After two articles on option-income CEFs (here and here), and one on an option-income ETF (DIVO), you’d think we could put the subject to rest. But there’s a lot of interest in the category. For good reason. It is, in my view, the way to go for income from equity CEFs. I have not looked recently, but years ago I compared the two categories of equity CEFs, option-writing and leveraged, using the Eaton Vance funds as models.
The results (here) were not even close: Option-income funds soundly beat the leveraged funds over an extended time period. I just quickly ran the same analysis, extending it through March 2021. The categories are much closer on CAGR now, but the option-income funds have meaningfully higher annual and cumulative income, and much better risk-reward metrics. So I remain satisfied that for equity CEF income, option-writing funds are the better choice.
I’ve focused so far on Eaton Vance funds. I’ve been asked several times about one of BlackRock’s (BLK) offerings in the category, so I thought I’d look at them as well. I generally like BlackRock’s approach to CEFs. They tend to lower distribution rates than their peers which puts them a bit out of step with the interests of many CEF investors. This can, however, lead to funds that are more sustainable and have some tendency for better growth prospects.
I’d call them more conservative, but every time I use that term to describe CEFs, someone jumps on me for even suggesting that a CEF can be considered a conservative investment choice. I’ll not argue the point here, but within their universe, BlackRock’s offerings do tend to the conservative end of the spectrum. I consider that an advantage.
The BlackRock Option-Income Funds
BlackRock has four option-income, general-equity funds that turn up on my screen. Two are primarily domestic: BlackRock Enhanced Capital and Income (NYSE:CII) with 87% USA in its portfolio, and BlackRock Enhanced Equity Dividend Trust (BDJ) holding 81% domestic stocks. The portfolios differ widely. CII’s looks a lot like the Eaton Vance funds in the top holdings which consist of much the same group of tech giants that dominate the top of the US equity indexes. BDJ’s portfolio is filled with higher dividend stocks befitting the fund’s name.
The other two are BlackRock Enhanced Global Dividend Trust (BOE), a global fund with 57% USA equity in its portfolio; and BlackRock International Growth & Income Trust (BGY), an international fund with no domestic holdings.
In the analysis of the Eaton Vance funds I looked at correlations to see if they supported an assumption that adding global exposure would enhance portfolio diversification. That’s worth repeating for these funds. I’ll also add the Eaton Vance funds that I selected in those articles and SPY for a large, domestic equity benchmark. This is the long-term correlation matrix from InvestSpy:
Once again, we see that in this large-cap equity category, international exposure adds little diversification relative to domestic holdings. So, we can again take that off the table as a factor to be considered. Without an advantage on this front for the global funds, I’m going to drop them from further consideration. Anticipating the discussion to come, I’ll note that they lag the domestic funds on all return metrics for all time frames; they offer no advantages in income, and they are not meaningfully better valued. I see no reason to take the time to go deeper there.
That leaves us with two funds to compare: BDJ and CII. I’ll look at them in comparison to the two Eaton Vance funds that rose to the top of that set of funds: The high performing, but low-yielding EOS; and the higher-yielding ETY.
I’ll open with a look at distribution rates for these four funds.
The primary negative we found with EOS was its low distribution rate. CII has a similarly low rate and BDJ’s is well below that of ETY.
BDJ has paid at least $0.0467 per share monthly (or its quarterly equivalent) from 2013. In July 2019 this was raised to $0.05, a 7.1% increase. It also paid out a large special distribution in 2019 and a full quarter’s income as a special distribution in 2014. The last time the fund reported return of capital was January 2017.
CII increased its distribution 5.7% from $0.0828 to $0.0875 per share in December 2019. Prior to that time there had been a series of three distribution cuts over nine years. Unlike BDJ, CII regularly reports return of capital. This is not unexpected nor is it a concern. By inference from the top holdings in the two funds, it seems BDJ’s portfolio generates a higher level of income from dividends than CII’s portfolio, so it requires less income from option premiums to support its distribution.
Both BDJ and CII have discounts greater than the Eaton Vance funds.
Discounts in the 9% to 10% range enhance distribution income appreciably. These add 47bps to BDJ’s NAV distribution and 32bps to CII’s.
Recent return charts for the four funds continue to show top marks for EOS on total return, price without reinvestment of distributions, and NAV without reinvestment of distributions.
The advantage for EOS in this three-year chart makes clear that its outperformance has primarily come in the year following the COVID crash. Prior to that event differences are much less as can be seen in this chart which lops off the pandemic downdraw and post-pandemic recovery period from the one above.
Notice how in both charts EOS’s recovery from the drawdowns (end of 2018 and March 2020) was much quicker than the other funds. By the end of 2019 the other three funds had largely closed the gap EOS opened for total return. EOS still ran ahead for NAV return, such is the advantage of its low (relative to the other funds) distribution rate.
In terms of comparing the two BlackRock funds, BDJ trails CII throughout the period.
One can only glean so much from past performance. It tends to give us a picture of how funds respond to market changes but does little to predict future performance. I think we can say that the tech-heavy portfolios of EOS and CII benefited the fund performances in a period when tech was king. Indeed, if we were to put the NASDAQ 100 on these charts, its total return would dwarf that of any of the funds. The fact that BDJ trails in the return metrics may be a reflection of a market that disfavored its portfolio style relative to the other three funds.
Contributions to Portfolio Risk
If we consider all four of these funds as an equal-weighted portfolio, this InvestSpy report tells us about how they have behaved as portfolio components relative to one another.
They are remarkably similar on all metrics except total return. For Risk Contribution, Annualized Volatility, Daily Value at Risk there are no meaningful differences among them. BDJ did suffer a deeper drawdown than the others, however.
The one metric that really stands out is Total Return, especially EOS’s 11.9 percentage point lead over the second-place fund on the one hand, and BDJ’s 4.7 percentage points behind the next worst fund. CII is a reasonably strong second-place finisher coming in 6.2 percentage points over ETY.
I found this analysis disconcerting, especially BDJ’s poor risk-reward balance which I had not expected. I wanted to confirm it with other stats. These relevant ratios from Morningstar do just that.
My inference from the portfolio holdings had led me to expect BDJ would have stronger risk metrics than it does. But this is an abysmal record: A 0.5 Sharpe Ratio and an imbalance of Upside, Downside Ratios by a wide margin.
Once again, EOS leads the field with a 0.94 Sharpe Ratio, and the best capture ratios, upside and down. Indeed, it is the only fund to have an upside capture ratio that exceeds the downside capture ratio.
Summary and Conclusions:
CII Tops the BlackRock Option-Income Funds, But Not the Best From Eaton Vance
I opened this exercise with the goal of comparing BlackRock’s offerings in the option-income category with each other to identify the best fund from the sponsor. With that in hand, I would turn to see how it stood up to the best of the Eaton Vance funds. It was easy to narrow the four BlackRock funds down to two: CII and BDJ, by eliminating the poorly performing global pair that would not be adding any meaningful diversification to the portfolio to offset their performance shortfalls.
On some counts BDJ looks attractive. It has a deeper discount and a higher yield than CII. Its distribution payment record is stronger (although one does have to go back several years on CII to find any issues). Its returns lagged CII’s but my initial thought was that was a characteristic of its less aggressive portfolio and it would be counterbalanced by more attractive risk metrics. If so, it might mean that it could potentially serve the portfolio well, especially in light of its higher income generation. This turned out to not be the case. A kind view would be that its portfolio ran counter to the market; a harsher view would be that it's just a dog.
My pick for the BlackRock funds goes strongly to CII. It's the clear winner among the four funds. That’s not to say that it’s not without problems. The distribution is low for the goals I’ve set, and its overall performance is mid-tier for the category. Risk metrics, while better than BDJ’s, offer no meaningful advantages over the competition. If I were going to go down to this level of yield, I’d go instead to EOS without hesitation. There is not a single evaluation criterion for which EOS doesn't beat or, at worst, tie CII.
I did this because I’d gotten several questions from readers asking for my opinion of BDJ. I wasn’t familiar with the fund and thought I’d check it out because the readers who were asking seemed enthusiastic about it. At first I thought it might be a better fund than it turned out to be, so I kept digging looking for reasons to like it. Unfortunately, they were not to be found.
At least I know how to respond next time someone asks me about it.