For income investors, closed-end funds remain an attractive investment class that covers a variety of asset classes and promise high distributions and reasonable total returns.
Closed-end funds are generally characterized by higher volatility and deeper drawdowns than the broad market. For these reasons, they are not suited for everyone.
In this monthly series, we highlight five CEFs that have solid track records, pay high distributions, and are offering “excess” discounts. We try to separate the wheat from the chaff using our filtering process to select just five CEFs every month from around 500 closed-end funds.
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Olivier Le Moal/iStock via Getty Images In this monthly article, we try to identify five closed-end funds that have a solid past history, pay high-enough distribution and offer reasonable valuations. In the first half of this year, CEFs and other high-income securities had performed very well. It’s unlikely that we’re going to see the same level of gains in the second half of the year. Even then, compared to a couple of years ago and specifically to the year 2020, the average CEF yields are much lower. At this point, it’s pretty difficult to form a brand-new portfolio that is conservative and relatively safe and still yields 8%. Nonetheless, if you were to start a new portfolio today, our recommendation would be to start small and build the positions over time.
Obviously, the CEF funds do not exist in a vacuum. For the most part, they move along with the broader market. This is especially true for equity funds. However, there are many funds with underlying asset classes that are known to provide divergence with the market. The market resumed its bull run in October and November after some jitters in September. It has been reaching for new all-time highs once again. Most of the market’s upward movement was based on third quarter earnings. However, during this time, we had plenty of other news, for example, the November elections, the October job report, the passage of the $1.2 trillion bipartisan infrastructure bill, the Fed’s announcement to begin tapering, and the October inflation readings. Even though the market appears to be doing well, the rise in inflation levels is a real cause for concern. In fact, the prices rose 6.2% in October on a year-over-year basis, the highest pace recorded since December 1990. If inflation continues to rise unabated, it can doom the bull market.
All that said, we can’t stand still in fear of market uncertainties. We should rather think in terms of long-term investing. It’s best to keep the focus on our long-term goals and strategies that have proven to work in good times and bad. If you are a new investor or starting a brand new CEF portfolio, our recommendation would be to start small and build the positions over time. We believe, for most investors, a 20%-25% allocation to closed-end and high-income funds should be enough. In that spirit, we keep looking for good investment opportunities and try to separate the wheat from the chaff on a regular basis. Why Invest In CEFs?
For income-focused investors, closed-end funds remain an attractive investment class that offers high income (generally in the range of 6%-10%, often 8% plus), broad diversification (in terms of variety of asset classes), and market-matching total returns in the long term, if selected carefully and acquired at reasonable price points. A $500K CEF portfolio can generate nearly $40,000 a year, compared to a paltry under $7,500 from the S&P 500. Now, if you were a retiree and needed to use all of that income, the portfolio would not grow much, but it may still grow enough to beat the rate of inflation. That certainly beats investment vehicles like annuities. With CEFs, you have to think in terms of income rather than capital growth.
Ideally, if you have a large enough pool of retirement funds, there’s generally no need to put more than 20% into CEFs, but these are decisions that can only be made on a personal level based on individual situations.
However, it’s important to be aware of the risks and challenges that come with investing in CEFs. We list various risk factors at the end of this article. They are not suitable for everyone, so please consider your goals, income needs, and risk tolerance carefully before you invest in CEFs.
CEFs had taken a […]