Income-ing! Other Ways To Invest For Current Income
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Open Your Mind To Closed-Ended Funds
by 1markb44
I covered Business Development Companies, or BDC’s as a good source of income in a series of articles previously (if you missed them, start here ), and also wrote about one equity CEF, or Closed-End Fund, Central Securities Exchange (CET), here, which has been an excellent performer through its entire life—beginning in 1929! Today I’m looking at a number of CEF’s that are widely used as income vehicles.
Why income? For retired investors it provides a monthly or quarterly stream of dividends that supplement Social Security or other pension plans to offer a reliable cash flow. Income also smooths out the market’s ups and downs. Here’s a personal example: I have a fairly large position in IGR, a fund of REIT’s run by the real estate experts CBRE. With the current hotter than expected inflation numbers all things real estate are taking it on the chin, so it’s down about 12%. But it pays 15% in yield monthly at the current price, so I’ll get paid every month to wait for the share price to recover. That makes for a much smoother emotional ride than waiting for a non-income stock to get back in the green.
So a lot of investors look to CEF’s for higher yields than stocks alone can provide. There are a few ways CEF’s can juice the yield. One is leverage: they borrow money and use that to take the yield on the portfolio from 4% to 8%. Another way is to return capital gains to investors as income rather than keeping it to raise the NAV of the fund.
A third way is writing covered calls. A covered call is one of the simpler forms of options, where you sell a call option on a stock you own, at a certain sell price within a certain time frame. If the stock hits the price the order fills and you lose the stock; if it doesn’t you keep both the stock and the money the call buyer paid you for the option. The downside of covered calls is that you lose any gain you might have seen if the stock goes past the call price, but if the market is down or flat you get two ways to win, keeping both the stock and the call premium.
Another way that I don’t fully understand, and so avoid, is to raid the NAV of the fund to goose the distributions. Basically it seems that over the long term the fund is worth less, but in the near term holders get a higher yield. There seem to be both strong fans and strong detractors for this approach. You see this method when you look at ROC, or return of capital, in the fund’s income statement. I mention it because it’s out there, but personally it sounds too wild for my taste.
Lastly there are preferred stocks. These are basically a hybrid stock-bond creature, with aspects of both. People usually think of them as bond proxies and use them for income. Financial firms are especially fond of issuing preferreds. You can buy individual preferreds if you want to do your own research, or just buy a CEF or ETF that holds only preferreds.
I’m going to go through a number of CEF’s in all these categories, some that I hold and some that are alternatives.
One metric you can use to judge whether a CEF is cheap or expensive is its discount or premium to NAV. You want to compare the current percentage to the historical average—in other words, has the price moved above or below a lot from where it normally is. There may be good reasons for the move, or you might have identified a market mispricing that you want to buy or sell on. But the NAV history can at least help you to know whether a CEF is expensive or cheap.
The best place for all things CEF is CEF Connect, here. It’s a free website offered by Nuveen that will show you all the basic information on any CEF—just type in any ticker and you’ll get multiple pages of information, including top ten holdings, price vs. NAV history, and distribution history.
Leveraged CEF’s
Let’s start with leveraged CEF’s. One I hold is UTF, Cohen & Steers Infrastructure. It’s a popular fund with just over $2B in assets, and pays about 8% monthly. It has over 50% in utilities and the rest is other infrastructure, real estate and bonds. It uses about 30% leverage, which is average for one of these funds. So it’s a good way to get exposure to utilities while collecting double the dividend yield you’d get by buying XLU.
I’ve had a very positive history with UTF. I held it for about a year in 2023-2024 and made 15% in total return, very solid for an income vehicle, and sold it when the premium to NAV went well above the normal level. I recently got back in when the price dropped about 10% and plan on collecting the 8% return while waiting to see what the price does. This is one of my go-to funds for solid income returns.
Popular alternatives to UTF are UTG (watch those ticker initials!), Reeves Utility Income, and BUI, Blackrock Utilities, Infrastructure and Power (you’ll see the big boys’ names all over these CEF’s, of course). All run the same way, using leverage to raise the yield.
On the subject of leverage, the expectation was that funds that use it would have a tailwind as rates came down, as the cost of borrowing money dropped. Now, with the inflation picture less certain, the tailwind might not be as strong, or there at all.
Covered Call CEF’s
Next are the CEF’s that use the covered call method to add income to their equity portfolios. To me these are increasingly interesting creatures, as covered calls should do better in a choppy market than in an always-up one that we’ve seen the last two or so years, since there’s less chance of the stocks being called. I’ve recently opened positions in two covered call CEF’s as a test case.
The first is one that invests in normal dividend stocks, like an ETF like SCHD or VYM does, but with the covered calls the yield is almost three times what you get in an ETF: BDJ, BlackRock Enhanced Dividend Achievers. It runs $1.5B in assets and pays 9% yield. I’m curious to see how it does while I collect the monthly dividends. The discount to NAV is not as high as at other times, but not that pricey either.
The second is ETY, Eaton Vance Diverse Equity. This is an interesting one, as it looks a lot like a Mag 7 index-type fund, but pays 8% monthly. So you have all the usual biggest S&P names while it acts like an income fund—weird! Again, a small position while I see how it does and collect the dividends. It has a couple billion in assets, and in a weaker market you’d expect the covered call approach to do better.
A popular alternative to ETY is STK, Columbia Seligman Premium Technology Growth. It’s smaller and has a lower yield, but has had a great run holding all the big names and also issued an eye-catching $3 a share special distribution from capital gains in December, so lots of happy holders at this point.
The most popular covered call vehicles are the JP Morgan JEPI and JEPQ ETF’s. They use various derivatives to be able to yield 7% or so, and have $20B+ in assets. I mention them since they are ubiquitous in the covered call universe.
Preferred Stock CEF’s
Preferred stock funds also use leverage to boost their yields. I’ve held PFO, Flaherty and Crumrine Preferred Opportunties, and have done well, with a 14% return in nine months, including a 6% yield paid monthly. PFO uses a little higher leverage, 38%. They are a preferred stock house and have a number of funds holding them.
An alternative I’m considering is PFFA, Virtus Preferred Stock, which pays a higher yield. PFO had a better total return last year, but I’ll probably rotate into PFFA and collect 9% monthly.
Equity CEF’s That Use Capital Gains
There is a strong field of equity CEF’s to choose from. I’ve been in CET, Central Securities Exchange, exactly a year and have a 19% return while experiencing a very smooth ride. All of CET’s metrics are top-notch: a fund to buy and forget. One just as good is ADX, Adams Diversified Equity, which has also been around since 1929 and has a stellar track record. You could buy either one and be happy. ADX is a little more index-like to the S&P with a higher proportion of Mag 7’s. Both use capital gains to be able to offer a high-yielding distribution, which varies each year depending on the capital gains level, so this last year was quite good for both. CET does a small distribution mid-year and then a very large one in December.
A last, interesting CEF is PEO, Adams Natural Resources Fund. This one is the other fund in the Adams family, along with ADX. It focuses on energy stocks and basic materials, with XOM and CVX being heavily weighted at 37% of the portfolio. It has a long track record and pays an 8% yield quarterly. I saw an interesting comparison between setting up an 80%/20% XLE and XLB portfolio and buying PEO: you got a slightly better return with the XL’s,but missed the higher dividends. PEO is a different way to play the energy sector while raising the yield.
This just scratches the surface of the CEF universe. Make sure to do your own diligence on cefconnect.com and at other sources like Morningstar and Seeking Alpha to decide which CEF’s are right for you. For those in search of higher yield CEF’s are a popular way to invest, and they are a good way to diversify from other income sources like BDC’s. Good luck!
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If you’re interested in investing in things that aren’t just Mag7 and the S&P500, please take a free trial to YX Insights. I am a regular contributor to this service which covers bonds, gold, silver, bitcoin (for grownups!), key stocks and indices.
Disclosure: 1markb44 has positions in, inter alia, UTF, BDJ, ETY, PFO, CET, and PEO.
Cestrian Capital Research, Inc - 14 Jan 2025.