How Much Allocation To CEFs Is Too Much For An Income Investor?
CEFs provide a great income source for retirees and income investors. A past performance screen with 10, 20 and 40% allocation of 4 CEFs in combination with VTI is presented. The portfolio with a 40% allocation to CEFs had the highest return for the given period. It has been become a ritual for me when rebalancing my portfolio to make sure that I am not over-allocated to high yield asset classes. However, I have been adding more Closed End Funds to the portfolio due to the attractive discounts especially last month. Adding high yield CEFs in a rising interest rate environment is generally not considered very safe. I therefore set out to see how three portfolios with 40%, 20% and 10% allocations to a set of 4 CEFs would have performed since January 2008. Investing in CEFs is certainly not appropriate for everybody, but it can be a great vehicle for investors in or near retirement who would like to have a higher income from dividends. It is important to keep a sizable portion of a portfolio in stocks or ETFs like the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) for growth especially for long retirement time horizons. This analysis tried to shed light on the performance impact of a larger allocation to CEFs. There are certainly plenty of CEFs to choose from for this analysis and the selection chosen is solely based on the fact that I own each of them (with the exception of MGF) in my personal portfolio. I included MGF since it is a taxable bond CEFs with a long history of data available. I hold the PIMCO Dynamic Income Fund (NYSE: PDI ) in my personal portfolio for taxable bond CEF investment exposure. However, since the inception date for PDI was May 2012 vs May 1987 for MGF, I included MGF in the analysis. My aim was to get a representative set of CEFs with investments in preferred securities, equity and bonds. Overview of CEFs included: The Flaherty & Crumrine Preferred Securities Income Fund (NYSE: FFC ): Invests in preferred securities. At least 80% of the preferred securities are investment grade quality. Leverage ratio 34.6%. I consider this one of the best available Preferred CEF funds. It currently trades at a premium of 5%. The Nuveen Tax-Advantaged Dividend Growth Fund (NYSE: JTD ): Equity CEF using 31.6% leverage. This CEF has historic data going back to June 2007 and currently trades at a 11% discount The Eaton Vance Tax-Managed Global Diversified Equity Income Fund (NYSE: EXG ): International Equity CEF using an option income strategy. I included EXG for its international equity exposure. EXG currently trades at 7.9% discount. The MFS Government Markets Income Trust (NYSE: MGF ): A taxable Bond CEF that invests at least 65% of its assets in US Government securities and may invest up to 35% of its total assets in foreign government securities. MGF trades currently at 5.7% discount. Here are the hypothetical portfolio allocations: Portfolio 1 2 3 VTI 60% 80% 90% FFC 10% 5% 2.5% JTD 10% 5% 2.5% EXG 10% 5% 2.5% MGF 10% 5% 2.5% I used VTI as the non CEF part of the portfolio since it is a largely diversified ETF. So here are the results as analyzed using portfoliovisualizer.com . I included the SPDR S&P 500 Trust ETF ( SPY) for reference: # Initial Balance Final Balance CAGR Std.Dev. Best Year Worst Year Max. Drawdown 1 $100,000 $185,521 8.21% 15.45% 38.14% -31.16% -42.42% 2 $100,000 $178,894 7.71% 16.13% 33.52% -34.07% -45.19% 3 $100,000 $175,342 7.43% 16.66% 31.21% -35.52% -46.68% SPY $100,000 $167,266 6.79% 16.77% 32.31% -36.81% -48.23% The individual returns for the selected funds are listed below: Year VTI FFC JTD EXG MGF Total Return 2008 -36.98% -44.86% -40.22% -30.87% 26.22% -31.16% 2009 28.89% 108.42% 49.32% 49.11% 1.24% 38.14% 2010 17.42% 27.46% 22.61% -1.98% -2.05% 15.06% 2011 0.97% 18.52% 2.78% -11.59% 10.51% 2.60% 2012 16.45% 22.77% 27.14% 19.95% 5.76% 17.43% 2013 33.45% -2.21% 16.22% 25.60% -9.62% 23.07% 2014 12.54% 18.31% 11.37% 4.44% 6.95% 11.63% 2015 (until Oct) 1.90% 10.26% -3.66% 4.78% 1.45% 2.42% Conclusions: The allocation to a set of CEFs seems to have helped the portfolio return for the selected time period. FFC had the biggest positive impact on the portfolio performance. This is by no means a guarantee that the future results will be similar. However, I personally feel a bit more comfortable that a set of equity, preferred and bond CEFs can enhance the overall portfolio returns while providing nice income.