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Is Closed-End Fund Investing "Chasing Yield"?

Dec. 01, 2021 10:19 PM ET3 Comments
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It is an unfortunate fact that many CEF investors do in fact "chase yield" while ignoring risk. CEFs are dominated by retail ownership, and it is understandable that many such investors do strongly seek out the ability to receive a high income from their investments. This is, in my opinion, why certain CEFs get bid to massive +50%-plus premiums despite the fact that their performances aren't better compared to their peers at the portfolio level. This type of yield chasing invariably does not end well. When the inevitable distribution cut occurs, the premium (and share price) usually collapses, saddling the investor with capital losses equivalent to many years of distributions (see Why CEF Distribution Stability Is Overvalued).

On the other hand, at the CEF/ETF Income Laboratory, one of our favorite sayings is "remember CEF investors, don't just focus on the yield!" This is how we've avoided many of the distribution cuts that have plagued CEF investors over the years.

This income growth our Income Generator has been steady throughout inception of the portfolio. The monthly income received by our portfolio in October 2021 is at an all-time high (excluding special distributions).

2019 saw a total of $11,603.29 in distributions paid including the specials. 2020 saw $12,992.91 - also including the specials. That means another gain of 12% in 2020 despite the pandemic. We are set to once again grow this in 2021 too. If we extrapolate what the portfolio has already generated (NOT counting specials that are coming this way) we would arrive at $13,605.31 in distributions. This will only likely be higher with specials coming, Eagle Point Credit Company (ECC) already announced a $0.50 coming.

Importantly, this income growth has been achieved without adding any new capital to the portfolio. The portfolio was incepted in 2017 with $100,000 capital, meaning that we're on track to achieve an over 13% yield-on-cost in only 4 years.

It's all about the assets

Newer members may wonder: why don't we place a greater emphasis on the yield of a fund? We are the CEF/ETF Income Laboratory after all.

The answer is that it's all about the assets. Remember, CEFs are not a separate asset class! They are simply an investment vehicle, or "wrapper" for a particular set of assets. (See Income Lab Ideas: Asset Classes And Portfolio Allocations)

When a group of funds are investing in the same sector, we'd expect them to all "earn" (whether from dividends, income, or capital appreciation) a similar rate of return from their assets. However, because CEFs often pay out return-of-capital ("ROC") distributions as part of their managed distribution programs, the actual yields exhibited by funds from the same sector can vary. The simple truth is that a fund manager can basically choose to pay out as much yield as they want without restriction.

What this means is that, when we're looking at funds from the same sector, what one fund lacks in the yield department is made up for by better capital stability and returns. Conversely, a higher-yielding fund would be expected to show weaker capital sustainability.

One area that has been delivering results this year is the energy space (it's about time after years of being the loser!). One of the ways that have helped us out is with our Tactical Income-100 Portfolio. That's a portfolio that will take greater risks like investing in sector-specific investments. One such holding that we picked up earlier this year was the Tortoise Energy Infrastructure Corp (TYG).

Since then, the investment has delivered a number of distribution boosts as they put in place a new target distribution yield of 5 to 7%. Considering how well the fund and energy more broadly has been doing this year, it has resulted in quite impressive growth every quarter for the last 5 now.


While higher yield does generally equal higher risk, the situation isn't so black-and-white with closed-end funds. For one thing, CEF managers can choose to pay out any amount of yield that they want but the total return is still going to be driven by the underlying assets. For example, the ~20%-yielding CLM/CRF had similar NAV returns to the ~2%-yielding SPY during the latest crash. Ten times the yield but the same risk? This is practically unheard of outside of the CEF world!

ChartData by YCharts

Here's another example, the ~10%-yielding Cohen & Steers Total Return Realty Fund (RFI) versus the ~5%-yielding Vanguard REIT ETF (VNQ). RFI has twice the yield of the benchmark but drawdowns were very similar at the NAV level!

ChartData by YCharts

RFI has also done way better than the eight 10%-yielding REITs mentioned in this article: 8 REITs With 10% Yields.

ChartData by YCharts

Ultimately, it's the assets that a CEF owns that drives returns. After deciding on sector exposure, look for management quality, historical performance, premium/discount valuation and the sustainability of the distribution. But yet, just because we don't practice yield-chasing for our portfolios doesn't mean that it is not possible to yield-chase CEFs. We've seen time and time again how high-yielding CEFs are bid up to stratospheric premiums, only for that (and the share price) to collapse once the inevitable distribution cut arises. We've called many of these for Income Laboratory members over the past several years. Remember CEF investors, don't just focus on the yield!


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