Tag Archives: etf

Equity CEFs: Buy What’s Working At A Discount

Summary The market cannot be any more clear. If you want to make money in this market, buy what has been working and ignore everything else. Indeed, every rotation head fake that seemed to finally benefit the “have not” sectors has only been an opportunity to sell and add more to the “have” sectors. Perhaps we’ll see another rotation at the beginning of 2016 but if history is any guide, the last few years has shown that trying to play a rotation is futile. Has anyone seen such a vast difference in sector performance than what we are seeing today? Just a month ago, I wrote this article, The Chasm Between What Works And What Doesn’t , and since that time not only has it gotten worse, its gotten a lot worse. In fact, it’s gotten to a point where if you want to play CEFs, which generally have not kept up with their ETF benchmarks, at least at the market price level, you have to play what’s working. And what’s working are funds which invest primarily in the large-cap technology sector. Yes, healthcare, banking and a few other sectors also are working but if you really want to follow what every institution is throwing all their weight behind here at year-end 2015, it’s large cap information technology. And what CEFs are best positioned for that? Well, let’s go to the scoreboard and see which equity CEFs have had the best YTD NAV total return performance. The following 35 funds represent the best NAV performances compared to the S&P 500 (which I use as a general benchmark for all equity CEFs). Funds in green in the YTD NAV Tot Ret column have seen their NAVs outperform the S&P 500, as represented by the SPDR S&P 500 Trust (NYSEARCA: SPY ), which is up 3.4% YTD through December 4th, 2015, including dividends. NOTE: The S&P 500 is generally quoted without dividends and is up 1.6%. (click to enlarge) Buying What’s Working At A Discount No other fund family has more equity CEFs working than from Eaton Vance , though I think you have to be selective at this point. My No. 1 pick is the Eaton Vance Enhanced Equity Income II fund (NYSE: EOS ) , $13.60 market price, $14.75 NAV, -7.8% discount, 7.8% current market yield . EOS has been a favorite of mine since 2011 and I have always maintained a position in it though I have added and reduced over the years depending on its valuation. And if you want to go on its current valuation, EOS is a buy again. This is reflected in EOS’ YTD Premium/Discount chart in which EOS has moved back down to almost an -8% discount, its widest all year and even wider than when I first wrote about EOS all the way back in February of 2011, EOS: A Compelling Valuation After A 2-Year Wait . (click to enlarge) Back in early 2011, EOS was trading at a -6.8% discount, which seemed wide at the time considering EOS often traded at a premium of 5% to 10% since its inception in early 2005. But a series of distribution cuts for all of the Eaton Vance option income CEFs beginning in 2010 and continuing through 2011 dropped their valuations to double-digit discounts of up to -16% in the fall of 2011 despite their NAVs beginning to show a turnaround. I wrote many articles during this time frame arguing that the distribution cuts were necessarily and would ultimately benefit the funds in the long run. So despite most investors giving up on the Eaton Vance option-income funds during this time and driving them down to valuations not seen since 2009, anyone who took my advice and bought these funds during this period has enjoyed one of the great runs of any family of CEFs. Today, the Eaton Vance option-income CEFs are probably the most popular equity CEFs to get exposure in the large cap information technology sector since virtually all of them own Apple (NASDAQ: AAPL ) , Alphabet/Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) , Facebook (NASDAQ: FB ) , Amazon (NASDAQ: AMZN ) and other strong performers in their top 10 holdings. In fact, they have become so popular that a couple, like the Eaton Vance Tax-Managed Buy/Write Opportunities fund (NYSE: ETV ) and the Eaton Vance Tax-Advantaged Buy/Write Income fund (NYSE: ETB ), now trade at the high end of their valuations with ETV at a 3.1% market price premium while ETB trades at a 5.4% market price premium. ETB, in particular, has gotten significantly ahead of itself based on its NAV performance and I would be swapping out of ETB and into EOS or really any other Eaton Vance option-income CEF at this point. ETB got a bump after a positive Barron’s article two weekends ago in which a money manager brought up its long-term outperformance over the S&P 500. That’s true, and I had been pointing out ETB’s outperformance at the NAV level for years, but ETB and indeed, ETV, are very defensive option-income CEFs and just because their NAVs have outperformed since inception, i.e. throwing in the 2008 financial crisis, does not mean that they are the best funds to own in a strong information technology stock-driven market. This is shown in the following table in which I re-sorted all of the equity CEFs by their NAV total return performance since 2012 when the ramp up Nasdaq-100 stock boom really got started. (click to enlarge) And if I just include the Eaton Vance option-income CEFs from the above table, this is how they have performed since 2012. (click to enlarge) As you can see, the lower the option % under Income Strategy , the more upside capture the fund generally offers. So in a continued up market, particularly if information technology continues to lead, you’re going to want to own EOS first over any of these funds. And at a -7.8% discount compared to ETB’s 5.4% premium despite both funds having similar 7.7% market yields, it’s not even a question. In fact, at a 7.1% NAV yield, EOS will probably be the first Eaton Vance option-income CEF to be in a position to raise its distribution if this technology rally continues. On the other hand, if you believe the markets are topping out and you want to consider a more defensive option-income CEF, I would swap out of ETB again at a premium and go into ETJ at an -11.7% discount and a much higher 11.0% current market yield. ETJ is the most defensive of all the Eaton Vance option-income funds due to its 95% put option collar in addition to writing 95% call options on its US-based stock portfolio. That uber defensive option positioning is why ETJ has the lowest total return of the group since 2012, both in NAV and market price but it also means ETJ will hold up dramatically better at the NAV level should the markets and primarily the S&P 500 weaken. But what I find surprising so far in 2015 is that despite ETJ’s extremely defensive risk-adjusted strategy, its NAV performance has significantly improved over years past and not only is it beating the S&P 500 by being up 3.5% YTD, it’s not that far behind ETB’s total return NAV performance of 4.6% YTD. I hadn’t always endorsed ETJ because historically its added put collar expense had been a major drag on performance. But obviously, Eaton Vance has found a way for the fund to load up on outperforming stocks while keeping its S&P 500 index option writing and put collar strategy in place at a reasonable expense. The bottom line is that the Eaton Vance option-income CEFs are a great way to get exposure to the large-cap information technology sector at a discount. All you have to do is choose which defensive option strategy suits your needs. Conclusion The Eaton Vance option-income CEFs certainly represent what is working in this market though you have to be selective during this period. Year end is one of the volatile times for equity CEFs as many investors use these funds for tax-loss selling and institutions often make big changes either due to forced selling/buying (hedge fund redemptions) or for re-balancing. Just last week, one of the other popular Eaton Vance option funds, the Eaton Vance Tax-Managed Global Buy/Write Opportunities fund (NYSE: ETW ) , $11.33 market price, $11.92 NAV, -5.0% discount, 10.3% current market yield , dropped on huge volume from some institutional investor who was probably just liquidating after seeing such a large run in the fund since 2012. ETW, which I also had reduced significantly before last week, had risen to almost a par valuation just two weeks ago, something the fund hasn’t seen for years. Here is ETW’s five-year Premium/Discount chart. (click to enlarge) This is what is going on in this market for the “what’s working” stocks and funds, though how long this can last while the “have not” crowd continues to plummet is the question. Though I never thought I would recommend investors swap out of a “what’s working” fund like ETB, I don’t get married to any CEF forever either. Just so you know, I wrote more positive pieces on ETB than any other CEF during 2011 and 2012. So how long can this go on for? Well, if you use 1999 as a template in which the Nasdaq rose something like 86% in the span of six months from September of 1999 to March of 2000 while the breadth of the overall market continued to narrow, I guess we have a little ways longer to go. Of course, back in 1999 the Nasdaq traded in fractions of 1/2 point, 3/4 point up to 1 point or even 2 point spreads. That means most technology stocks on the Nasdaq traded with $0.50 to up to $2 spreads between bid and ask. Today, the Nasdaq uses decimals in which spreads, even for the high flying Nasdaq stocks, are often quoted in just pennies. You don’t have to be a genius to figure out that its a lot easier to move stocks up or down with very wide spreads than very narrow spreads so even though it has taken a few years this go around to move the Nasdaq back up to all time highs, thanks to Quantitative Easing and buybacks, I think the end result will be the same, particularly in a rising interest rate environment. As such, I think the Nasdaq peaks sometime before February of next year.

Is The Market Fair? Yes Vs. No

Summary Yes. Mostly. But not entirely. 3 recent exploitable examples. Is the market fair and efficient? Yes. Well, almost always. The second best piece of news I have for you is that markets work quite well. Few activities allow for so much success for the people who don’t even try. If you sign up for a marathon and get to the starting line but don’t try to run, you lose to every other runner. If you don’t try to beat the market, you simply sign up for an index fund or buy a passive ETF in the S&P 500 (NYSEARCA: SPY ), you beat about three quarters of other investors. No. Not entirely. The best piece of news I have for you is that market prices fail sometimes – and do so in ways that are exploitable for profit. One of the best books to date on the subject has one of the worst titles: You Can Be A Stock Market Genius . It reveals the world of spinoffs, merger securities, bankruptcy, restructuring, recapitalizations, stubs, and warrants. It is in such investment opportunities where the price system often fails to accurately reflect underlying value. Today, there are three such investment opportunities where the price system continues to fail. These are not prices that are off a bit. They are prices that are wrong. They include share class trades such as CBS / CBS.A , parent/sub stubs such as Yahoo! (NASDAQ: YHOO ), and closed-end fund IPOs such as CCD . CBS There are two related opportunities in CBS. The first is that there are two share classes, each with the same economic value. According to the company, CBS Corporation has two classes of common stock: Class A, which is the voting stock, and Class B, which is the non-voting stock. There is no difference between the two classes except for voting rights. Shares of CBS Class A and Class B common stock generally trade within a close price range of each other. There are, however, more shares of Class B common stock outstanding, and most of the trading occurs in that class. The second is that it is unlikely that CBS remains a standalone company after a transition from its 92-year-old founder and executive chairman departs his role. (click to enlarge) So, it is reasonable to expect the price difference to converge. Given the likelihood that it will get a takeover premium, it is probable that the convergence is upward from the current market prices. What should one do with such situations? CBS Class B shares (NYSE: CBS ) are probably a bargain around $50 per share, even if it remains a standalone company. They are even better if Time Warner (NYSE: TWX ) or someone else buys CBS after Redstone’s tenure. But what is even more interesting is that the share class spread will probably go to zero in such a deal. One way to capture this spread is to buy the B shares ( CBS ) while writing calls on the Class A (NYSE: CBS.A ) shares. For example, you can write May 2016 CBS.A $50 calls, These have a $5.40 bid and a $7.50 ask. This is an attractive amount of premium to capture in addition to the share class spread. In an efficient market, this opportunity should not exist. But it is there for the taking. Yahoo! Net of cash, Yahoo Japan, and Alibaba (NYSE: BABA ), the public capital market valued Yahoo’s core business at $0.11 as of the beginning of this month. The structure can probably be resolved in a number of different tax-efficient ways according to this recent analysis. Reasonable people can differ on the value of the core business, but the stub is probably worth somewhere in the range of $4-$5 per share. $0.11 is just wrong. Net of cash and the exposure to BABA and Yahoo Japan, if the process goes badly and the company performs poorly, the stub should at least double. If the process goes well and the company performs well, the stub should at least double again. CEF IPOs The CEF IPO is an opportunity to lose 8% of your money quickly, then much the rest slowly. They are useful for investors because they are the financial world’s equivalent of a ski mask on a warm sunny day in that any broker caught with one has identified himself as a likely swindler. While I am a longtime skeptic of boom era IPOs generally, my skepticism is greatest when it comes to initial public offerings of closed-end funds. With industrial IPOs, there is some pre-existing corporate asset being supplied. With CEFs, the IPO is driven by the demand. What CEFs get IPOed? Whatever the retail mass market wants. Whatever is most in favor, priced-in, or trendy is what gets invented and then sold to the trusting public. At least industrial IPOs initially pop 16% or so on average on the first day and only later lose investors’ money. But with CEF IPOs, there is not even that initial pop. Then, average CEFs are down about 8% within three months, 13% within five months, and 19% within a year. While there is a market inefficiency in the repeated ability to sell such CEFs to the public for a 5-10% premium to NAV, the market is subsequently efficient at wrenching that premium out of the price. Over a billion dollars of value has been transferred from CEF investors to underwriters on day one. That is about 8% of the money that they invested. There is zero evidence of skill in the (typically expensive) management of the remaining 92% of their money. It is instructive that only about 4% of investors in new CEFs are institutional investors compared with the 22% of investors following similar industrial IPOs. One recent example is Calamos Dynamic Convertible and Income (NASDAQ: CCD ). This has been a smashing success… for its underwriters are brokers. These wealth transfers are useful tools for investors to identify brokers who are willing to do anything and say anything to take your money. So far, it is right on schedule. The market squeezed out massive underwriting fees, losing 11% of value in 100 days (slightly ahead of the -8% historical average) and 25% within five months, well ahead of the -13% pattern such funds have seen in the past. This was not a problem; this was the plan. These can be good opportunities to buy at deep discounts to NAV. Nobody sells shares for no good reason like an investor who bought them for no good reason. By the time they have sold off, the investors are probably in the market for a new broker while the broker is in the market for his next mark. Conclusion The market is good. It is good enough to trust in its general fairness and approximate efficiency. You can put all of your money in passive exposure to equities, debt, and cash with the confidence that – on average and over time – you will get what you pay for. But it is also imperfect. For diligent bargain hunters, some durable inefficiencies include occasional share class spreads, cheap parent-subsidiary stubs, and broken CEF IPOs. It is possible to beat the market over the long-term by judiciously selecting securities within such categories. Is the market efficient? I find much of the academic literature that indicates significant efficiency to be persuasive, yet in my direct experience, I keep finding lucrative exceptions. What do you think and what have you found? Please use the comment section below to weigh in with your findings.