1100 13th Street, NW, Suite 1000Washington, DC 20005202.887.6400Toll-free: 800.544.0155
All Contents © 2020The Kiplinger Washington Editors
By Michael Foster, Contributing Writer
| January 28, 2019
Closed-end funds (CEFs) joined the rest of the market in steeply selling off late last year. The result, however, was an excessive selloff resulting in greater distribution rates and larger discounts to the assets they hold. The question now is: Which CEFs are ripe for the picking in 2019?
“Interesting” is perhaps too nice a word for 2018, but that’s still exactly what it was. Corporate America delivered multiyear-best earnings growth for several quarters. Yet we still saw two massive corrections that lifted volatility much closer to its long-term average after several years of relative calm. But what will 2019 hold?
The outlook is mixed. While market analysts broadly see GDP growth slowing in 2019, most of those same analysts also see the broader markets heading higher by year’s end. Wages are growing, unemployment remains low and there are plenty of other potential drivers for a rally. But if more of the bearish drivers peek through – GDP growth slows even more than expected, tariff tensions linger, etc. – investors will need protection, including high dividends to offset the lack of price gains.
With that said, here are the best CEFs to buy for 2019. You can learn more about closed-end funds in detail here, but in short, these are funds that trade on exchange like ETFs, but have some differences; for instance, they can trade at significant discounts or premiums to the assets they hold, and they are actively managed more often than not. These 10 CEFs boast a number of perks, including deep value, high distribution rates and strong track records.
Data is as of Jan. 27, 2019. Distribution rate can be a combination of dividends, interest income, realized capital gains and return of capital, and is an annualized reflection of the most recent payout. Distribution rate is a standard measure for CEFs. Fund expenses and discounts/premiums to net asset value (NAV) provided by Morningstar.
Market value: $526.3 million
Distribution rate: 8.0%
Eaton Vance Enhanced Equity Income (EOI, $13.59) is, on its face, an attractive blended equity fund made up of mega- and large-cap stocks – not unlike, say, a fund tracking the Standard & Poor’s 500-stock index. But obviously something is different, given that EOI has a distribution rate of 8% versus a roughly 2% yield for an S&P tracker.
Part of it is that distributions include capital gains, not just dividends. But CEFs also are able to use a few dividend-enhancing tricks that other types of funds can’t or don’t. That includes using debt (“leverage”) to invest even more in certain assets, which can juice both income and returns. That also includes using options techniques to generate more income. EOI can do both.
As for the portfolio itself, top holdings include the likes of Microsoft (MSFT), Apple (AAPL) and Amazon.com (AMZN), reflecting a fund-high 20.4% allocation to information technology. Other heavy weights include health care (15.5%) and financials (12.9%). It’s an overwhelmingly American portfolio, too, with just 1.5% allocated to non-U.S. stock.
The EOI tends to “trade barbs” with the S&P 500, outperforming some years while underperforming others. What makes the fund so attractive right now is that it’s trading at a 3.6% discount to its net asset value, whereas on average it has traded at a slight premium. In essence, you can get all of EOI’s high-value quality holdings for less than if you bought those shares on your own – about 97 cents to the dollar, to be more specific.
Market value: $688.4 million
Distribution rate: 6.0%
The technology sector got pounded in the final quarter of 2018, with many tech stocks falling from sky-high valuations as concerns about global growth and tariff effects became too much to shoulder. Yet, technology still is one of the best places to look for growth, simply because of the continued sprawl of technology in our daily lives, the enterprise – everywhere.
Income investors can occasionally find a good-yielding tech stock here or there, though the sector as a whole isn’t a hotbed for yield. The Technology Select Sector SPDR ETF (XLK), for instance, yields just 1.6%, plenty less than the S&P 500.
But you can have the best of both worlds via the BlackRock Science and Technology Trust (BST, $30.77), which yields more than 6%, on payouts that have been growing steadily over the past few years.
BST invests in many American large-cap tech stocks such as Apple, Microsoft, Amazon and Alphabet (GOOGL), but it’s not exclusively U.S. A little more than 70% of the fund is dedicated to American holdings; roughly 12% of the fund includes Chinese stocks such as Tencent Holdings (TCEHY), and BST also holds small positions in companies from the Netherlands, France and other countries.
BlackRock Science and Technology has only been around since October 2014, so it doesn’t have a long track record. But it has blown out the XLK, 34.7%-20.1%, in average annual total returns over the past three years.
Market value: $294.6 million
Distribution rate: 10.2%
BlackRock Science and Technology isn’t the only way to slice the technology pie.
BST has a bias toward software and software-as-a-service (SaaS) companies. That’s not a bad thing at all, but there are contrarian opportunities in the hardware world too, and that’s where Columbia Seligman Premium Tech Growth (STK, $18.85) comes into play.
Chip stocks such as Lam Research (LRCX), Broadcom (AVGO) and Micron Technology (MU) were fantastically oversold thanks to 2018’s trade-war freak-out. LRCX, for instance, trades at around 10 times estimates for next year’s earnings, and MU trades at less than six times estimates. STK has since gone head-first into these and other stocks in anticipation of a rebound. BRCM and LRCX alone make up nearly 15% of the fund, with MU another 4% or so.
Columbia invests in these stocks while also using covered calls (an income-generating options strategy) to enhance its income potential. That has helped the STK outperform the XLK over both the past three- and five-year periods, and also helps to explain its 10%-plus distribution rate.
Market value: $1.1 billion
Distribution rate: 3.9%
If you want to protect yourself from excessive losses through value investing, and want an income stream to tide you over as you wait for the market to recover, the Boulder Growth & Income (BIF, $10.51) is a great place to start. Despite the name, BIF actually is a value-focused fund that uses a “bottom-up” process to find underappreciated companies.
BIF’s investment strategy is to mimic Warren Buffett’s portfolio and investment style, which it does in both direct and indirect ways. That is, it currently dedicates more than a third of its assets in Buffett’s Berkshire Hathaway (BRK.B), and much of the rest in either stocks that Buffett loves, or stocks that fit a general value thesis. At the moment, that includes JPMorgan Chase (JPM), Cisco Systems (CSCO) and Yum! Brands (YUM).
The goal is steady returns with minimal downside, though the fund was far from immune to the broad-based selloff in Q4 2018. The upside? It has snapped back considerably, while boasting a whopping 17% discount to NAV that stands in stark contrast to its typically near-NAV price. That equates to a fire sale in value stocks, including Berkshire Hathaway.
Distribution rate: 10.6%
The aforementioned equity beatdown hit everything, growth and value alike. That’s good news for new money in funds that provide exposure to both while also demonstrating a tremendous track record.
That perfectly describes the Liberty All-Star Equity (USA, $5.70), which equally distributes its assets across five managers – three focused on value, and two focused on growth. Each manager has their own goals, whether it’s companies that have “predictable, sustainable earnings and cash flow growth over the long term,” “superior sales growth” or “catalysts for change.”
This is a diversified portfolio in which the largest holding – currently Visa (V) – makes up just 2.3% of assets. Tech is well-represented in the top holdings, including Amazon.com, Adobe (ADBE) and Salesforce.com (CRM). But the fund also is thick with health care (16.9%), financials (15.9%) and consumer discretionary stocks (12.4%).
USA has beaten the broader market, 15.1%-14.7% annually on average, over the past decade. However, like the other funds on this list, its lousy performance of late has created a nice discount – 8% below NAV compared to a three-year average premium of about 1%.
Market value: $861.9 million
Distribution rate: 10.1%
Tekla Healthcare Investors (HQH, $20.62) is one of four funds managed by Tekla Capital Management, and perhaps the most notable thing about HQH is its long-term dominance compared to the indexed Health Care Select Sector SPDR ETF (XLV). Since the CEF’s launch in the late 1990s, it has gained more than 1,000%, versus about 380% total returns for XLV during the same period.
Technically, HQH is a broad sector fund just like XLV, but its industry weights are considerably different. Tekla’s health-care fund heavily bets on biotech, at nearly two-thirds of the fund; Amgen (AMGN), Biogen (BIIB) and Gilead Sciences (GILD) sit solidly atop the top-holdings list with weights of around 6%-7%. Pharmaceuticals – a huge holding in most broad health-care funds – are just 18% of the fund. And HQH holds smatterings of other industries, such as life sciences tools & services, as well as health care providers & services.
HQH often trades at a premium (it last did so in mid-2017), but its discount has dropped considerably to more than 9%, which is far deeper than its three-year average around 1%. Meanwhile, investors are getting a 10%-plus distribution rate at the moment.
Health care has long been one of the strongest-performing sectors in the S&P 500, and the necessity of its products, as well as the continued aging of the Baby Boomer generation, should help HQH recover in 2019.
Market value: $719.4 million
Distribution rate: 7.8%
Tekla Healthcare Opportunities (THQ, $17.35), which is managed by the same team that runs HQH, is more in line with what you’d expect out of a broad-based health-care fund. Whereas Tekla Healthcare Investors has sold out hard on biotech, THQ is a much more balanced split among health industries. Pharmaceuticals and health care providers & services make up about a quarter of the fund each, biotech is 20% of the fund, health care equipment and supplies are 13% of the fund, and it’s also peppered with medical devices and even health-care real estate investment trusts (REITs).
Top holdings reflect this balance – for instance, Johnson & Johnson (JNJ) is tops at 7.4%, followed by insurer UnitedHealth Group (UNH) at 6.5% and biotech Gilead at 3.9%.
THQ is a younger fund but has delivered a better total return over the trailing three- and one-year periods. And it’s also trading at a nearly 10% discount right now – a nice bargain considering the fund has traded close to NAV on average over the past three years.
Market value: $385.7 million
Distribution rate: 7.7%
The Nuveen Floating Rate Income Opportunity (JRO, $9.53) closed-end fund attracts a lot of attention with its 7%-plus distribution rate. The JRO specializes in senior loans (or floating-rate loans), which are debts that large and midsize companies take out at variable interest rates. That’s important, because when interest rates go up, the rates on these loans go up, resulting in a higher income stream for JRO.
The market had been very bullish on floating-rate loans thanks to the Fed’s plan to more aggressively hike interest rates, but a panic selloff has driven JRO to more attractive prices. Note that this CEF’s distribution has been more or less stable over the past decade, and it still delivered payouts during the 2008-09 downturn. And yet, Nuveen Floating Rate Income Opportunity now trades at a nearly 12% discount … versus a 1.4% three-year average. That’s simply striking.
At this point, the market seems to have priced in any slowdown in Fed interest-rate hikes. And if investors return to floating-rate loans as a hedge against more aggressive views toward rate hikes, that discount could narrow – driving the fund higher while investors collect their healthy income stream.
Market value: $204.4 million
Distribution rate: 9.1%
Another floating-rate loan fund with a big discount is Apollo Tactical Income (AIF, $14.15) which provides a solid income stream and an impressive track record. The fund has delivered an 11.8% average annual total return since very early 2016 – a period in which the Fed has been steadily hiking rates – and it currently offers a distribution rate north of 9%.
That distribution has been juiced, of course, thanks to falling prices, which also have taken its discount to NAV from about 9% in September to 14% currently. And that’s well below its three-year average of less than two.
Apollo Tactical Income also has a secret weapon: its mandate. Unlike other floating-rate funds, AIF also can make tactical purchases of oversold or high-value corporate bonds if it sees particular value, which means it can oscillate between floating-rate loans and corporate bonds according to market conditions.
And the many opportunities in both floating-rate loans and corporate bonds thanks to the Q4 selloff gave AIF’s management plenty to play with.
Market value: $187.5 million
Distribution rate: 9.7%
Blackstone/GSO Long-Short Credit Income (BGX, $14.76) is a somewhat cautious fund that uses Blackstone’s experience in private equity investing. BGX tries to create a low-risk portfolio of loans from medium- and small-sized businesses. The fund also can hold unsecure loans and high-yield bonds, and it also will short other low-quality loans to help manage the risk of a significant selloff.
At the moment, 83% of its portfolio is in secured loans, with another 15% in high-yield bonds, and the rest in CLO liabilities, equity, cash or “other.”
The market panic sent this often stable fund reeling far more sharply than its NAV, and as a result, its discount sits at a wide 8%, versus a three-year average of trading right around NAV. Note: This is a fund that has trounced the Bloomberg Barclays US Aggregate Bond Total Return Index in every meaningful time frame since inception in 2011.
This oversold situation is a rare opportunity for investors to secure this fund, and a nearly 10% distribution rate, on the cheap.