Tag Archives: closed-end-funds

Is Leverage Really An Advantage In Equity Closed-End Funds?

Prevailing wisdom holds that bullish market conditions favor leveraged, equity closed-end funds. Similarly, declining or flat markets are seen as favoring the unleveraged, option-income equity closed end funds. I look at comparable funds of each type for the period 2006 through 2015YTD to see how well this premise holds up. Closed-end funds (or CEFs) are primarily about income, less so about beating the market. If I may generalize, it’s the rare equity closed-end fund that beats, or even matches, other investment vehicles in its individual arena over sustained periods of time; but nearly all of them provide high levels of distribution income to their investors. If you’re not interested in the high yield, for domestic equity, you’re almost always going to be ahead of the game in either individual holdings, wisely chosen, or a solid indexed ETF. Of course there are exceptions; every generalization has exceptions, and I welcome your examples if you want to share them (with evidence if you please). But, by and large, I think this view holds up to careful scrutiny. Of course, some have success trading funds as their discounts and premiums fluctuate, or rack up gains in odd arbitrage situations that occasionally come up for CEFs, but that’s more specialized than what I have in mind. For the purposes of this article, I’m considering equity CEFs held primarily for current income and capital appreciation. For equity CEFs, there are two paths to generating that high income with capital appreciation. First is by exploiting the power of leverage to drive gains, and second is by an aggressive use of option trading, especially covered calls. Each strategy has its upsides and downsides. The conventional wisdom is that option funds are more defensive and do better in down or sideways markets. By this view, leveraged equity funds are at their best in strongly bullish markets. Makes sense, but the subject has come up several times in comment streams and private messages questioning those assertions when I’ve repeated them. I’ve been looking for evidence to support (or negate) that particular set of generalizations. I’m sure such research exists, but I’ve not put my hands on it so I thought I’d take a quick look. What I’ll report on here is not a rigorous analysis. It has a limited number of data points, covers a brief period, and is hardly more than observational in the large scheme of things. But it is what I’ve been able to put it together without an excessive investment of time given the limited sets of data I have access to. I would encourage anyone so inclined to make a more detailed analysis. For the present, I think CEF investors will find even a cursory analysis interesting enough to generate discussion. I decided to look at CEFs from a single sponsor. I selected 6 Eaton Vance equity closed-end funds, 3 each leveraged and unleveraged. I picked Eaton Vance because I think a good case can be made that theirs are among the best-managed equity CEFs. That, plus I own several, so it was of interest to me on a personal portfolio level as well. Funds were chosen on the basis of having the best 3 yr returns on NAV, an arbitrary cut, but straightforward data to obtain for large numbers of funds – NAV returns for longer time periods is not readily available in formats that can be used as to filter the data. I compared total return (market) for each by calendar year using data from YCharts for each of the funds. The six funds and current values for effective leverage are: Effective Leverage EV Enhanced Equity Income II (NYSE: EOS ) 0.00% EV Tax-Managed Div Equity Inc (NYSE: ETY ) 0.00% EV Tax-Managed Buy-Write Opps (NYSE: ETV ) 0.00% EV Tax Advantaged Dividend Inc (NYSE: EVT ) 21.05% EV Tax Adv Global Dividend Inc (NYSE: ETG ) 23.25% EV Tax Adv Global Div Opps (NYSE: ETO ) 24.38% The earliest year with complete data for all 6 funds is 2007. The period from 2007 through 2015 YTD covers the deep downturn of the recession and the strong bull market of the past few years, so there is a complete and extreme cycle. Plotting the average, maximum and minimum returns from the three funds of each class produces these charts. It’s clear that the leveraged funds fared much more poorly in the 2008 bear market than did the unleveraged funds. But it is difficult to see a clear pattern over the other years. To bring some clarity, I calculated the excess return of leveraged funds vs. unleveraged funds for each year, and plotted those values against annual returns of the S&P500 index. (click to enlarge) In this plot the Y axis represents the level of relative performance by leveraged funds and unleveraged funds. Outperformance by leveraged funds is represented by the area above the 0 line. Differences between funds in the two categories are shown here in basis points, so these data include highly meaningful differences in return to an investor. The trend line is consistent with the predicted relationship: For down years the option-income funds outperform. The correlation is weak at best, however: r 2 for the relationship is only 0.188. The trend line we see in this chart is strongly influenced by the 2008 data where, as we have already seen, the unleveraged funds strongly outperformed (in the sense of being much less negative) the leveraged funds. What happens if we look at the chart with that heavy weight of 2008 omitted? A different picture, but not one that adds clarity, emerges. (click to enlarge) What we see here is a weak trend in the opposite direction. The trend is even weaker than when 2008 is included (r2 = -0.069). Unleveraged funds outperformed the leveraged funds during the two years of highest returns for the S&P 500 (2009, 2013). This result cuts against that predicted from conventional wisdom. The leveraged funds did, however, outperform in years with moderately high returns, but from the full set of results that can as easily be attributed to chance as any advantage derived from market conditions that those funds may have had. The best we can say here is that any outperformance by leveraged funds is essentially uncorrelated to broader market performance. So, how fares the prevailing dogma on the topic? There’s a bit here to support it, in the sense that for the disastrous 2008, leveraged funds suffered much deeper losses than the unleveraged funds. But beyond that extreme case, which is after all only a single data point, there is little to support (or negate) the prevailing view that strongly up markets favor the leveraged funds. Clearly, this is only a glimpse at the full situation but, to my mind, there is sufficient information here to call into question idea that there are advantages for leverage funds in relation to prevailing market up trends. Which leads to the question: If leveraged funds cannot consistently outperform in bullish markets, why invest in them at all? I think an evaluation of the advantages or disadvantages of investing in leveraged equity is particularly relevant to the current situation where rising interest rates will increase leverage costs, however modestly, thereby increasing the drag on those funds. I have been avoiding leveraged equity CEFs for some time, in part because of the widely held view that less bullish markets favor the option-income funds, and in part because of previous research ( Debunking the Myth of Leverage for Closed-End Funds ), which did not consider overall market conditions, that showed little advantage to leverage in closed-end funds of various categories. As readers know, I am a fan of CEFs for providing income with capital preservation — as bond substitutes if you will. It’s been my view, which this brief look at the issue supports, that option-income is a more effective strategy for accomplishing those objectives than simply throwing leverage at it. So, for those looking for an explicit conclusion: Leverage is unlikely to provide returns that justify its inherent risk, even under conditions that are assumed to favor leveraged investing.

SRV And SRF: Playing Games In Closed-End Funds

Summary Cushing Royalty & Income Fund and Cushing MLP Total Return Fund have both gone through a reverse stock split. The press release suggests it was done for shareholders. That’s sort of true, but you shouldn’t thank the CEFs for it. On September 14th, the Cushing Royalty & Income Fund (NYSE: SRF ) (now known as the Cushing Energy Income Fund ) and the Cushing MLP Total Return Fund (NYSE: SRV ) effected 1 for 5 reverse splits. That changes very little for shareholders except the price of the closed-end funds, or CEFs. That said, a higher price is better in some ways, but you still shouldn’t be thanking the funds for this move. What changes? The first thing to keep in mind with any stock split is that it does nothing to a shareholder’s ownership in a company. Your proportional ownership remains unchanged. So, in many ways, a stock split is mostly about theatrics. But that can be important. For example, some companies split their stocks two for one when the stock gets to around $100 a share. The idea being that people are more likely to buy shares in a company with shares selling at $50 than one with shares trading hands at twice that level. Maybe, maybe not… but clearly it’s about the show since the split would just turn a $100 share into two $50 shares. Reverse splits like the ones SRF and SRV just did are a bit trickier. Sometimes a company’s shares are trading at such low levels that they risk being delisted by their exchange. In that case, the split has a very real purpose, but that’s normally only an issue that impacts true penny stocks. In other cases, the move is just a show. Investors often avoid low-priced companies because of a concern over the risk of owning a company with a low share price. Institutional accounts, for example, often have minimum share price limitations. That’s not an unfounded fear, but it isn’t always realistic either. So companies with relatively low share prices will sometimes do a reverse split to prop up the price to attract more investors. Reversing the above example, a company that did a one for two reverse split would simply take two $50 shares and turn them into one $100 share. An Investor’s stake in the company isn’t altered, just the share price and the number of shares he or she owns. What about SRF and SRV? So a split doesn’t really change anything, even though there may be good reasons to do them. Are there bad reasons? The answer is yes. The reverse split at SRF and SRV has been billed as: The intent of the reverse share split is to potentially increase the Fund’s market price per common share and trading volume, thereby reducing the per share transaction costs associated with buying or selling the Fund’s common shares in the secondary market. Sure, with a higher share price, it may be easier to trade SRF and SRV. But that’s not likely the reason for the split. Although neither was at the point where you’d worry about a delisting, both were at the point where investors could reasonably be scared off by the low price. So the reverse split makes both SRF and SRV appear a bit more respectable. The problem is that both have made material use of return of capital in recent years. In fact, SRF has supported its distribution with nothing but return of capital since its initial public offering in early 2011. The net asset value, or NAV, fell from roughly $23 a share at the IPO to $5.60 at the end of May. By the time of the split, the NAV had fallen even further, falling into the $3.80 a share range. That’s brutal, particularly for a fund that’s only provided return of capital to its shareholders. The fund’s goal , by the way, is to seek a high total return with an emphasis on current income. I’m hard pressed to see how it’s lived up to that objective. SRV has done a little better, with its NAV falling to the $3.75 a share range before the reverse split from around $5.75 or so in late 2009. However, the high in the period was an NAV of around $8. So for many investors the NAV drop has been pretty harsh. And return of capital has been a big part of the distribution, representing roughly 60% of the disbursement between December of 2009 and May of 2015. That’s not a good number, but, to be fair, not nearly as bad SRF’s 100%. No dividend cuts, yet… At this point, neither fund has enacted a distribution cut. But with SRF offering a yield of over 15% and so much return of capital, I wouldn’t expect the payment to hold up. And if it does, then the split was cosmetic in that it helps to hide the fact that the fund has basically been self-liquidating since the day it came public. Based on the numbers, I just find it really hard to buy into the “ease of trading” logic the fund is using to justify the reverse stock split. SRV’s reverse split doesn’t look quite as bad, since the CEF yields around half as much as SRF. That could actually be sustainable, but only if the oil and gas sector on which the fund focuses turns around. If that doesn’t happen soon, the note in the split announcement highlighting that the September distribution was expected to be all return of capital is a not-so-subtle problem. And it could just get worse if low oil and gas prices force more dividend and distribution cuts in the oil and gas sector from which SRV generates its income. So SRV will be “easier to trade” too. But bumping up the share price via a reverse stock split still looks more like an attempt to paper over the trouble brewing with the distribution and NAV. Not where you want to be SRF and SRV are focused on a rough area of the market. If you are a contrarian that might interest you. But the high levels of return of capital for funds that have seen their NAVs fall dramatically should be a big concern. And the reverse stock split does nothing to change that dynamic – unless potentially large distribution cuts are made. The reverse split will probably make it easier to trade SRF and SRV, as the CEFs suggest. However, the splits look more like an attempt to cover deeper problems to me. I would avoid this pair. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.

You Can Buy This 11.2% Yielding, Unleveraged Equity CEF Without Paying A Premium

STK pays a distribution yield of 11.2%. The fund is an unleveraged, option-income CEF in the technology sector. There are only five unleveraged, domestic-equity CEFS with positive returns TTM. STK has the highest yield and largest discount of that set. Let’s start with a tale. There’s a domestic-equity closed-end fund that is paying an 11.2% distribution from a quarterly payout that has been stable since the fund’s inception over five years ago. It is one of only five unleveraged, domestic-equity CEFs that is in positive territory TTM; the other four are well-covered CEFs with lesser distribution yields. Its investing strategy is conservative, focused on covered-calls to generate income. At least here on Seeking Alpha, it stays well under the radar with essentially no attention from the site’s contributors. Impossible, you say? Well take a look at Columbia Seligman Premium Tech (NYSE: STK ). I’ve been writing about this fund for two years . If any other Seeking Alpha contributor has paid any attention to it, it’s not obvious. Put STK in the search box and the only thing you get is a few articles by Left Banker. Readers are no more interested than Seeking Alpha’s authors: those articles are solidly among my least. Despite its impressive numbers, STK remains about as unnoticed as a fund can be on this site. STK has $254M in AUM, which places it as a mid-size equity CEF. Trading volume is modest but not so low as to present exceptional liquidity problems. The fund invests in the technology sector. Management looks for capital appreciation from the portfolio holdings, and generated income from a covered call option-writing strategy. Calls are written on the Nasdaq 100 or its ETF equivalent on a month-to-month basis. The aggregate notional amount of the call options will typically range from 25% to 90% of the underlying value of the fund’s holdings on common stock. The fund has a managed distribution policy. It pays $0.4625 quarterly and has done so since its inception date. There had been considerable return of capital earlier, but in the last two years RoC has totaled only $0.37. At its current price, that is an 11.15% yield, just about its midpoint for the past two years. (click to enlarge) The fund has faltered along with the tech sector since mid-year, but even so it has a 1-year total return of 4.15% which places it 18th of 192 general equity funds indexed by cefanlayzer . Of those 192, only 40 are positive for this stat. Return on NAV TTM is 3.08%, which places 25 of 192 funds. STK is unleveraged. Some 60% of the 192 funds in the general equity category use leverage greater than 5% to enhance their yields. Leverage comes with risk, of course, an important risk factor that STK avoids. The fund had been priced at a premium as high as 10%. Since mid-summer, that has fallen to a discount reaching -6% early in September. The discount is climbing again and stood at -0.72% at Friday’s close. (click to enlarge) Annual portfolio turnover is 60%. As of the end of July, the top 10 holdings were: (click to enlarge ) It is the highest yielding of the 12 equity CEF that are both unleveraged and have a positive return for the last 12 months. Only five domestic equity funds pass those filters; the other seven are single-country funds. Three of these are in healthcare and one is a general equity, option-income fund. None has a distribution yield that approaches STK’s, and all but one sells at a premium. They have all turned in better TTM returns than STK, the two Tekla funds having done so by a large margin. Fund Distribution Yield TR 1yr Prem/Disc Columbia Seligman Premium Technology Growth Fund ( STK ) 11.15% 4.15% -0.72% Tekla Life Sciences Investors (NYSE: HQL ) 8.19% 35.08% 0.93% BlackRock Health Sciences Trust (NYSE: BME ) 5.36% 8.19% 4.64% Tekla Healthcare Investors (NYSE: HQH ) 8.30% 27.35% -0.32% Eaton Vance Tax-Managed Buy-Write Income Fund (NYSE: ETB ) 7.99% 7.80% 4.83% I should add here that HQL, HQH and ETB are long-time favorites of mine. If I were making recommendations in specialty equity CEFs, ETB or one or more of its sibling option-income funds from Eaton Vance would be at the top of that list. Right up there would be either HQL or HQH, which I consider must-own funds for the CEF investor. But for someone already invested in those funds and looking for opportunities for diversification in other sectors, STK is, in my view, among the strongest candidates. In conclusion, I think it’s clear that STK remains one of the most attractive options among high-income equity CEFs. Its 11.2% yield is near the top of the category. The income comes primarily from option premiums, which tends to position a fund somewhat more defensively in uncertain markets. Income is stable and, with the managed distribution policy, is likely to remain so, albeit with some risk of erosive return of capital in edgy times. On the negative side, while the fund has performed well over the past two years, its performance was erratic prior to 2013. It has also faltered since mid-2015 as its sector and the overall market started to turn sour. This may call into question the ability of management to handle less positive market environments. Disclosure: I am/we are long STK, HQH, HQL, ETB. (More…) 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. Additional disclosure: I remind readers that this article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any fund mentioned here is suitable for his or her portfolio. As always I welcome your comments and critiques, particularly from those readers who have contrary opinions.