After the run we've had in the markets, I believe we should start to see the more defensive option-income funds perform relatively better over the more aggressive leveraged closed-end funds ("CEFs"), many of which have had strong advances over the past month and have moved to high market premiums.
That assumes that the broader markets take a breather here after a surprisingly bullish August so far that has confounded many bears who expected further downside. But with a strong jobs report and lower inflation numbers from CPI and PPI earlier this week, investors have jumped back into the markets full force.
Or maybe it's been more of a dumb money retail crowd clamoring to put cash back to work while institutions are forced to cover their shorts and hedges. Whatever the reason, I thought it might be productive to see what has worked among my Actionable Buy and Buy rated equity CEFs and exchange-traded funds ("ETFs") from the Equity CEF/ETF Portfolio spreadsheet and what might work better if the next couple months in September and October live up to their more notorious bearish history.
But let's first see how these CEFs and ETFs have performed in a bull market environment which has seen the S&P 500 (SPY), $419.99 current market price, recover well over half of its losses YTD.
In this exercise, I'm going to use July 15th as a starting point since not only did that mark a recent low point in the markets (though a higher-low from mid-June), but it also coincided with the third Friday of the month, which is an option rollover day. That is, July options expired on July 15th while August options were initiated on July 15th and will expire Aug 19th.
The first four funds are the of the aggressive and/or leveraged type CEFs and they include the Eaton Vance Tax-Advantaged Global Dividend Opportunities Fund (ETO), $28.80 current market price, the Cornerstone Strategic Value Fund (CLM), 10.81 current market price, the PIMCO Energy & Tactical Credit Opportunities Fund (NRGX), $15.30 current market price and the Cushing NextGen Infrastructure Income Fund (SZC), $44.58 current market price.
All of the funds that will be shown below are rated either a Buy or Actionable Buy in the Equity CEF/ETF Portfolio and they all represent medium to large positions of mine, though some like ETO, have been sold down recently.
Note: I also have a large position in the Cornerstone Total Return Fund (CRF), which is up a similar return as CLM at +20.3%. The Cornerstone funds CLM & CRF are not leveraged but I do consider them aggressive positions
The second portfolio grouping do use option-writing but are what I would call the moderately defensive option-income CEFs and they include the Eaton Vance Enhanced Equity Income Fund (EOI), $16.90 current market price, the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG), $8.96 current market price, the BlackRock Science and Technology Trust II (BSTZ), $22.46 current market price and the BlackRock Enhanced Capital & Income Fund (CII), $20.16 current market price.
These funds sell index or individual options against a portion of their portfolio, roughly 30% to 50%, and thus can capture more upside than the next group, which includes the most defensive option strategies.
This third grouping includes the Eaton Vance Tax-Managed Buy-Write Strategy Fund (EXD), $10.56 current market price, the Eaton Vance Global Buy-Write Opportunities Fund (ETW), $9.20 current market price, the Eaton Vance Risk-Managed Diversified Equity Income Fund (ETJ), $9.69 current market price and the Madison Covered-Call & Equity Strategy Fund (MCN), $7.43 current market price.
This third group generally writes options against virtually 100% of their portfolio value, thus giving them the distinction of being the most defensive CEFs. As you might expect, they have the lowest appreciation and EXD is even negative during this period. More on that in a moment.
Finally, I wanted to show you the two Actionable Buy ETFs I have a large position in, the Global X S&P 500 Covered Call ETF (XYLD), $44.03 current market price and the Global X Russell 2000 Covered Call ETF (RYLD), $21.21 current market price.
As you can see, the returns of XYLD and RYLD over the past month or so pale in comparison to their benchmarks, SPY and IWM. This is what can happen when funds that sell index options At-The-Money on 100% of their portfolio value, do so at a market low which also happened to coincide with a monthly option rollover.
Though the returns for XYLD and RYLD are minimal since July 15th, on a YTD basis, XYLD and RYLD are still outperforming their benchmarks, though the margin has narrowed quite a bit.
But this is why you need to have a diversified portfolio of equity CEFs and ETFs in which some funds can outperform during strong market periods and some funds can hold up during flat to even bear market periods.
I believe the low-hanging fruit of this market advance, and probably the high-hanging fruit as well, have just about been picked clean and yesterday's reversal, which was tied to a weakening bond market, may signal a change in leadership from the aggressive/leveraged CEFs to the more defensive option income CEFs.
And considering the valuation changes we've seen over the past month with many of the aggressive/leveraged CEFs rising to double-digit premiums, like ETO at a 13.7% market price premium and other buy rated funds like the Calamos Global Dynamic Income Fund (CHW), $7.78 current market price at a 11.6% market price premium and the Liberty All-Star Growth Fund (ASG), $6.76 current market price, at a 13.5% market price premium, I'm more inclined to sell down some of these positions than add to them.
What would I be looking at now if the next two months prove to be more difficult? I still think the Eaton Vance Tax-Managed Buy-Write Strategy Fund (EXD), $10.56 current market price, is relatively underpriced and if you have a taxable account, EXD offers an 8.1% annualized yield that is essentially tax-free due to the large ROC in its distributions.
EXD has virtually the same stock portfolio and the same option strategy as the Eaton Vance Tax-Managed Buy-Write Opportunities Fund (ETV), $15.57 current market price, a much larger option-income CEF that trades at a 14.0% market price premium while the much smaller EXD trades at a 2.9% market price premium.
It doesn't take many shares to move EXD down, and that's what seems to have happened after a strong move in June, but considering how defensive the fund is, you really don't take much of a risk in EXD in case we go into a down period.
And if you can take advantage of the ROC in the distributions, due to EXD's accumulated losses before it changed its strategy in February of 2019 to an ETV clone, you could generate tax-equivalent yields as high as 11% depending on your tax-bracket.
Note: ROC is considered non-dividend income on 1099's and thus, is not taxable in the year received though you are supposed to lower your cost basis by the ROC amount. Thus, ROC is deferred until you sell the position
I can't say where the markets go over the next month or two, which also includes a Federal Reserve meeting on September 20th-21st, but if history is any guide, I think it makes sense to re-balance portfolios into the more defensive option-income CEFs that trade at reasonable valuations still.
Thank you for reading my article. My goal is to give you observations and actionable ideas in Closed-End funds while educating you on how these unique and opportunistic funds work.
CEFs can be one of the most exhilarating and yet most frustrating security classes to invest in, and it's important that you have someone who can be a level head during up and down periods of the market. I hope to be that voice of calm when necessary. ~ Douglas Albo
This article was written by
Registered Investment Advisor since 2009. Prior experience includes 12-years as a Vice-President, Financial Advisor at Smith Barney from 1994 to 2001 and Morgan Stanley from 2001 to 2007.
Disclosure: I/we have a beneficial long position in the shares of ALL 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.