Closed-end funds have become a kind of alternative vehicle to gobble up high yields, ever since the Federal Reserve wiped out the bond market as a source for fixed income.
CEFs operate like a cross between a stock and mutual fund. CEFs raise equity via an IPO. The proceeds are then used to execute the desired investment strategy for the fund, and a limited and finite number of shares are issued. Thus, it trades like a stock but operates more like a mutual fund or exchange-traded fund ,since they hold a basket of securities.
The trick with CEFs is finding the ones that are well-managed, that offer commensurate reward to whatever risks they are taking.
So here are three different types of CEFs that are a bit riskier than I personally like, but offer acceptable 10%-plus yields for those who don’t mind that extra risk.
Closed-End Funds to Buy: Eaton Vance Risk-Managed Diversified Equity Inc. (ETJ)
Distribution Rate: 11%
Eaton Vance Risk-Mngd Dvrsfd Eqty Inc Fd (NYSE:ETJ) is pretty much what it is described as, although its title doesn’t mention its core strategy, which is selling covered calls. I like ETJ because it takes a very similar approach that my forthcoming stock advisory newsletter, The Liberty Portfolio, takes. It buys certain high-quality stocks and then sells covered calls against them.
ETJ buys stocks like Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT) and Visa, Inc. (NYSE:V) and sells covered calls against them. That means they sell contracts for another party to buy that stock from the fund at a given price on or before a given day. Obviously, if the stock is below that price, the fund keeps the stock and can sell more calls. Most importantly, it holds stocks that are quality companies, so if the market tanks and they get stuck with those stocks … well, there are worse things.
The distribution rate is 11% and it currently trades at more than a 9% discount to net asset value.
Closed-End Funds to Buy: Pimco High Income Fund (PHK)
Distribution Rate: 11%
Pimco High Income Fund (NYSE:PHK) is one of the best CEFs that I have found, in regards to diversification. PHK has 343 holdings across many different kinds of bonds. While half are corporate bonds, 27% are asset-backed, 12.5% are municipals and 5% are government bonds, and they are spread across just about every kind of sector that exists. Maturities are also diversified, with a healthy 38% maturing in 1-4 years, 25% in 5-9 years, 16% in 10-20 years, and the rest are longer-term.
The average coupon is 7.95%, but manages to distribute about 10.9% annually, thanks to capital gains. Since inception, its annualized total returns are 13.8%, almost twice that of the 7.4% category benchmark. That’s also a major reason why the PHK trades at a 30% premium to its NAV.
Normally, I wouldn’t go near something trading with that premium, except that it’s about the average it has traded at since the financial crisis.
Closed-End Funds to Buy: Franklin Limited Duration Income (FTF)
Distribution Rate: 10.8%
Franklin Limited Duration Income Trust of Beneficial Interest (NYSE:FTF) is similar in structure to PHK, but has a few important differences from other closed-end funds that invest in corporate debt. While 43% of the FTF portfolio consists of corporate bonds that offer generous yields, 40% are invested in senior loans.
What are senior loans? They are loans that are often secured by a company’s assets. They are not considered investment grade and privately issued by various banks and institutional investors in a secondary market. They tend to be illiquid.
The difference between senior loans and bonds is that the latter’s interest rates are usually fixed whereas senior loan rates tend to float. Another big difference: bond prices will move inversely with interest rates, but senior loan prices do not change when interest rates change. Thus, they act as a hedge against rising short-term rates.
FTF has a 10.8% distribution yield.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
