Closed-End Fund Distribution Tax Character Mistakes And Misunderstandings

Summary

• There are three primary things that I see a lot of newer CEF investors get hung up on; return of capital, section 19a and data aggregators distribution classifications.
• All three of these have to do with the tax character of the distributions and the mistakes that can be made.
• These are important things to take note of for investors holding in a taxable account.
• This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

Photo by VioletaStoimenova/E+ via Getty Images

Written by Nick Ackerman, co-produced by Stanford Chemist

Closed-end funds are an excellent way to generate income, use as arbitrage exploiting premiums/discounts or gain exposure to illiquid assets that wouldn't normally work in traditional mutual funds or ETFs. They can provide access to assets that retail investors wouldn't normally have the chance of owning. However, one of the most important things is to understand the tax situation behind these funds if you are holding them in a taxable account. Some of the confusion comes from what the funds are required to provide themselves, and some are from data aggregators that just can't get it right.

Some of these are topics we have discussed in the past - though they are worth revisiting for new investors, or just a great refresher for veterans too. It can feel like going through a labyrinth when starting out with CEFs. However, once you realize some of these misconceptions of CEFs, it can be a lot less confusing. Especially once you start to realize where to find the most accurate information.

(Source)

Return Of Capital Confusion

Going to return of capital (ROC) right off the bat as it is the number one most confusing - and is often the primary source of the rest of the confusion that this article is based on. As some investors think all ROC is bad no matter what.

As we've discussed in the past, there can be several reasons why funds distribute out ROC. So determining if it is destructive or harmless is important.

One of the simplest ways to know if a fund is utilizing destructive or constructive ROC is to watch its NAV. A growing NAV over a period of time indicates that the fund is earning its distribution. An eroding NAV will indicate that they really are merely returning your investment to you, without earning these through unrealized gains or elsewhere. An eroding NAV isn't a sustainable long-term investment and an investor will eventually see distribution cuts.

Some funds utilize an options strategy. This includes some of the more popular funds in this category from Eaton Vance (EV). These include Eaton Vance Tax-Managed Buy-Write Opportunities Fund (ETV), Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (ETW) and Eaton Vance Tax-Managed Buy-Write Strategy Fund (EXD).

Through writing calls on indexes, they can generate losses. Writing options against an index can result in losses since they are cash-settled. Meaning that if an index rises too high the premium collected will not be enough to offset the cash payment that will be due, or the amount that it will take for the fund to close the position will be greater than the premium received. In theory, losses can be unlimited for option index writing since an index can go to infinity. In practice, we know this won't typically happen for obvious reasons. Also, the managers can roll the positions or close them, just like any other option position for an individual.

This is also where the other side of the portfolio can benefit. If an index is going to be rising significantly, then chances are the underlying positions within the fund are also rising in at least a similar upward trajectory. After all, these funds own a lot of what the index they are writing on reflect as well. That's how ETV and ETW can generate losses, even when the underlying positions might be rising and accumulating unrealized gains. If they never sell the unrealized gains to turn them into realized gains, then that is exactly where they remain.

The other common factor for a fund where we see ROC is in the MLP structure. MLPs regularly distribute out ROC themselves as they have a lot of physical assets that they can utilize depreciation against the gains. Of course, it has been harder to decipher between destructive ROC or good ROC with MLP funds as they've been the worst-performing for several years now. Though 2021 is looking promising so far.

Finally, it could be as simple as not realizing enough gains of the underlying portfolio. Instead, leaving the appreciation as unrealized. A good example of this is BlackRock Science and Technology Trust II (BSTZ). In 2020, this was the top-performing CEF with returns near 100% for the year. Quite impressive! Yet, they classified ~12% of the distributions as ROC. In this case, it definitely wasn't destructive - they just hadn't realized enough of their underlying gains to classify them all as long-term capital gains.

(Source - BlackRock Tax Notice)

Another BlackRock Fund, BlackRock Utilities, Infrastructure, & Power Opportunities Fund (BUI) was in a similar situation. The fund performed really well and the NAV rose for the year. Yet, they are also showing around 12% in ROC for their distribution.

Section 19a Notices Confusion

One of the most confusing, I believe, is section 19a. It sounds like a fancy form, but it really is quite simple. If a fund believes that any distribution contains anything other than income from the fund, they are required to provide this notice.

The problem is it is just simply an estimate. There is no way of knowing exactly what the fund's distribution classifications will become by the end of the year. It can vary wildly sometimes as well. Some funds are closer to their estimates, and others are really off. This can be due to some unforeseen circumstance or some drastic changes in a portfolio that they didn't anticipate.

Remember, a CEF is just holding a basket of investments. This means that whatever dividends, distributions or gains that they get themselves, will also affect the classification to the CEF holder as well. The easiest example is what we mentioned above if an MLP fund is collecting a lot of ROC that will translate into the CEF itself paying a lot of ROC.

Let's look at an example of this. Below is from John Hancock Tax-Advantaged Dividend Income Fund (HTD). Their fiscal year-end is October 31st. In September their section 19a was showing that they were estimating 13% of the distribution as ROC.

(Source - HTD September Section 19a)

For prior months, it was bouncing around too; sometimes including ROC and sometimes not. July's section 19a was around a similar ROC amount at 14%. One month before that though, in June 2020 it was showing no ROC and only income and gains.

Below is what was estimated as of October 2020, as provided by the section 19a.

(Source - HTD October Section 19a)

So one would probably imagine that it should be pretty close by this time. After all, it is the last month of the fiscal year. Well, one would be wrong if they thought that. The final tax classification showed about 25.5% as long-term capital gains and ordinary income the remainder.

(Source - HTD Annual Report)

In fact, if you go to the official tax release excel file that they provide (really hard to read and not as presentable as many other fund sponsors) you will notice that most of this was considered qualified dividend income. Which is a great thing to help lower tax obligations. However, the total capital gain distribution was more around 26.54%, with the rest being ordinary income.

Data Aggregator Confusion

This one is a big one that I see a lot. Investors asking questions on the tax character and referring to CEFConnect. To be quite frank, I've never once seen these numbers be accurate. That is the challenge if someone can show me once where CEFConnect's data is correct on the distribution history.

To be fair, I use CEFConnect an absolute ton. It is a great website with many tools geared specifically towards CEF investors. It is tremendously helpful and I would recommend the site and tools for any investor into CEFs. However, there is some information that you just cannot utilize from a data aggregator.

The biggest one here being the distribution history, as that is the topic of the day. I would also say the "portfolio characteristics." That is a discussion for a different day though.

It is also worth noting before showing some examples that CEFConnect simply gets its information from Morningstar. So once you see it is wrong on CEFConnect, you will know it is wrong from Morningstar.

So, what's the problem. Let's look at some examples using BSTZ as just the first. Below is an image grab from CEFConnect's distribution history.

(Source - CEFconnect)

We already presented the distribution breakdown above for BSTZ. As we can clearly see, for the year it is not matching up. They are showing around 66% of the distribution would be ROC. We know that it officially, from BlackRock themselves, is around 12%.

Now let's look at HTD. We know that their fiscal year-end doesn't line up with calendar year-end, so to be the fairest we will look at distribution breakdown between October 2019 and October 2020.

(Source - CEFconnect)

Once again, we are seeing a considerable amount of ROC, that wasn't in the final classification. We also see here that it doesn't even match with the section 19a notices that they filed. That always made me chuckle a little bit, as I really don't know where they are getting their information (making it up out of thin air?)

Now here is another good example. We will use Nuveen Real Estate Income (JRS). They actually run the CEFConnect platform, but again, the information comes from Morningstar.

(Source - CEFconnect)

This time, JRS did classify some of its distribution as ROC last year. From the above, though it would appear that 22% was ROC, 28% as long-term capital gains and the remaining ~50% as ordinary income.

As you can probably assume by now, this would be wrong again.

(Source - Nuveen Tax Notice)

Conclusion

The bottom line here is that ROC isn't always destructive, there are reasons that funds might be distributing ROC. It could have to do with their investment strategy, the types of distributions they are receiving themselves or just not realizing the underlying gains and keeping them unrealized.

For section 19a notices, the bottom line is that they are supposed to help investors, but it is only an estimate. The final tax classification cannot be known officially until year-end. Not even the fund sponsor publishing these section 19a forms know. Unfortunately, this is just one of those things that the SEC requires, without actually seeing the real-world consequences. Good intentions, but causing some confusion.

Finally, using a data aggregator as a source for tax classifications often isn't correct. We need to go to official sources from the funds themselves on distribution taxation. Official tax characteristics will not be known until year-end. Right here are the most important sentences of this whole article, if you take away nothing else, take away that.

Data aggregators can be great, but we have to know what information to use and what can be ignored. In the case of distribution history, I've never once seen the data be correct come year-end. I've even noticed that it regularly doesn't match the section 19a notices that funds provide as well. That can be a big shock if someone is holding a sizeable position and they are anticipating ROC or capital gains.

In the case of ROC, an investor isn't taxed in that year and instead it reduces the cost basis of the investment. Now imagine if you get hit with a big tax bill you weren't planning. Long-term capital gains can also be beneficial to investors as they are typically taxed at a lower rate, lowering an investor's tax burden.

I know the above is a lot of numbers and reading, but these are important points for investors holding in a taxable account.

Analyst’s Disclosure: I am/we are long BSTZ, HTD, BUI, EXD, JRS, ETW. 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.

This article was originally published to members of the CEF/ETF Income Laboratory on March 26th, 2021.

Comments

[PrinceGardner]

Thank you for a very useful article. One question for an investor entering my first tax year with MLPs and CEFs: If a CEF invests in MLPs does the individual owning the CEF have to deal with K1s? (Lots of abbreviations I've never used before.)

[Retired Investor]

@PrinceGardner I have never found a MLP owning fund (CEF or otherwise) that required K1. Check the fund’s description or Prospectus for certainty.

[Nick Ackerman]

@PrinceGardner as @Retired Investor was leaning towards - you will not receive any K-1 forms with a CEF. They all issue 1099s. That being said, some ETFs issue K-1s.

[clrodrick]

@Nick Ackerman - which ETFs issue K-1? I have not read of that. I do know partnerships issue out K-1 forms

[User 47845185]

Thank you, Nick for a very informative article. How well does Pimco mgt manage ROC in their closed end funds?

[Nick Ackerman]

@47845185 thank you! From the fund's I'm most familiar with, they don't show a lot of ROC. It is mostly ordinary income.

[User 47845185]

@Nick Ackerman

Thank you, Nick.

[jazznut]

I think your point about a growing NAV versus an eroding NAV in regard to evaluating ROC is essential--it's been made in other articles but needs to be remembered. For example, one of my holdings, MGF, seems to be suffering from eroding NAV and thus destructive ROC, with the dividend decreasing month to month.

[Nick Ackerman]

@jazznut indeed! Definitely an important topic and discussion. MGF, I believe, can be nice during certain short-term time frames. Also, if you have some reasonable expectations. It holds a lot of Treasury exposure, thus, the 7.4%+ distribution rate seems high at this time.

[mikefconnell]

@jazznut I sold my $MGF and cut my $MIN by half because of the eroding NAV. I think it will come back in the future. At which point, I'll get back in. As @Nick Ackerman says. It can be very good during certain short-term time frames. Short-term could be 2 years which was about how long I last owned it (Sold in Dec-Jan).

[DanThomasNelson]

The discussion of updated 1099s each year reminds me of a situation I had with eTrade. I have mostly closed end funds in my portfolio, and have had for twenty years, and I typically get an original 1099 plus two updates, or three sets, the last one generally in March. I used to call eTrade and ask when the updates were scheduled so I knew when to do my taxes, and the person always wanted to know why I needed an update, "Has there been a mistake?" was the constant question. When I explained that the income from closed end funds would often be restated as other types of income, the eTrade people never seemed to understand the concept. Now I don't call them. I just wait for the 1099s to come.

[Nick Ackerman]

@DanThomasNelson yes! All we can do, unfortunatley. Just not a lot of support for CEFs as they are misunderstood.

[ALoverofSmoothJazz]

Great article, I found it to be very informative. Interestingly, (though not surprisingly) the “data aggregator” problem is certainly not unique to CEFConnect/Morningstar. Last week, I was shocked to learn from a well regarded SA contributor writing about QYLD (an ETF) I had been looking at, that ~82% of the ETF’s 2020 distribution was ROC, as I had researched the ETF on Fidelity which reports 100% of the distribution for 2020 as “dividends”. I then researched the Fund documents for myself on their website (where the contributor told me they got their info) and obviously found the SA contributor to be correct. I wonder now if Fidelity is getting their data from Morningstar, too(?). Just goes to show that you really have to do your research thoroughly and go directly to the “original” source to verify the data.

[Nick Ackerman]

@ALoverofSmoothJazz indeed! It is a problem across the board - not specific to just Morningstar/CEFConnect. Though some of the data can be utilized, we just need to pick through what is good data and what can be ignored.

[Retired Investor]

For ROC data, I go to the sponsors site as Fidelity seems to lump it all together.

[Nick Ackerman]

@Retired Investor absolutely! Need to go to the fund sponsors' website just to confirm. It is another step, but I see too many people falling victim to incorrect information. (Even our own fellow contributors, though won't name names - hopefully, they read this too!)

[LowerForLonger]

How about tax reporting from brokerage companies for ROC? Has anyone had any problems with inaccurate year-end reporting?

[Retired Investor]

@LowerForLonger Occasionally Fidelity has had to send out corrected tax statements. They usually are final by mid-March so I wait to file until after the 20th. Changes after that are rare and usually small enough not to be troubled about.

[Idiom]

@LowerForLonger I get 3-5 corrections every year from TDAmeritrade. The final one comes in may the last two years. I delay my taxes to the fall due date which necessitates one runs your estimated taxes and pay a buffer to avoid any penalties. Hasn't been a big issue for me yet

[Nick Ackerman]

@LowerForLonger as others mentioned, it isn't a tax year for a CEF investor until they get the third or fourth corrected 1099. It can be frustrating if you want to get your taxes filed right away. For me, I just wait until the beginning of April when I do my quarterly payments as well.

[integritycoatings]

What about THW where NAV has declined for many years due to an exorbitant distribution

[JANFA]

@integritycoatings I hope somebody will answer your question.

[Jcb331]

@JANFA @integritycoatings I'm not sure why you guys keep harping on THW nav. From SA graphs: XTHWX NAV only graph

07/2015-07/2016 -10.8%
04-2016-04-2201 5yr---+27.5%
04-2018-04-2021 3yr-- + 23.02%
04/2020- 04-2021 1 yr--+ 13.2%
10-2020- 04-2021 6 mo---5.39%
03-2021-04-2021 1 mo--- 3.6%

So THW is earning its distribution in all cases except the first year.
No DIV cuts in its 6 year history. it may not be growing much but it is earning its distribution. and with tax free ROC it adds even more value to the distributions.

[JANFA]

@Jcb331 I am retired and I like the THW steady distributions but would like to be sure that the ROC is not destructive. I am not a financial specialist to analyze ROC so I go with a recommended rule of thumb - checking NAV over time whether it is dropping or rising. I looked at the NAV chart at Fidelity and the NAV values were dropping since the beginning of the fund as follows / 1 year intervals/:
7/31/2015 - $19.14
7/29/2016 - $16.60
7/31/2017 - $15.69
7/31/2018 - $14.89
7/31/2019 - $13.66
Then the NAV reached the lowest point in March 2020 - courtesy of Covid 19, and it keeps rising from there. I bought THW in April 2020, and am adding some now.
I plotted values of shares of companies that THW currently contains against xTHWx for the period of existence of THW. Most of the companies saw their share value going up since 2015 - like for example JNJ, a few, like NS and BMS followed xTHWx.
I am hoping the NAV of THW will stabilize, because I like the income but not dropping NAV.

[misscbd]

Thank you for another informative article.

I have a few dumb questions. First, does the "buy/write" designation mean the fund deals exclusively in stock *indices*?

Also, does ETY differ from the Buy/Write funds you mention because they do not option trade *exclusively* in indices but also in stocks?

Your article made me think further about the BUY/WRITE cefs: ETV, ETW, EXD mentioned and how they compare to the other EV fund, EOS.

Am I missing something or does EOS only write call options, etc. on stocks and not indices?

Since indices obviously reflect the current market and can rise or drop markedly, I'm thinking that can negatively affect those funds during a bear market more than a cef that doesn't trade the indices but instead trades around individual stocks.

There's so much to learn -- appreciate your articles and the clarity you provide.

[Nick Ackerman]

@misscbd thanks for reading!

1. Something I always wondered too. That is because when someone says they use a buy-write strategy - I always thought it meant they bought the stock to write calls against that individual position. In this case, it is buying the stock, then writing against an index. So, I guess it can be more flexible than I originally would have guessed.

2. ETY does write calls against indexes. Here is an easy breakdown for all of Eaton Vance's funds. funds.eatonvance.com/...

3. Reading that PDF above, you will note that EOS writes against underlying positions in the portfolio/individual positions. That is why they don't show ROC in their distribution as much. Though they do for other reasons (such as just not realizing enough capital gains and leaving positions as unrealized - means they still "earned" their distribution - they just haven't realized it yet.)

4. Absolutely right, even in a not very volatile market as the market just rises naturally upward - that generates losses on the option sleeve of their portfolio. At the same time, a lot of their underlying positions are rising - enough to offset the said losses. Then boom! You get ROC because they had realized losses - while NAV rose or stayed relatively flat due to the underlying unrealized appreciation.

I hope this helps! Let me know if anything else comes up.

We do a ton of educational articles at the CEF/ETF Income Laboratory. Not trying to do a sales pitch but there we have a "Library" and you could literally spend years reading through the pieces and learning. We are also always there to help with any questions in a live chat. (Yes, this is a bit promo but just thought I'd put it out there if interested. Of course, always feel free to reach out via comments on articles as well - as you have here. Though a bit harder to explain without being able to include images and such as we could in a chat. seekingalpha.com/... )

[misscbd]

@Nick Ackerman
Thank you for this detailed response.

I see that the funds I hold writing against indices (ETY, EXD) seem to have more fluctuation in distributions (regardless of how they accumulate the $$ for dispersement :). I love your explanation of why this can happen.

I really appreciate the EV link info because I was considering adding to EXD but now that I understand buy/write a bit better, I will stick to my original preference (when I bot EOS in 2015) and let my small EXD opening position sit as is. ETY is now a full position and I'm okay with that but will not add shares.

I notice UTF and UTG, while not "tax-managed", had distributions classified as "qualified" and the rest was Capital Gains. For that reason, I expect to add to those if/when they are not at a big premium and have placed BUI on my radar too.

It would be nice if they were all in IRAs but unfortunately, I have less $$ in that one so I have to buy some shares in the taxable.

Prior to joining SA I had no interest or understanding of these things. I hope it's true that learning new stuff increases that magic juju in senior brains, reduces the bad amyloid placque things and keeps us from forgetting our names because my "left" brain has Never been used this much, ever!!! :0

[surfgeezer]

@misscbd First I agree with Nick's, but let me just add- since I do use options extensively in my portfolio also and hold several CEF's that do.

Writing an option is basically just guaranteeing a price- at a certain time, and getting paid a "Premium" for that "guarantee". It is basically very much like an Insurance product.

As the insurers, they get cash up front- for the time period- with no way of actually "knowing" what will happen. That's universal.

So... that cash received is by definition simply unrealized and unknown how much will have to be "paid out", it is an unrealized "cash pool" that can be used immediately.

What ALL Insurance companies depend on is the CONTINUING incoming Premiums, as well as how well they use the already paid Premiums. That's the big deal.

That continuing part is as big a deal as how well its used because of what is called Theta- time value. Think Insurance policy cost for 1 year vs 1 month- obviously less. THAT "time" change coupled with the continuing is the big deal.

We all know price is volatile and can easily outrun a stocks dividend, well sold options are a multiple of that same thinking.

Meaning, as an Income investor, I am fine with accepting, in the short term, the fact I could buy something and have price go down more than my div- BECAUSE I know the div will continue and be EVENTUALLY outrunning the price change. Same with options.

So if I buy a stock and immediately sell a Call for a set price higher, I am by definition "making money". HOWEVER, if that stock goes higher than my Premium I will "lose" money on that contract-BUT I can in fact simply wait for time to go buy and then roll that contract to add more "time". Adding more time should add more cash $ by definition ( as explained above)- BUT by closing/realizing that first contract I would book a realized loss AND have more unrealized cash STILL in my "pool" to maybe pay divs or buy stocks> WITH a HIGHER GAAP realized price on that next contract (change in price of the stock (Delta) + new time (Theta)).

SO.... I "lost" money on the first contract and hopefully also collected a divvy by still owning the stock, then I get a new one with a net higher price and that is simply unseen in the reports because it is technically "unrealized" cash. Repeat, repeat, repeat.

It does show up in NAV as a NEGATIVE because accounting demands they always show the immediate "buyback" along with that one time offsetting cash on each contract.
On a Call, as the stock price rises the option "buyback" shows a higher "loss" and gains when the stock price drops. By definition a buy/write is DELIBERATELY offsetting stock gains with taxable "loss's- OR if the stock stays flat boosting the div cash payout with Time burn.

That's a big deal as far as watching the NAV, because, if done correctly, the option "losses" are again going to improve with time as they get rolled ( time)- maybe even into ever higher strike prices that will show possibly less unrealized cash pool bumps. Maybe not.

The real deal is looking at the changes in the unrealized cash pool YOY- which are very hard to see with most CEF's. The realized/unrealized is just accounting crap as each contract reflects the stocks price change. My personnel unrealized "pool" ( Calls and Puts sold ) is currently sitting at 1.59 X my estimated divs. That would be the salient point- the unrealized pool can be bigger than what I expect in divs easily. It can also easily be bigger than the actual stock gains and is by definition just unrealized cash sitting and deployable.

WHY these funds have such a large % in ROC is simply because know one can know what that unrealized cash ( constantly churning)) in the "pool" will do and the "pool" itself is simply unrealized prepaid $.

[Nick Ackerman]

I published an exclusive article yesterday to members of the CEF/ETF Income Laboratory. It is around the same topic, but going into what the tax characters can all mean - their benefits for a taxable account or the not-so-beneficial distribution classifications (ordinary income, short-term capital gains...) seekingalpha.com/...

Consider joining the CEF/ETF Income Laboratory today and getting an early look at the article! Free 2-week trial available for those interested. seekingalpha.com/...

[littlecubbie2019]

Nick,
Thanks for article. I appreciate you clarifying these subjects.
Jason

[Nick Ackerman]

@littlecubbie2019 glad you enjoyed! Thank you!

[Dick Cod]

The misleading generalization (straight from the ancient and definitively incorrect EV "thought piece," perhaps?) that a declining/eroding NAV signals the CEF is just giving you your capital back is easily demonstrated to be false. Consider...
A CEF portfolio composed of one or more coupon bonds will ALWAYS suffer a declining NAV as interest rates rise. However, the coupon cash flows remain unaffected...so if net interest income covered the distributions before rates rose, they will continue to cover the distribution after rates rise despite a decrease in NAV.
Further --- in an unrelated type of NAV reduction -- CEFs may distribute special / extra year end distributions composed of either realized gains or additional interest income. Such extra distributions DO reduce NAV but clearly DO NOT signal that the fund is no longer capable of supporting continuing regular distributions with interest income or gains.
It's important to avoid facile generalizations and get this stuff right to avoid making poor investment or trading decisions.
Regards, Dick

[Nick Ackerman]

@Dick Cod thank you for the input!

[clrodrick]

'That always made me chuckle a little bit, as I really don't know where they (CEFConnect) are getting their information (making it up out of thin air?)'

That's a good question! Thanks for the article

[Nick Ackerman]

@clrodrick I emailed them, I know they get their information from Morningstar - but where are they getting it as it doesn't match even section 19a files! So always was curious.

[ManWithoutName]

ETV is a core holding in my taxable portfolio due to most of it's distribution being classified as ROC. I'd also echo an earlier comment about waiting on filing your taxes for the year if you have an investment with high ROC, as the first 1099's can have a distribution classification shown incorrectly.

Investors that dismiss these investments simply because they have a portion of their distribution labeled as "return of capital" are not doing themselves any favors by paying higher taxes.

[Nick Ackerman]

@Texdude well said!

[hawkeye46]

@Texdude
I love my ROC taxable funds.
Good point on waiting to file your a Income Taxes
I received 3 corrected tax forms from my Broker, the last on March 10

[dashriprock2]

Great analysis, thanks.
Can you advise a reliable source for finding the end of day NAVs for CEFs?
Also, ROC is it true that diminishes our tax basis?
Thanks
TDJ

[usiah]

@dashriprock2

Yes, ROC reduces basis.

[wbrad90]

@dashriprock2
NAVs for most CEFs can be looked up by adding an X before and after the ticker symbol. (eg. for DNP, XDNPX).Yes, ROC reduces your tax basis.

[NV_GARY]

@dashriprock2
Actually- that is one thing that cefconnect does well - end of day NAV.

[Jmzol2067]

I am watching BSTZ closely. I will probably start a position in the next few months. I do not understand why there is a big difference in the NAV of the BST vs BSTZ funds..Any comments.

JMZ

[Nick Ackerman]

@Jmzol2067 I'm not sure exactly what you mean about having a difference. They are two different funds. I'm long both of them! Thank you and good luck!

[hawkeyec]

@Nick Ackerman

Thank you once again for being SA's resident expert on CEF distributions, among other things. A couple of extra comments. First, I love non-destructive ROC (and sometimes even the destructive kind). I have 50 CEFs and many reported large LT gains and ROC distributions this year, all of which helped push my tax bill down. I just love writing income on my 1040 and then looking up at the little box on top of my Turbo Tax program and seeing no change in the tax bill when the income goes in.

The things you mention in this post can cause some irritations however. By law I am supposed to receive 1099s by mid-Feb. I do, but virtually all the ones with securities data tell me they are not final numbers. Corrections will be coming. This, of course is for reasons you have explained here. I had 45 changes in reported income classifications this year (so far; hoping they are all there is). Those corrected reports didn't come until two weeks ago so I was unable to finish my taxes until I was sure all the data was in. Also, I had many surprises this year, huge unexpected capital gains distributions, from UST mutual funds, of all places, and CEFs. If I bother to check, Vanguard usually forewarns me of gains distributions up to a month early (unfortunately I forgot to look this year). I don't know if CEF sites pre-warn also.

Finally, you mention MLPs as a source of ROC, sometimes destructive. I bought AMLP at the IPO and added to the position many times over the years until it got quite large. Even though much of the distribution from this fund was from ROC sources, that is the point of MLP's, to lower taxes on other investment income. I just sold the whole position this year and in true fashion, it proved to be a gift that keeps on giving, in spite of falling NAV, and a corresponding decline in basis, I managed to take a nice loss, erasing all of my surprise capital gains distributions and a huge gain on a strip treasury. Meanwhile, my net earnings on this stock, including positive tax benefits, have been among my best over the years. When the energy picture settles I am thinking of doing a reset with ALMP or a cousin or two.

[jasonjones]

@hawkeyec I love happy endings

[clrodrick]

@hawkeyec - a few commentators from other SA articles implied holding a CEF that has a fiscal year end that does not match up with calendar year end (Dec 31) can potentially have an issue where it issues corrected 1099 well after tax deadline. Ever since reading that I have been careful to only select CEFs for my taxable account that have fiscal year end of Dec 31. I hold a few that are not aligned and likely will sell them once I classify for LTCG and move money into similar fund with an aligned fiscal year end.

[Nick Ackerman]

@hawkeyec always appreciate your thoughts! Thank you for taking the time to share your thoughts.

[villanema]

CEFs are a significant portion my investments and I also find lack of knowledge amongst brokers who are extremely reliable and experienced. So I tend to invest in funds with good reputations and usually do

not reduce dividends. PIMCO, Guggenheim, Cohen and Steers are some examples. In addition I consider Nick to be one of the more knowledgeable SA contributors as he answers questions rapidly. In addition there number of intelligent commenters who provide ideas. Finally, I try to invest in a number of different CEFS to provide some diversity.

[Nick Ackerman]

@villanema agreed! Thank you for reading. Good luck with all your investments!

[kyle191]

@villanema ...I used to think that way about Cohen and Steers until their MIE fund got obliterated! There is a share holder vote to liquidate the fund at the NAV. So if you bought any time above $3.50 you will get shellacked.

I have written repeatedly to C&S about why the fund is liquidating and all I get back is a canned response "blaming Covid."

When MIE liquidates, it will be my single biggest loss in my investing career. I purchased in the $7.00 range

[Nick Ackerman]

@kyle191 I don't blame C&S for MIE, personally. It was the whole sector that just got annihilated. Several liquidated in the space or did reverse splits.

I also believe, though it seems like an unpopular opinion, that you could simply move that capital somewhere else. To another MLP focused fund and you would be able to participate in the rebound if it should continue. If it is held in a taxable account, even better - you now have losses to offset some gains you could realize.

Though I understand your frustration. It is liquidating because it just simply isn't large enough for them to concern themselves with at this point.

[jasonjones]

Great article. In the past, I didn't invest in CEFs because of ROC and management fees. Fortunately, I had time in retirement to figure out these issues to the value of CEFs.

Does a person have to continuously trade them to avoid destruction of NAV? I see some funds to are able to maintain NAV, ie., BME, BST, etc.

[Nick Ackerman]

@jasonjones thank you for reading and the comment! I don't think that trading is necessarily required. As you mentioned only a few of the fund's higher NAV now than at inception. With the latest rally since March lows last year - there are now quite a few funds in that category.

[jasonjones]

@Nick Ackerman Yes, CII is a it's initial price and BDJ is headed that way although these are unusual times.

[hingroyield]

@Nick Ackerman yes alot of CEF's now have wonderful year NAV returns that readers love to tout , hard to imagine an equity CEF that doesn't have a growing NAV . Folks need to take a longer time frame to see if the funds managers distribution policies are too generous ,sooner or later there will be a bear market or an extended sideways market, that will quickly separate out the better funds . Its still surprising how many funds even now have lower NAVs than they started with

[Jcb331]

I always wonder where the origin of the misconception about ROC started. Is it financial advisors that just don’t know any better and give their clients bad information? Is it banks and brokerages that pine for clients and thus scare them to enroll in their services. Is it a carryover from the 2008 financial crisis where I assume a lot of CEFs were paying ROC with declining NAVs?

[Nick Ackerman]

@Jcb331 I often wonder too!

[Universal Huckleberry]

@Jcb331 I think the misconception lies in the name itself: "Return Of Capital". The idea of getting your own capital back in the form of a so-called distribution sounds a lot like a ponzi scheme.

[Nick Ackerman]

@Universal Huckleberry right! I think that does cause some confusion. Perhaps why others classify it as "nondividend distribution."