Author’s note: This article was released to CEF/ETF Income Laboratory members on January 24, 2022. Please check latest data before investing.
Quantitative screens help to rapidly narrow down attractive candidates from the database of 500-plus closed-end funds for further due diligence and investigation.
Based on feedback from members, it seems that a very many number of investors, understandably, place a great emphasis on coverage and return of capital. While I'm not going to rehash the entire ROC argument here (it is suffice to say that the issue is much more complicated than "ROC = bad"), some investors may consider a fund with over 100% coverage to be attractive simply because they know that the distributions are being covered by earnings. Such a fund may be at lower risk of a distribution cut, which can cause devastating impacts to a fund's market price and may even afford to raise its distribution in the future.
What does the "quality" label indicate? Simply put, it means that the distribution coverage is greater than 100%. However, please note these caveats: Firstly, coverage ratios are calculated using earnings data from CEFConnect. Although there are sometimes discrepancies with CEFConnect's data, this allows us to automate the calculation process for the entire universe, and we consider it to be sufficient for a preliminary screen anyway. Before buying or selling any fund, it's recommended to independently verify the coverage ratios from the individual fund annual/semi-annual reports themselves. Secondly, having a coverage ratio >100% does not guarantee that the fund's distribution is secure. Many funds reduce their distributions periodically in line with market conditions in order to maintain good coverage. Thirdly, a coverage cut off ratio of 100% is, ultimately, an arbitrary number. A fund with 99.9% coverage will be excluded from the rankings, whereas funds with 100.1% coverage will be considered, even though only a sliver of coverage separates the two.
The coverage ratio is calculated by dividing the earnings/share number provided by CEFConnect on the "distributions" tab by the distribution/share. CEFdata also provides earning coverage numbers as well.
I hope that these rankings of quality CEFs will provide fertile ground for further exploration.
Key to table headings:
P/D = premium/discount
Z = 1-year z-score
Lev = leverage
BE = baseline expense
Cov = coverage
Data were taken from the close of January 21st, 2021.
The following data show the 10 CEFs with the highest discounts and coverage >100%. Yields, z-scores and leverage are shown for comparison.
|(ENX)||New York Munis||-11.81%||3.71%||-2.5||35%||1.06%||106%|
|(VTN)||New York Munis||-11.46%||4.59%||-2.6||37%||1.18%||104%|
|(NAN)||New York Munis||-11.14%||4.33%||-2.5||37%||1.15%||100%|
CEFs with the best (most negative) z-scores are potential buy candidates. The following data show the 10 CEFs with the lowest z-scores. Premium/discount, yields and leverage are shown for comparison. Only funds with coverage >100% are considered.
Some readers are mostly interested in obtaining income from their CEFs, so the following data presents the top 20 highest yielding CEFs. I've also included the premium/discount and z-score data for reference. Before going out and buying all 10 funds from the list, some words of caution: [i] higher yields generally indicate higher risk, and [ii] some of these funds trade at a premium, meaning you will be buying them at a price higher than the intrinsic value of the assets (which is why I've included the premium/discount and z-score data for consideration). Only funds with coverage >100% are considered. To make the charts more manageable, I've split the funds into two groups of 10.
For possible buy candidates, it's probably a good idea to consider both yield and discount. Buying a CEF with both a high yield and discount not only gives you the opportunity to capitalize from discount contraction, but you also get "free" alpha every time the distribution is paid out. This is because paying out a distribution is effectively the same as liquidating the fund at NAV and returning the capital to the unitholders. I considered several ways to rank CEFs by a composite metric of both yield and discount. The simplest would be yield + discount. However, I disregarded this because yields and discounts may have different ranges of absolute values and a sum would be biased toward the larger set of values. I finally settled on the multiplicative product, yield x discount. This is because I consider a CEF with 7% yield and 7% discount to be more desirable than a fund with 2% yield and 12% discount, or 12% yield and 2% discount, even though each pair of quantities sum to 14%. Multiplying yield and discount together biases toward funds with both high yield and discount. Since discount is negative and yield is positive, the more negative the "DxY" metric, the better. Only funds with >100% coverage are considered. The DxY score is scaled by 100.
|(VTN)||New York Munis||-11.46%||4.59%||-2.6||-0.5||37%||1.18%||104%|
|(NAN)||New York Munis||-11.14%||4.33%||-2.5||-0.5||37%||1.15%||100%|
This is my favorite metric because it takes into account all three factors that I always consider when buying or selling CEFs: Yield, discount and z-score. The composite metric simply multiplies the three quantities together. A screen is applied to only include CEFs with a negative one-year z-score. As both discount and z-score are negative while yield is positive, the more positive the "DxYxZ" metric, the better. Only funds with >100% coverage are considered. The DxYxZ score is scaled by 100.
|(VTN)||New York Munis||-11.46%||4.59%||-2.6||1.4||37%||1.18%||104%|
|(NAN)||New York Munis||-11.14%||4.33%||-2.5||1.2||37%||1.15%||100%|
The CEF sell-off over the last few weeks has brought value, especially to munis that have been struck by concerns over high rates. However, munis are still valuable as safe-haven ballasts for an equity portfolio, and are also particularly attractive to high-earners investing in a taxable account.
Two funds that I'd like to highlight as being particularly attractive are the Pioneer Municipal High Income Advantage Fund (MAV) and Eaton Vance Municipal Income Trust (EVN). Both funds are holdings of our Taxable Income portfolio.
We can see that MAV and EVN both sold off hard alongside the equity markets, falling by nearly -7% on the month, compared to SPY (-7.81%) and QQQ (-11.40%). However, on a NAV basis they fared much better with only a -2% decrease in their NAV total return performance.
Note that as a high-yield muni fund, MAV will have the ability to invest in non-investment grade munis. According to CEFdata though, most of the fund is still allocated to investment grade holdings totaling over three-quarters of the fund, consisting of AAA (17.5%), AA (43.6%), A (9.4%) and BBB (6.0%).
EVN was the 4th-ranked DxYxZ fund in this month's "Quality". It last closed at a discount of -8.73% and with a yield of 4.53% with 101% coverage. The 1 year z-score is -3.5, indicating that it is severely undervalued relative to its recent history. For reference, the 1, 3 and 5-year average discounts are -3.03%, -6.55% and -6.75% respectively.
While EVN isn't billed as a high-yield muni fund, the managers still have the ability to invest in junk or unrated debt. The fund's latest factsheet shows that 79.5% of the fund is investment grade-rated.
EVN also has the distinction of being a historically very strong performing fund, ranking 1st (!) out of 53 muni funds over 10 years per CEFdata. Its more recent performance has been a mixed bag, with underperformance over the 1-year time frame, but it's still near the top at the 3- and 5-year time intervals.
If I had to pick one of the two, it would be EVN. We may add to our EVN position in our Taxable Income portfolio this week.
At the CEF/ETF Income Laboratory, we manage closed-end fund (CEF) and exchange-traded fund (ETF) portfolios targeting safe and reliable ~8% yields to make income investing easy for you. Check out what our members have to say about our service.
To see all that our exclusive membership has to offer, sign up for a free trial by clicking on the button below!
This article was written by
CEF/ETF Income Laboratory is a premium newsletter on Seeking Alpha that is focused on researching profitable income and arbitrage ideas with closed-end funds (CEFs) and exchange-traded funds (ETFs). We manage model safe and reliable 8%-yielding fund portfolios that have beaten the market in order to make income investing easy for you. Check us out to see why one subscriber calls us a "one-stop shop for CEF research.”
The CEF/ETF Income Laboratory is a top-ranked newsletter service that boasts a community of over 1000 serious income investors dedicated to sharing the best CEF and ETF ideas and strategies.
Our team includes:
1) Stanford Chemist: I am a scientific researcher by training who has taken up a passionate interest in investing. I provide fresh, agenda-free insight and analysis that you won't find on Wall Street! My ultimate goal is to provide analysis, research and evidence-based ways of generating profitable investing outcomes with CEFs and ETFs. My guiding philosophy is to help teach members not "what to think", but "how to think".
2) Nick Ackerman: Nick is a former Financial Advisor and has previously qualified for holding Series 7 and Series 66 licenses. These licenses also specifically qualified him for the role of Registered Investment Adviser (RIA), i.e., he was registered as a fiduciary and could manage assets for a fee and give advice. Since then he has continued with his passion for investing through writing for Seeking Alpha, providing his knowledge, opinions, and insights of the investing world. His specific focus is on closed-end funds as an attractive way to achieve income as well as general financial planning strategies towards achieving one’s long term financial goals.
3) Juan de la Hoz: Juan has previously worked as a fixed income trader, financial analyst, operations analyst, and economics professor in Canada and Colombia. He has hands-on experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He is the "ETF Expert" of the CEF/ETF Income Laboratory, and enjoys researching strategies for income investors to increase their returns while lowering risk.
4) Dividend Seeker: Dividend Seeker began investing, as well as his career in Financial Services, in 2008, at the height of the market crash. This experience gave him a lot of perspective in a short period of time, and has helped shape his investment strategy today. He follows the markets passionately, investing mostly in sector ETFs, fixed-income CEFs, gold, and municipal bonds. He has worked in the Insurance industry in Funds Management, helping to direct conservative investments for claims reserves. After a few years, he moved in to the Banking industry, where he worked as a junior equity and currency analyst. Most recently, he took on an Audit role, supervising BSA/AML Compliance teams for one of the largest banks in the world. He has both a Bachelors and MBA in Finance. He is the "Macro Expert" of the CEF/ETF Income Laboratory.
Disclosure: I/we have a beneficial long position in the shares of EVN, HYB, MAV either through stock ownership, options, or other derivatives. 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.