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All Contents © 2020The Kiplinger Washington Editors
By Michael Foster, Contributing Writer
| January 14, 2020
Investors should be seeking out diversification and income-producing assets as they enter a potentially wild 2020 – especially after 2019's monster run. Closed-end funds (CEFs) provide both, reducing the risk of slower or even negative returns if this year proves to look more like 2018 than 2019.
While mutual funds and exchange-traded funds (ETFs) get a lot of attention, CEFs fly well under the radar by comparison. You can learn more about closed-end funds in detail here. But in short: These actively managed funds offer a few advantages, including sometimes trading below the value of the assets they hold (which means investors can buy those assets at a discount), as well as being able to leverage debt to generate extra returns and income from their portfolio picks. The best CEFs, then, are capable of clobbering similarly constructed mutual funds and ETFs.
Yes, the very short-term outlook is encouraging. The market's on a heater to enter the year, U.S.-Chinese trade relations are thawing, unemployment remains low, wages continue to grow, and GDP growth, while not as brisk as it once was, remains solidly positive.
But sky-high stock valuations, Middle East discord and a looming presidential election cycle are among the potential headwinds standing in the way of a peaceful stroll higher in 2020. So indeed, investors might need some protection this year – and closed-end funds can deliver that.
Here are the 11 best CEFs to buy for 2020. This list of elite funds covers an array of assets and investing strategies. Each pick boasts various perks, which may include deep value, high distribution rates and strong track records.
Data is as of Jan. 13. Distributions can be a combination of dividends, interest income, realized capital gains and return of capital. Distribution rate is an annualized reflection of the most recent payout and is a standard measure for CEFs. Fund expenses and discounts/premiums to net asset value (NAV) provided by Morningstar.
Market value: $1.6 billion
Distribution rate: 6.7%
2019 was a massive year for Cohen & Steers Quality Income Realty Fund (RQI, $14.26). It marked the first time RQI's 10-year annualized return (19.2%) beat every other CEF out there. Across all closed-end funds, the average total return for the past decade is 6.6%, so clearly, Cohen & Steers is doing something right.
Cohen & Steers is one of the best real estate-focused money managers in the country, and it boasts three of the 10 best-performing CEFs of the past decade. Of course, we can't chalk every cent of those returns up to their investing acumen – real estate has been a great investment for a long time, too.
Cohen & Steers Quality Income Realty Fund invests in real estate investment trusts (REITs), primarily through common stock, though 14% of its assets are currently invested in preferreds. It holds the likes of telecommunications infrastructure operator Crown Castle International (CCI), industrial REIT Prologis (PLD) and health-care property owner Welltower (WELL).
Investors started to notice how much RQI was outperforming its real estate competitors, and they piled into the fund as a result, driving it from a high-single-digit discount to a premium for the back half of 2019. But it's currently trading back at a 4% discount, which is a much more reasonable price.
* Includes a 1.33% baseline expense and 0.84% in interest expenses.
Learn more about RQI at the Cohen & Steers provider site.
Market value: $3.2 billion
Distribution rate: 8.3%
Pimco Dynamic Credit Income Fund (PCI, $25.27) is a perpetually misunderstood CEF. It's frequently maligned for both its high fees (which top 4% once you include interest expenses) and its portfolio. You see, PCI holds mostly mortgage-backed securities, the infamous villain of the Great Recession and The Big Short.
But the hard numbers indicate that this derision is unfair.
For one, PCI's 111% total return since 2013 inception is far better than the 18% from the indexed iShares MBS ETF (MBB). It's also better than high-yielding fixed-income products such as the SPDR Bloomberg Barclays High Yield Bond ETF (JNK): a standard in junk bonds.
Dynamic Credit Income's 8.3% distribution is compelling, too – even more so when you consider that it has increased a couple times since inception. An additional income bonus: PCI has paid a special dividend in every year of its history except 2017, which means investors sometimes receive a double-digit annual income stream from this fund.
Then there's pricing. Pimco's closed-end funds almost always trade at a premium, and those premiums can be very high. For instance, Pimco Corporate & Income Opportunities Fund (PTY) traded at a monstrous premium of between 20% and 30% for most of 2019. PCI, on the hand, trades at a roughly 10% premium — high for most funds, but relatively low for a Pimco product.
That premium has been climbing, too, indicating the market might finally be realizing that Dynamic Credit Income deserves the "Pimco treatment" given its market-crushing performance and high income stream. That sets PCI up to be among 2020's best CEFs to buy.
* Includes a 2.12% baseline expense and 2.51% in interest expenses.
Learn more about PCI at the Pimco provider site.
Market value: $255.2 million
Distribution rate: 8.8%
Neuberger Berman High Yield Strategies Fund (NHS, $12.41) is one of numerous CEFs focused on below-investment-grade debt, with a goal of staying on the higher-quality end of the junk-bond spectrum. But this one stands out in part because of how many headlines it has generated over past year.
In the middle of 2019, activist hedge fund Saba Capital Management took a 19%-plus stake in NHS in an attempt to force several initiatives intended to create more value for shareholders. This came after years of Neuberger Berman's fund holding one of the biggest discounts in the junk-bond CEF universe (a discount of more than 10% for most of the past three years).
The activist agitation helped to close NHS's valuation gap, from a 16% discount in January 2019 to just around 4% presently. It also resulted in a fascinating vote on electing new board members, repurchasing shares and firing Neuberger Berman as fund manager.
But NHS's killer 2019, in which it delivered a total return of 39%, wasn't built on boardroom intrigue alone. Fundamentals helped it continue its trend of outperforming many other corporate-bond closed-end funds.
The portfolio at present is primarily low duration – the measurement of a bond's price sensitivity to interest rates. Roughly two-thirds of NHS's holdings have a duration between one and 4.99 years, with another 17% or so in bonds with a duration of less than one year.
* Includes a 1.96% baseline expense and 1.45% in interest expenses.
Learn more about NHS at the Neuberger Berman provider site.
Market value: $276.6 million
Distribution rate: 6.5%
Nuveen is a massive investment manager with more than $1 trillion in assets under its watch, and it's the No. 1 closed-end fund provider in the world, boasting a lineup of 74 CEFs.
Thus, its sponsorship of the Nuveen S&P Dynamic Overwrite Fund (SPXX, $16.36) alone makes it one of the more compelling options among covered-call stock funds.
SPXX provides exposure to many of the stocks within the S&P 500 Index of large U.S.-listed companies, but with a twist. It also sells covered calls: an options-trading strategy that is used to generate income.
The downside of this strategy is that it's weak in long, roaring bull markets. The SPDR S&P 500 ETF Trust (SPY), which tracks the S&P 500, has generated a total return of 247% over the past decade, versus 166% for SPXX.
The covered-call strategy works best in flat to slightly down markets, though SPXX has outperformed the index during a few bumper years, including 2017 and 2009. It also provides a high stream of income with more stability. Nuveen's CEF also sports a beta of 0.68 – with beta, which measures a stock or fund's volatility compared to the market, anything below 1 is considered less volatile than the market.
Learn more about SPXX at the Nuveen provider site.
Market value: $1.2 billion
Distribution rate: 6.4%
AllianceBernstein Global High Income Fund (AWF, $12.22) is one of the best CEFs to buy for 2020 if you want to spread out the geographical risk in your fixed-income portfolio.
AWF's investment mandate is to put together "a globally diversified portfolio that takes full advantage of our best research ideas by pursuing high-income opportunities across all fixed-income sectors to bet on one of the clearest investing trends right now." It does so primarily by investing in corporate bonds globally – both inside and outside the U.S. – but also sovereign debt.
For instance, right now, 65% of the portfolio is invested in the U.S. The remaining international exposure is thinly distributed, with Brazil (3.9%), Indonesia (3%) and the U.K. (2.1%) the only countries with 2%-plus weightings. Corporate bonds (41%) are the largest chunk of the portfolio, followed by sovereign bonds (32.1%) and agency mortgage-backed securities (MBSes, 7.4%).
The strategy worked well in 2019, as the fund compiled a 15.2% total return. Indeed, AWF – which still trades at a nearly 9% discount to NAV – is one of the top-performing foreign-focused funds out there. That's because it diversifies away from potential risks in the U.S. without being too much at the mercy of foreign markets, where black swans have been appearing with alarming regularity.
* Includes a 0.99% baseline expense and 0.05% in interest expenses.
Learn more about AWF at the AllianceBernstein provider site.
Market value: $355.6 million
Investors in utility stocks had plenty to celebrate in 2019. The sector produced a total return of 26% last year – a surprisingly strong result for a traditional dividend-and-safety play during a red-hot year for growth. That's in part because while many other sectors saw their earnings decline or barely inch higher across the first three quarters of 2019, utilities enjoyed the highest rate of growth at 8.3%. (2019's final tally won't come in for another couple months.)
Many investors missed out on this trend because utilities are, to be honest, boring, and rarely enjoy the media's spotlight.
Macquarie Global Infrastructure Total Return Fund (MGU, $25.85) is an example of how neglect can create buying opportunities. Despite the utility sector's rise in 2019, a 42% total return last year and a sustainable 6%-plus dividend yield, MGU still trades at a 9% discount to its net asset value.
However, Macquarie Global Infrastructure is a lot more than just utilities. It's an "infrastructure" CEF that invests in numerous utility-esque industries, including pipelines and toll roads. Its top holdings include the likes of Australian toll-road operator Transurban, American natural gas company Cheniere Energy (LNG) and British electricity-and-gas utility National Grid (NGG), which also operates in the northeastern U.S.
MGU has a long track record of moving its assets from country to country to take advantage of where utilities will produce the highest profits. As a result of its adept management, it has generated 11.4% in annual average returns over the past decade, versus 6.7% for the indexed iShares Global Infrastructure ETF (IGF). And it currently trades for a 9%-plus discount to NAV.
* Includes a 1.76% baseline expense and 0.85% in interest expenses.
Learn more about MGU at the Macquarie provider site.
Market value: $998.5 million
Distribution rate: 7.8%
Tekla Healthcare Investors (HQH, $21.02) is a classic contrarian bet. This fund has fallen out of favor as the health-care sector has lagged the broader market, but it's still run by one of the best pharma and biotechnology asset managers out there.
So why HQH, and why now?
Health care is more of an "all-weather" sector that can provide upside in good times and bad. Health-care spending in the U.S. and worldwide grows each year, and it's an expense that's difficult to cut back on when the economy slows down. Moreover, health care was tied for utilities for the highest rate of earnings growth through the first three quarters of 2019, and it was first in revenue growth. The sector appears to be underappreciated; election-cycle fears might be holding it back.
Tekla Healthcare Investors is an interesting option because it can invest up to 40% of its assets in pre-public (or "venture") companies, just like its cousin, Tekla Life Sciences Investors (HQL). However, HQH is a bit more diversified and tends to hold larger, "commercially staged" companies (firms that generate revenues and earnings).
HQH currently is trading at an astounding 10.3% discount to NAV, more than twice as nice as its 4.8% five-year average discount. In fact, in the fund's 33-year history, its discount has only fallen this low a handful of times – most recently, 2009. That sets the stage for Tekla's fund to be among the best CEFs to buy … if the market comes back around to favoring health care.
Learn more about HQH at the Tekla Capital Management provider site.
Market value: $1.5 billion
Distribution rate: 5.7%
BlackRock Science and Technology Trust II (BSTZ, $21.03) is one of the newest CEFs on the market, going live on June 25, 2019. And it made a splash in a hurry. Over its first few months, it swelled to an unusually high 8%-plus premium to NAV, proving to the market that there still is ample demand for an actively managed approach to tech stocks – even in this age of the index fund.
The reason for the demand is simple: Its management has a stellar track record. BSTZ is a sister fund to the BlackRock Science and Technology Trust (BST), which has returned 178% over the past five years – 24 percentage points better than the indexed Technology Select Sector SPDR Fund (XLK). At times, the original Science and Technology Trust's outperformance relative to the index has been significantly higher than it is now; investors are confident management can do something similar with BSTZ.
What makes BlackRock Science and Technology Trust II particularly compelling is its off-the-radar approach to tech investing. In a world where "FANG stocks" dominate investor focus, BSTZ's portfolio delves into lesser-known (but still high-potential) name such as European online food-delivery service Delivery Hero (DLVHF), semiconductor firm Marvell Technology (MRVL) and German remote-software company TeamViewer. You'll note the global themes: BSTZ is split 54%-46% between American and international stocks.
Whether BSTZ becomes one of the best CEFs of 2020 or any year is yet to be seen. But given BST's track record, it deserves the benefit of the doubt out of the gate.
Learn more about BSTZ at the BlackRock provider site.
Market value: $216.0 million
Distribution rate: 3.8%
BlackRock MuniYield PA Quality Fund (MPA, $14.49) is the kind of CEF that outsiders rarely know about, and that rarely falls onto the experts' radar, but that its investors love nonetheless. At only a little more than $200 million in assets, it's a fraction of the popular municipal-bond funds that investors rely on for tax-free income.
Also, its 3.8% distribution won't blow anyone away, but remember: Municipal-bond income is exempt from federal taxes. Let's say every cent of the 3.8% yield is from interest income. The "tax-equivalent yield" – what a taxable product's yield would have to be to equal a tax-exempt product's yield – is actually closer to 6.0% for Americans in the highest tax bracket. And if you live in Pennsylvania, where the fund's bonds are also exempt from state taxes, your yield is closer to 6.2%. If you don't? BlackRock offers a number of other state-specific muni-bond funds.
The MPA portfolio itself is a collection of 182 municipal bonds primarily from the state of Pennsylvania. They cover several types of funding, most heavily health (28.3%), education (15.3%) and school districts (13.3%). Maturity is tilted toward longer-dated bonds, with 82% of the portfolio in debt at least 15 years away from maturing.
Its current discount of about 10.5% is slightly cheaper than its five-year average. Meanwhile, its 18.9% total return in 2019 trampled the iShares National Muni Bond ETF (MUB), which returned just 7.1%, and put it among the best municipal-bond CEFs last year.
Learn more about MPA at the BlackRock provider site.
Market value: $1.4 billion
Distribution rate: 5.4%
Investors tend to think of municipal bonds for their tax-advantaged income. But taxable municipal bonds exist – and they do haver merits of their own. Specifically, they can be less risky than other types of bonds with similar yields, such as corporates.
The BlackRock Taxable Municipal Bond Trust (BBN, $24.87), and its 5.4% yield, is worth a serious look right now. It had a strong 2019, at 22.8% total returns, and it has pumped out 10.6% annual returns since inception in August 2010. The CEF provides exposure to several states, but most prominently, California (20.3%), Illinois (11.7%) and New York (10.5%). It's also mostly long-term in nature, with 83% of its assets in bonds that will mature in 15 years or later.
BBN is cheap, too, compared to other muni-bond CEFs with stellar track records. Pimco Municipal Income II Fund (PML), for instance, trades at a whopping 22.9% premium to its NAV, whereas BBN trades at a mere 1.4% premium. And that's expensive for this fund. BlackRock Taxable Municipal Bond Trust typically trades at a small single-digit discount, so it might be worth waiting for a slightly better price before entering – but not a must.
* Includes a 0.93% baseline expense and 1.60% in interest expenses.
Learn more about BBN at the BlackRock provider site.
Market value: $108.3 million
Distribution rate: 7.6%
The first year of the Federal Reserve's reversal on interest-rate policy should have been a disaster for floating-rate loans, which tend to go up in value as interest rates go up, and vice versa. Yet the three interest-rate cuts of 2019 did little to drag down these loans.
The iShares Floating Rate Bond ETF (FLOT), an index fund that invests in floating-rate debt, delivered a 4% total return in 2019. Meanwhile, Legg Mason's Western Asset Corporate Loan Fund (TLI, $9.97), by Legg Mason, gained a whopping 18.8%.
How – and why – did this happen?
We need to look at investments in context. While FLOT had a solid 2019, its 2018 was weaker, at a 1.5% total return. TLI did far worse, losing more than 9% even with income included. The reason? A panic in the corporate lending market in late 2018, as everything from the trade war to the Fed's last-minute rate hike of 2018 increased fears that defaults would rise. The corporate loan market experienced a panic selloff, and in 2019, investors compensated for 2018's hasty retreat.
This is important context for 2020 for one big reason: While the selloff largely fixed itself (those corporate bankruptcies didn't happen), there is a lot of uncertainty about what the Fed will do to rates this year. With the yield curve partially restored, there's a growing belief in the market that the Fed could go back to raising rates in late 2020 or early 2021 – and floating-rate funds would benefit. Traders might anticipate that move and start buying into the most discounted floating-rate funds as a result.
Western Asset Corporate Loan Fund's 8.5% discount is among the widest of any floating-rate loan funds right now. That would put TLI among the best CEFs to buy to get ahead of those yield-curve traders.
* Includes a 1.40% baseline expense and 1.51% in interest expenses.
Learn more about TLI at the Legg Mason provider site.