on this dip.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
