This is the promise which comes our way from the folks at Contrarian Outlook:
“I’ve found a proven way for you to bag double-digit price gains – year in and year out – in your income portfolio.
“And you won’t have to sacrifice a single cent of dividend income to do it. In fact, you’ll be pocketing payouts 5 times greater than what the average S&P 500 investor is forced to take today.
“I’m talking SAFE 7.4% dividend payouts (and in many cases higher than that).”
I know that kind of idea is catnip to the whiskers of those of you out there in Gumshoedom who are looking at living off of your portfolios, or pocketing cash returns instead of hoping for capital gains windfalls, so let’s dig in and see what they’re pitching.
The ad letter comes from Michael Foster, and the subscription they’re selling is to the CEF Insider ($399 for the first year, 60-day refund period), where he’s the Investment Strategist. This is one of the few services that focuses on closed-end funds… so what they’re talking about, of course, is investing in closed-end funds (CEFs), which are a mostly income-focused backwater in the investment industry… more from the ad:
“CEFs routinely hand investors safe 6% to 12% dividend yields and FAST double-digit gains, too!
“And since they get so little attention from journalists and the suits on Wall Street, we can pick up these income wonders at spectacular discounts, as I’ll show you in a moment.
“So if you’re at or near retirement – or just looking to grab some extra cash to pay the bills or bulk up your savings, these unsung funds are EXACTLY what you’re looking for.”
That’s true, though you can sacrifice some returns by focusing on an income-obsessed investment like (most) closed-end funds… but let’s see which ones they’re teasing here, then you can dig into the details and think them over for yourself. Here are the hints about the first one…
“Bargain CEF Play #1: An 8.8% Payout and 20% Upside
“My first pick hands us an incredible 8.8% cash dividend as I write this… and pays out that dividend every single month.
“What’s more, this fund holds the very best investments for the COVID-19 crisis and beyond: utilities and real estate investment trusts providing services that will be in demand now and after the crisis eases….
“The team at the top has carefully calibrated its biggest holdings to focus on the infrastructure that will be in the highest demand as the 21st century continues to unfold.
“These days, it’s focusing on the safest, highest-yielding electrical utilities (including renewable power producers), whose steady operations back up this pick’s mammoth dividend.”
“Now is a terrific time to buy – because this fund trades at a totally undeserved 9% discount….”
Thinkolator sez that’s Nuveen Real Asset Income and Growth (JRI), which as of yesterday trades at about a 9% discount to its $16 net asset value (NAV), is about 28% levered (most closed-end funds use borrowed money, typically 15-40%, to boost their returns — something that helps to juice dividend distributions in a bull market but can hurt when rates rise, markets crash, or the debt becomes a burden), and pays a distribution of about 8% (9.65 cents/month). The amount of the distribution was reduced from 11.7 cents in March of last year, when the pandemic hit, but has stayed steady for a year now, with about half of the distribution “income” from the dividends and half “return of capital.”
The bad news? That’s the heaviest reliance on “return of capital” that they’ve ever had with this fund, which is about ten years old, the expense ratio is fairly high at 1.8% (not including the cost of leverage — total 2.26%), and the current discount at which the fund trades is actually a little below average (according to CEFdata.com, the average discount has been almost 13%, and the lowest discount 6.4%).
The good news? Leverage is pretty cheap, these are not shockingly overpriced assets that the fund owns (mostly utilities, MLPs and REITs), the fund is still below its pre-COVID highs, and a 9% discount is pretty decent these days and helps boost the yield (the yield on NAV would be only 5.6%, but since you’re paying a discount you get a 8% yield). Like many closed-end funds, it will be interest rate sensitive (they have to pay to borrow, and as an investment it’s seen as competing with bonds and other income investments that might be lower risk, so if yields go up for lower-risk investments, the yield will probably go up for this fund, too… and if the effective yield for new investors goes up, all else being equal, that means the price has to go down). This is a monthly dividend payer, which is also common for closed-end funds.
This fund definitely prioritizes income, so they’ve bought some of the higher-yielding REITs and utilities, which helps to provide a much higher yield than you would from average players in those sectors… REITs like STAG and MPW (I also own MPW, for what it’s worth) pay much higher yields than many others… so instead of getting a dividend of about 3.5% (that’s roughly what you’d get from an average “utilities and REITs” portfolio today), you get 5.6%, both from selecting higher yields and from the benefits of leverage, and you also get to buy that at a discount. If you’re very much income focused, that can be a decent deal… just don’t expect to beat the market or accumulate a lot of capital with these kinds of investments.
What else do they tease here? These are the clues for number two…
“Bargain CEF Play #2: A 6.5% Payer With Totally Ignored Upside!Are you getting our free Daily Update
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“My second pick is a high-yield bond fund trading at an unheard-of 8.5% discount as I write this. That’s despite the Federal Reserve promising to go to the wall for the bond market.
“But investors are choosing not to see that game-changing fact, giving us an unbeatable chance to buy in. That wide discount also stems from 2 other things that have kept this fund off the radar of the “first-level” crowd….
“It’s made a quiet shift in its strategy that’s driven it nearly triple the return of its benchmark since it made the switch….
“This fund is run by a major insurance company that doesn’t pay much attention to CEFs. That means the all-star team behind this fund, as well as its dividend, just don’t get a lot of marketing thrown behind them.”
Best guess here (and yes, it is a bit of a guess) is PGIM High Yield Bond (ISD), which is indeed run by the asset management affiliate of a major insurance company (Prudential (PRU)… whose stock itself yields 5%, by the way). I don’t know exactly what “strategy shift” they might have had, and PGIM is certainly not an “afterthought” company for Prudential (they manage about a trillion dollars), but it’s probably fair to say that the closed-end funds are not a priority for that particular asset manager.
ISD currently carries a distribution yield of about 8.1% (10.5 cents/month), and trades at roughly an 8% discount to NAV at the moment. You can see their latest quarterly commentary and the other basic fund info on their website here. The fund seems to follow the same basic strategies as some of PGIM’s big mutual funds, like PGIM High Yield (PBHAX), and it has the same management team, but the combination of leverage, the high leverage-fueled distribution, and the shifting discount/premium dynamic you can get with closed-end funds means that ISD has outperformed those similar-sounding mutual funds in recent years.
Another? Sure, let’s see what we can find.
“Bargain CEF Play #3: A Solid 6.6% Dividend No One’s Talking About (for now)
“Imagine a fund holding all the stocks you know well: blue-chip names with staying power, like Alphabet (GOOGL), Home Depot (HD), Netflix (NFLX) and Microsoft (MSFT)….
“… throws off a 6.6% dividend and lets you buy all of these top-notch names at a 12% discount.
“There’s more, too, because this fund also employs a savvy strategy that both boosts its dividend income and cuts its volatility at the same time, making it perfectly suited for the continued market volatility we’re likely to see until the coronavirus comes completely under control.”
This could be a lot of different closed-end funds, there are several that have a dividend trading strategy and buy up a lot of those big S&P 500 leaders while also trying to generate extra income. One of the most popular over the years has been Alpine, which is now managed by Aberdeen, so one example that might fit is the Aberdeen Total Dynamic Dividend Fund (AOD) — that has a discount of about 10.5% today and pays a 7.5% dividend, owning big companies like Apple and Microsoft and Alphabet, but also with a focus on dividends, particularly capturing special dividends and boosting returns a little bit by rotating positions to capture more dividends (holding a position through the dividend payment, selling it and moving on to buy the next one to pay a dividend, etc.). Here’s how they describe it on their fact sheet:
“The Fund combines four research-driven investment strategies—growth, value, special dividends and dividend capture rotation—to maximize the amount of distributed dividend income and to identify companies globally with the potential for dividend increases and capital appreciation.”
Frankly, these strategies tend to be expensive (lots of transactions and taxes) and don’t really do particularly well over time, and I’m guessing with this one — that’s not enough info to confirm whether this is really a recommendation being pitched here… just for some comparison, here’s what the total return of AOD looks like compared to the S&P 500 over the past three years:
There are plenty of closed-end funds that offer a similar bargain of higher income and lower total return — in other words, you can generate higher dividend payments if that’s what you want or need, but you usually end up paying for that over time. It might well be worth it to some folks, the steady distribution payments for these funds can be a nice income stream and they’re fairly predictable (unless there’s a financial crisis and all the levered closed-end funds crater because they can’t refinance their short-term debt, like in 2008), but there is no free lunch.
“Bargain CEF Play #4: A Monster 7.6% Dividend From an Overlooked Sector
“I’ve saved the best for last with our fourth and final pick.
“This one gives us a rare “double discount”: it holds top-notch industrial stocks that have been left behind in the rebound but are set for big gains as the recovery takes hold.
“That’s our first discount.
“The second is on the fund itself: a 5% markdown that’s spring-loaded to gap all the way up to 0% and beyond! Such a move (a near certainty in my books, as it’s happened many times in the recent past) sets us up for a fast price gain just from the closing discount alone!”
OK, so it’s trading at a 5% discount and pays a 7.6% distribution, but owns a bunch of industrial stocks… which means they’re probably using a lot of leverage. Any other clues?
“This one is also beautifully diversified, which helps cut our risk while we enjoy it’s outsized 7.6% payout. In addition to industrial cash cows like engine maker Eaton and conglomerate Honeywell, it holds well-established names from other sectors, like telecom mainstays AT&T and Verizon.”
Thinkolator sez our best match here is Voya Infrastructure Industrials and Materials (IDE), which is indeed a closed-end fund that has a pattern over the past decade or so of closing the discount to near zero and then widening it again. The average discount has been about 10%, though it has also been as high as a 2.5% premium at some points, and the discount right now is about 5%, with a distribution yield of 7.6% per CEFdata.com. Can’t be 100% certain about this match, those aren’t many clues, but it fits.
This is a fund that tends to hold industrial and telecom names for the most part, but all of those teased names are in the top ten holdings. It does not use leverage, according to CEFdata, so that’s a plus, and the expense ratio is high for a mutual fund or ETF (1.2%) but low for a closed-end fund… and in place of leverage they juice their returns with a buy-write strategy, selling options on their holdings to increase their ability to distribute cash. That is likely to help smooth returns, particularly these days, when options premiums are fairly high, though “smoothing” also means “missing huge gains sometimes.” The fund has generated a much lower total return than the S&P 500, and even than the industrial sector in general, so, again, it’s probably a place to look for regular cash income without high-risk leverage, not for total returns.
So there you have it… finally we look at some dividends and closed-end funds, something readers have been asking about as they look for income in a low-rate world. Not terrible ideas, but you do certainly have to enter the CEF world knowing that you’re taking a little risk with the leverage and high expense ratios that these strategies often come with, and that the fluctuation between premium and discount prices can mean a lot of volatility.
If you know you need to collect a fairly high cash dividend from your holdings and don’t like to sell to get to that kind of distribution, closed-end funds can help. If you’re a trader, it might be worth your while to identify some closed-end funds you like and buy them when they’re at relatively large discounts and sell them when that discount closes. But if you’re a regular ol’ “let it compound” investor and don’t need the monthly distribution income that these funds often focus on, it’s usually true that lower-cost ETFs outperform Closed End Funds for the “buy and compound” crowd who are trying to accumulate wealth, not collect income from their savings.
That’s what I think, anyway — your thoughts might differ, and it’s your money so it’s your thinking that really counts. Wanna share it with us? Just use the happy little comment box below… thanks for reading!