- International securities are currently priced well.
- Exposure to markets outside the U.S. can be a valuable source of diversification.
- ETO provides a reliable distribution from a solid portfolio with geographic diversification.
- ETO trades at a 7% discount with the 6.5% yield paid on a monthly basis.
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Co-produced with PendragonY
International Equities Are Very Attractive Today
The last 10 years have been great for U.S. equities. For over a decade now, the S&P 500 index has shown significantly better performance than the rest of the world. The U.S. dollar, long a safe haven, has continued in that role. The strong dollar has helped U.S. equities as well. This is a major reason why the majority of “High Dividend Opportunities” income stocks have been from U.S.-based companies.
Over the last 10 years, SPDR S&P 500 Trust ETF (SPY) returned 263%, compared with just 61% for the SPDR MSCI AWCI ex-US ETF (CWI) that tracks the MSCI All-Country World Index ex-USA, resulting in international stocks being very inexpensive today.
U.S. Equities Are Set to Lag Their International Counterparts
A recent report from Fidelity stated:
International companies currently have lower price-to-earnings ratios than US stocks... And, when investing in actively managed funds, you can benefit from having portfolio managers who can use their skills to try to find the best buys... Outperformance that's been cyclical. Over the past 4 decades, US and international stock performance leadership has generally alternated... US markets have outperformed over the past decade. Although there's no guarantee that this cycle will continue, investing in international funds may be able to offer you a good balance with further growth potential.
Takeaways from this include:
- Ignoring international stocks is a mistake. Global activities outside the U.S. are 85% of the total. And the U.S. population is only around 4% of the total. As the global economy recovers from the pandemic, there will be opportunities for investors to benefit.
- The political landscape for the other big world economies (Europe and China) continues to improve (although not steadily). While U.S.-China tensions are likely to persist, notably around technology issues, the Biden administration has made efforts to lessen tensions. As vaccine distribution increases, the economic situation should improve.
- The significant undervaluation of non-U.S. stocks is very notable. Large banks and financial institutions continue to shift a larger part of their portfolios to international equities.
- Large amounts of stimulus spending, funded by more debt and printing money, could continue to cause the dollar to weaken against other currencies. The latest $1.9 trillion package may cause this trend to continue. With the Federal Reserve promising to keep interest rates low for more than a year, this latest boost in Federal spending makes it probable that the trend of a weakening dollar will continue. This means that companies or funds that earn money denominated in other currencies, like the euro, but pay shareholders in dollars, will have more dollars to pay shareholders.
Let's Look At a Fund From Eaton Vance: ETO
The Eaton Vance Tax-Advantaged Global Dividend Opportunities Fund (NYSE:ETO) is an equity CEF (closed-end fund) which currently yields 6.5%. It invests in assets intending to provide a high level of after-tax total return. The fund generates its returns primarily from tax-advantaged dividend income and capital appreciation. Under most conditions, ETO will invest at least 80% of its total assets in dividend-paying common and preferred stocks from both foreign and domestic sources. ETO offers a nice yield of 6.5% with its distribution paid monthly.
While an attractive yield is very nice to have, it doesn't mean much unless the fund can sustain it. Equity CEFs produce a high distribution by some combination of asset sales and income from their holdings. Asset sales, unless done at a profit, reduce the fund's NAV (Net Asset Value) and can eventually result in distribution cuts.
So, on balance, we want to invest in funds that can realize capital gains when they sell assets, as well as collect dividends and interest from those assets. An easy way to check this is to compare the total return on NAV to the yield on NAV. If the total return on NAV exceeds the yield on NAV, then it is very unlikely that the fund is eating itself to generate distributions.
A History Of Strong Outperformance
Rather than look at the return on Net Asset Value over the past 12 months (which would start very near the bottom of the COVID crash), we will look instead at the performance for the full year 2020. Here we can see that the total return on NAV for 2020 was 15.25%. That is more than twice the 6.0% yield on NAV that ETO earns, and more than the 6.5% that ETO pays to its shareholders.
The fund itself actually reports that the average "total return" on its NAV over the last 5 years is 14.0% while the yield on NAV annualized using the current distribution is about 6.5%, meaning that ETO on average has out-earned the yield on its NAV by over 2 times over the past 5 years.
Therefore, the current distribution has a very solid coverage ratio. With Net Asset Value near an all-time high, it is very surprising that this fund still trades at a discount to its NAV, a subject that we will touch on later in this report. In fact, one of the main reasons that ETO has been a big winner is that it is able to keep a lot of cash to re-invest in the best stocks available, after paying the distributions to shareholders. In this way, it can grow its NAV and increase its share price, thus further rewarding its shareholders.
The slide below shows the top 10 holdings of ETO, as well as both sector and country coverage.
Source: ETO Fund
With less than 60% of its holdings in the U.S., ETO has significant foreign exposure. Spain and Ireland have had some struggles over the last decade or so, and Spain was hard hit by COVID, but otherwise, all of the countries with 1% or more of the portfolio have strong economies.
- IT has done well during COVID, and that should continue even as COVID wanes. The recent pullback in this sector has brought back some opportunities. This is the largest exposure for ETO comprising 17% of its total portfolio.
- Healthcare, which is one of the fastest-growing and most promising sectors, has lagged the general markets and is a deep value sector today. With an 11.5% exposure, this should bode very well for ETO.
- The Consumer Discretionary sector was a sector that has taken the biggest hit during the pandemic and is set to have the most upside as the economy picks up and people go back to work. This should be one of the best-performing sectors going forward. This is the 3rd largest exposure for ETO with 10.3% of its portfolio.
On the individual company level, we see good exposure to FAANG stocks. These stocks should do well, especially after the recent pullback. ETO also has exposure to Mondelez International (MDLZ), and Unilever (UL), both international dividend-paying stocks. For those with a sweet tooth, Nestle (OTCPK:NSRGY) pays around 3% and in the past had a pretty good dividend growth rate.
Based on our analysis, our outlook is that nothing from the recently generated returns isn't repeatable, so we think past performance makes a reasonable projection of fund performance in the future.
Leverage and Fees
ETO is an actively managed fund that uses approximately 20% leverage to boost total returns. Management takes a fee for its work, as do all funds. The base fee is at 1.2%, which is modest for an actively managed CEF. The 1.74% total fee includes 0.50% for the cost of the leverage it uses. It is also important to understand that the current yield of 6.5% (based on the $0.1425 monthly dividend) is net of expenses, so investors will collect the full distribution amount.
Source: ETO Fund update
Looking at the NAV performance of ETO as of the end of 2020, we can see that management's move to reduce the distribution in response to the COVID pandemic was indeed very smart. Keeping more cash on hand allowed the fund to keep more cash to buy stocks on their lowest levels, and thus build its NAV.
The dividend was reduced last May from $0.18 to $0.1425, but it has resulted in tremendous returns for the fund that management would not have been able to achieve otherwise. In fact, this helped ETO to easily beat the performance of the S&P 500 index over the past 12 months.
At the current coverage level, we expect management to hike the distributions very soon.
Tax Advantage Fund
ETO calls itself tax-advantaged because it looks to generate its distributions from qualified dividends and long-term capital gains. Both of those sources are tax-advantaged in that they are taxed at a lower rate than unqualified dividends, interest, and short-term capital gains. ETO can work very well earning a good income with lower exposure to taxes.
A Bargain Valuation
The best company or fund, purchased at too high a price can turn out to be a poor investment, so what does the price of ETO look like now?
One metric to use in determining whether or not the price of a fund is a good one is whether or not (and by how much) the fund is trading at a share price that is at a premium or discount to its NAV. In most cases, the comparison to the average for the fund tells us more than just the raw ratio.
With the 5-year average discount being just 0.34%, the current discount of 7.0% means that ETO is trading at a bargain valuation in today's market.
A low price isn't always a good thing. There is a difference between buying something that is cheap and buying something that is inexpensive. Buying cheap can often cost more in the long run. Looking at NAV since the start of 2020, we can see the big crash caused by COVID. But we can also see that despite that setback, ETO has grown its NAV by over 10% since the start of 2020.
That is a significant accomplishment and a credit to management's skill. And that is the type of investment we want to make. It is even better that we get it at a price that is well below its Net Asset Value.
Income investors want a fund that can both grow NAV and that pays out the large distribution of 6.5% as a regular cash payment. ETO has significant NAV growth over the last 5-year periods, averaging 14% per year. The proper way to use that information is to help understand what the future may hold.
Don't be afraid to start investing today, there are still bargains around! During a strong bull market, the markets can always surprise the upside. With the economy recovering from COVID and the recent government stimulus package we see share prices increasing from here. ETO is already very attractive, trading at a discount of 7% to its asset value. It is important to note here that ETO is an actively managed fund; investors should be at peace knowing that the managers are working hard to buy the most attractive international equities for this fund.
Over the past 5 years, ETO has over-earned its current yield on its NAV by more than 2 times, giving it more cash to invest in bargain stocks. This also certainly means that a distribution hike will be coming very soon. When earnings are strong, this management has a long history of raising the distributions.
The bottom line is that it is increasingly difficult to find bargains in today's markets. ETO is one of them. It has a 5-year average discount of 0.3%, yet it is trading today at a 7% discount. The 6.5% yield, which is paid on a monthly basis, is set to increase soon. ETO has good exposure to international stocks, and they should not be overlooked. They can drive your returns higher in 2021 and beyond!
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This article was written by
Rida Morwa is a former investment and commercial Banker, with over 35 years of experience. He has been advising individual and institutional clients on high-yield investment strategies since 1991.Rida Morwa leads the investing group High Dividend Opportunities where he teams up with some of Seeking Alpha's top income investing analysts. The service focuses on sustainable income through a variety of high yield investments with a targeted safe +9% yield. Features include: model portfolio with buy/sell alerts, preferred and baby bond portfolios for more conservative investors, vibrant and active chat with access to the service’s leaders, dividend and portfolio trackers, and regular market updates. The service philosophy focuses on community, education, and the belief that nobody should invest alone. Lean More.
Analyst’s Disclosure: I am/we are long ETO. 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.
Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.
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