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8% Current Income And Stable Principal From A Portfolio Of Closed-End Funds

Summary This High-Income, Stable-Capital CEF portfolio is designed to generate current income with reasonable tax efficiency. The portfolio’s second, and equally weighted, objective is long-term sustainability of capital. The objectives are addressed by entering positions in quality funds when their discount status is attractive. This article summarizes the final quarter of 2015. High Current Income and Capital Stability from CEFs At the end of 2015’s gut-wrenching third quarter (chart at right) I took note of the sharp declines in closed-end funds and considered that an opportunity was at hand. I proposed a portfolio of CEFs ( A CEF Portfolio For High Current Income With Capital Preservation ) designed to generate high current income with capital sustainability: The Stable-Capital, High Current-Income Portfolio. With the fourth quarter in the books, it’s time to review the results. I’ll not spend time here rehashing the details of the portfolio; interested readers should refer to the article cited above. But I will say that one incentive for building this model grew from my frustration with the performances of ETFs, ETNs and CEFs that offer portfolios of CEFs. As the name implies, the model has three objectives: First is high yields for current income. I’ve targeted 8% for taxable funds and 5% for tax-free municipal bond funds. Any excess is to be reinvested. Second is sustainable principal value. Capital growth is not an explicit objective, but maintaining a sustainable principal while withdrawing income at approximately 7.6% will obviously require periods of capital growth to offset inevitable periods of capital erosion. Third is tax efficiency. I wanted a manageable portfolio, so I limited the selections to 15 funds and equally weighted them. The portfolio is diversified across income asset classes. The funds selected are: Equity (40%) Dow 30 Premium & Dividend Income Fund Inc. (NYSE: DIAX ) Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (NYSE: ETW ) Eaton Vance Tax-Managed Diversified Equity Income Fund (NYSE: ETY ) Tekla Healthcare Investors (NYSE: HQH ) NASDAQ Premium Income & Growth Fund Inc. (NASDAQ: QQQX ) Columbia Seligman Premium Technology Growth Fund, Inc. (NYSE: STK ) Real Estate (6.7%) Cohen & Steers Total Return Realty Fund Inc. (NYSE: RFI ) Preferreds (13.3%) Flaherty & Crumrine Preferred Securities Income Fund Inc. (NYSE: FFC ) First Trust Intermediate Duration Preferred & Income Fund (NYSE: FPF ) Fixed Income – Taxable (26.7%) Western Asset Mortgage Defined Opportunity Fund Inc. (NYSE: DMO ) PIMCO Strategic Income Fund, Inc. (NYSE: RCS ) AllianzGI Convertible & Income Fund (NYSE: NCV ) PIMCO Dynamic Income Fund (NYSE: PDI ) Fixed Income – Tax-Free Municipal Bond (13.3%) Eaton Vance Municipal Bond Fund (NYSEMKT: EIM ) MFS Municipal Income Trust (NYSE: MFM ) Comparables The comparables I’m using for this portfolio are: Cohen & Steers Closed-End Opp (NYSE: FOF ), an unleveraged closed-end fund of funds with 85 CEFs in its portfolio. PowerShares CEF Income Composite (NYSEARCA: PCEF ), an unleveraged ETF holding 147 closed-end funds. UBS E-TRACS Mthly Pay 2x Closed End ETN (NYSEARCA: CEFL ), an ETN (Exchange Traded Note) indexed to a 2x leveraged portfolio of 30 closed-end funds. YieldShares High Income ETF (NYSEARCA: YYY ), an unleveraged ETF that holds a portfolio of 30 closed-end funds using the same index as CEFL. Fourth Quarter Results Income The first objective is current income, so let’s start with a look at distributions for the funds. Recall that any distributions for the quarter over 2% (8% annualized) for 13 taxable funds and over 1.25% (5% annualized) for two tax-free, muni-bond funds are retained for reinvestment. (click to enlarge) Total distribution was $3430.00, a return of 3.26% for the quarter. The return is enhanced by three funds posting special distributions. PDI added $2.61/share for $608.13; DMO added $1.20/share for $322.80; and RCS added $0.04/share for $32.28. Thus, special distributions put an extra $963.21 or 28.08% to the quarter’s yield. When only the regular distributions are considered, the portfolio paid $2466.79, which exceeds the anticipated $2,372.43 by 4% (see previous article for a discussion of anticipated yields). Distributions for all but three funds met the 8%/5% target. The shortfalls were minimal and were anticipated at the onset: DIAX -$10.60, FPF -$31.10, and QQQX -$14.62. Overall, the 8%/5% target objective was exceeded by $1,428.03, which is available to reinvest. At the quarter’s close, yields for the funds are as shown in this next chart. (click to enlarge) As we see, a few have increased but most now have decreased yield percentages, reflecting changes in market prices. This leads to discussion of the next objective: stability of principal. Price Performance and Capital Stability It was a good quarter for the portfolio. Somewhat surprisingly so, in fact, considering the generally poor performance of equity and fixed-income markets. Here is the market price performance for the portfolio’s funds. (click to enlarge) Only four funds had price declines. For two of these, PDI and DMO, the declines were partially a consequence of their high special distributions. One, FPF, is essentially flat. And one, NCV, is the portfolio’s big loser having given up 4.5%. I added NCV to the portfolio because I felt that it was due for a move up. It had just come off a large dividend cut and moved from a perennial premium to a discount of -15%. The fund was paying a 13.44% yield. I anticipated the discount would be reduced and the fund would stabilize at a somewhat higher valuation to NAV. This has happened; the discount is now -11.2%, but NAV has been falling along with the rest of the high-yield bond market. The fund does, however, continue to pay an exceptional distribution (14.1%). Two funds that have been long-time favorites of mine, STK and HQH, had stunningly good quarters; they’re up 13.8% and 12.1%. I’ve written on both of these several times over the past couple of years, and regular readers are aware of my high regard for both of them. HQH had been unduly beaten down. As the biotech sector dropped mid-year, HQH dropped even further. This is yet another example of the exaggerated panic selling so often seen in closed-end funds. STK was also oversold in response to the summer’s market upheavals in technology. It fell to a -6.2% discount at one point, but was back up to a 2.4% premium when I began this portfolio. Anyone who was quick enough to grab that -6% discount gets my admiration and compliments. Premiums and Discounts Let’s look at the changes in discount/premium status for the funds which provides a bit of an object lesson in CEF investing. (click to enlarge) In large measure I felt that these funds were undervalued and oversold at the end of September. As such they offered especially attractive entry points. As we see here, only one fund (NYSE: DMO ) has not gained value from a favorable move in the discount/premium. Two, FFC and RCS, have grown from moderate-to-modest discounts to substantial premiums. I held both of these at the time I started this exercise. I’ve since sold FFC (and anticipate replacing it with FLC or, perhaps, another preferred share fund) to take advantage of that profit and have been considering doing the same for RCS. RCS is a fund that has run a perennial premium. It dropped to a discount after PIMCO cut distributions on several of its high flyers (not, however, RCS). I felt that RCS’s drop was unwarranted at the time and it quickly turned around. I will likely echo my real-money swap of FFC for another preferred shares fund in this model portfolio once I’ve reviewed the space. It could be FLC here as well, but there are other strong contenders which may be a better fit. Preferred shares are presently a bit of a hot asset class, so everything out there (except FPF which is already in the portfolio) is above its mean discount status. I’ll add here a view of the Z-Scores for the funds from the beginning and end of the quarter because I think it helps to reinforce the emphasis I’ve been putting on moves in discount/premium status relative to mean discount/premiums. (click to enlarge) On the whole, the 29 September Z-scores were indicating reasonable entries for most of the funds. As I noted at the time DMO, EIM, PDI and STK were exceptions, but I wanted those high-quality funds in here despite those apparently unattractive valuations. Notice too, how frequently the Z-scores predict reversion to mean values. By these indicators, HQH remains an especially attractive opportunity (especially so if, like me, you’re inclined to think biotech is due for a recovery), but little else in the mix is. Indeed, I would not be surprised to see some corrections in the other direction in the coming months. As I noted above, RCS and FFC look ripe for profit taking. The equity option-income funds, DIAX and QQQX, which I also suggested were good buys because of their unjustified under-valuations have moved to highly positive Z-scores as well. The problem with trading out of these funds is that one needs to find a replacement. I’ll be working on that as time allows and as I go through a similar exercise for my own portfolio which shares many of these positions. Performance Summary Fourth quarter performance is summarized in this table. (click to enlarge) As shown, the portfolio is up $5,550.27 (5.5%) on market price. Results for the quarter for some asset-class benchmarks are seen in this chart. (click to enlarge) The portfolio performed well relative to these benchmarks. On price returns it lagged the S&P 500, Russell 3000 index and the Dow Jones REIT index, but it beat corporate and high-yield bonds and preferred stocks. Consider that the 5.5% price return does not include the 3.3% distribution yield, a yield unmatched by any of these benchmarks, and it’s clear that it was a good quarter for the HI-SC portfolio. The next chart summarizes the total returns for combined market price and distribution yields for each fund. (click to enlarge) Only NCV is negative for the combined values. Comparables As noted earlier, there are products that offer exposure to CEFs. I’ve not been a big fan of these, but I know many readers are. Here’s how they stack up for the quarter. Each is based on a $100K investment at the quarter’s start. The table that follows shows percentage return for combined market value and distributions. The chart says it all, in my mind. CEFL, true to its charge and 2x leverage, generated remarkable income. But, true to its ongoing track record, that income has come at a substantial capital cost. It does beat FOF and YYY, as it should with its 2x leverage, but it lags PCEF. The lag is trivial but PCEF is an unleveraged product, so in an up-trending quarter, one would have certainly expected a better showing from CEFL than an essentially even run with the ETF. None of these comes close to the HI-SC returns. I’ll be the first to admit here that the model had an unfair advantage in that it was selected at the beginning of the quarter with valuation as a high priority. But I’d also argue that the model portfolio has a much higher quality of funds than any of the comps here and that is also a consideration. We’ll continue following these funds as I do quarterly updates to see if the outperformance trend continues. Updating the Portfolio As it stands there is $1,428 in excess distribution returns to reinvest. One possibility is to add them to the funds that are the greatest distance from the equal-weighted goal. My typical target for rebalancing a portfolio is more than 10% out of balance. This table shows none at that level, but three over 9% out of balance. If I add a third of the reinvestable capital to each of DMO, PDI and NCV it would bring them closer to equal weighting. A good case can be made for this. DMO and PDI are top-of-their-class funds, but their valuations look pricey at the moment. NCV has, as I noted, been hit hard by the flight from high-yield. Is that due to turn around? I think it might to some extent, but I’m not anticipating a good year for that asset class. And when an asset class falters, the CEFs for that asset class almost invariably exaggerate the declines. The fact that NCV has such a high yield argues in favor of bringing it up to near balance. I also am considering taking some profits and swapping out of some funds. I should have some clarity on that in the coming weeks, so I’ll be holding off on the re-investment until I make those decisions. I’ll update on changes when I make them. If you have suggestions, I’d love to hear your opinions in the comments.

Evaluating Actively Managed Stock Funds With iM’s Terminal Value Rating System

This rating system identifies funds which may provide better returns than a benchmark index-fund by measuring fund performance from the perspective of savers who make regular monthly contributions to funds. It compares the terminal value from periodic $1.00 monthly contributions to a fund with the terminal value from the same contributions to a benchmark index-fund over the same time period. Specifically, the system calculates 1-year and 5-year rolling terminal values from $1.00 monthly contributions to the fund and the benchmark index-fund. Predictive information comes from the relationship between the fund and the benchmark rolling terminal values, allowing an estimate of future fund performance relative to the benchmark index-fund. The Terminal Value Rating System Since most investors aim to save an adequate amount for retirement, it is appropriate to calculate the terminal value from monthly contributions to a particular fund and compare this to the terminal value if the same contributions had been made to a benchmark index-fund instead. (In this analysis SPY, the ETF tracking the S&P 500, is used as the benchmark index-fund, hereinafter referred to as benchmark.) This method provides a better picture of fund performance for savers as it measures the end value from periodic investments to a fund, rather than performance over standard fixed time periods. (Fund prices adjusted for dividends are mainly from Yahoo Finance. Also, the system only applies to funds with no front load fees.) An evaluation of the relationship between the 1-year and 5-year rolling terminal values for investments in a fund, and the corresponding rolling terminal values for investments in the benchmark, can provide a good estimate of future fund performance relative to the benchmark. The relationship is termed “Rolling Performance” and is defined in the Appendix. The ratings derived from this analysis range from a grossly underperforming ‘E’ to a good outperforming ‘A’. In the charts, the ratings are based on the most recent past 1-year and 5-year Rolling Performances, shown as “iM RATING: 1yr(5yr)”. Desirable funds should have a 1-year rating of ‘C’ or better, and a 5-year rating of ‘B’ or better. (See the Appendix for Rating Criteria) Over and above the simple 5-bin rating, charts are produced to visualize, and substantiate, the fund’s rating. How to interpret the charts The upper two graphs in the charts show the actual terminal values obtained from investing $1.00 every month in the fund and the benchmark. These are the sums of all contributions including all gains and losses to the end of November 2015, and indicate the total savings over time. A desirable fund would continuously have had higher terminal values than those for the benchmark. The lower two graphs in the charts are the 1-year and 5-year Rolling Performances. The 5-year Rolling Performance should preferably be continuously positive, which would indicate that an investor would always have done better investing in the fund than in the benchmark over a five year period. For future fund performance to be better than the benchmark would require the 1-year and 5-year Rolling Performance graphs near the end to be positive and to have upward (positive) slopes as well. Positive 1-year and 5-year Rolling Performances show that a fund performed better than the benchmark over the last year and the last five years, respectively. Upward slopes of the Rolling Performance graphs would indicate that fund performance had constantly gained over the benchmark while the slopes were positive and should also signal further excess gains for the fund over the benchmark in the near-term future. Example of a fund likely to outperform SPY An example of a fund that should continue to provide better performance than the benchmark is T. Rowe Price Growth Stock (MUTF: PRGFX ) with an iM-Rating of B(A). Had one invested $1.00 each month starting on the last day of February 1993, one would have contributed a total of $274 including the last contribution at the end of November 2015. The terminal value, that is the sum of all contributions including all gains and losses to November 2015, would have been $893. Had one made the same contributions to SPY, then the terminal value would have been $746. A saver would have had 19.7% more money at the end from investing in PRGFX than from investing in SPY. The upper pair of graphs in the chart which are plotted to a semi-log scale shows the performances over time. (click to enlarge) (click to enlarge) The terminal value rating system is especially useful to determine the likely future performance trend for a fund. The 1-year and 5-year Rolling Performances are shown by the green and purple graphs, respectively, at the bottom of the chart. One can see that since May-2000 for most of the time PRGFX provided better returns over five years for savers than SPY. As of 11/30/2015, the value of the 5-year Rolling Performance is +7.6%, and the 1-year Rolling Performance is +2.8%. This indicates that over the last five years and one year a $1.00 per month investor would have had, respectively, 7.6% and 2.8% more savings from PRGFX than from SPY. Both Rolling Performance values are positive and the slope of the 5-year Rolling Performance graph since Aug. 2014 is also positive, which is a good indication that performance of this fund relative to SPY should be higher also for the near-term future. Example of a fund likely to underperform SPY An example of a fund that will likely continue to underperform the index-fund is the CREF Stock Account (QCSTRX) with an iM-Rating of D(E). This is one of the oldest and largest actively managed stock funds in the U.S. with about $117-billion in assets, representing about 13.5% of total assets under management at TIAA-CREF. Had one invested $1.00 each month starting on the last day of February 1993, one would have contributed a total of $274 including the last payment at the end of November 2015. The terminal value, that is the sum of all contributions including all gains and losses to November 2015, would have been $651. Had one made the same contributions to SPY then the terminal value would have been $746. A saver would have had 14.6% more money at the end from investing in SPY than investing in the CREF Stock Account. The upper pair of graphs in the chart which are plotted to a semi-log scale depicts the performances over time. (click to enlarge) (click to enlarge) The fund versus benchmark 1-year and 5-year Rolling Performances are shown by the green and purple graphs, respectively, at the bottom of the chart. One can see that QCSTRX provided worse 5-year returns for savers than SPY from 1998 to 2002 and then again from 2011 to 2015. The latest value of the 5-year Rolling Performance for QCSTRX is -8.2%, meaning that over the last five years a $1.00 per month investor would have had 8.2% less savings from the CREF Stock Account than from SPY. Similarly, the 1-year Rolling Performance for QCSTRX is -2.2%, meaning that over the last year a $1.00 per month investor would have had 2.2% less savings from the CREF Stock Account than from SPY. Both Rolling Performance values are negative, and at the end the trajectories of both Rolling Performance graphs also point lower. This indicates that this fund is likely to provide lower returns for investors than SPY in the foreseeable future as well. Conclusion Of the many actively managed stock funds we investigated only a few funds have produced better returns than the benchmark SPY, and are likely to continue to outperform SPY. These funds are characterized with 1-year and 5-year ratings better than ‘C’, and would have had positive 5-year Rolling Performance over longer periods. The charts and iM-Ratings for three such large-cap stock funds, JGASX, FDGRX and GTLLX are provided in the Appendix. Appendix Special terms and abbreviations Terminal Value (TV): The sum of all contributions including all gains or losses from a specified starting date to the present or to a specified past date. PRGFX(+1/mo), QCSTRX(+1/mo), SPY(+1/mo): Terminal values from all past consecutive monthly $1.00 contributions made in PRGFX, QCSTRX, and SPY. 1-year Rolling Performance: The percentage difference between the terminal values from the past 12 consecutive rolling monthly $1.00 investments made in a fund and the benchmark, calculated as (TV12 (fund) – TV12 (bench) ) / TV12 (bench). 5-year Rolling Performance: The percentage difference between the terminal values from the past 60 consecutive rolling monthly $1.00 investments made in a fund and the benchmark, calculated as (TV60 (fund) – TV60 (bench) ) / TV60 (bench). iM-Rating Criteria The Rating criteria are based on the most recent past 1-year and 5-year Rolling Performances with the thresholds as listed below. Performance Rating Thresholds Rating Thresholds A above 6% B 2% to 6% C -1% to 2% D -5% to -1% E below -5% Other Funds likely to outperform SPY JPMorgan Growth Advantage Sel (MUTF: JGASX ) with iM-Rating C(A). The funds VHIAX, JGACX, JGVRX, JGVVX are of the same class family and all enjoy the same rating. (click to enlarge) (click to enlarge) Fidelity Growth Company (MUTF: FDGRX ) and FDEBX of the same class, both have an iM-Rating of C(A) (click to enlarge) (click to enlarge) Glenmede Large Cap Growth (MUTF: GTLLX ) with IM-Rating C(A) (click to enlarge) (click to enlarge) No Recession Is Signaled By iM’s Business Cycle Index: Update December 31, 2015

Can Flight To Safety Save These Treasury Bond ETFs?

The bond market behaved in a peculiar manner when it started recording decline in yields across the yield-curve spectrum from December 17, just a day after the Fed hiked key interest rate after almost a decade. Agreed, the Fed move was largely expected and much of the meeting’s outcome was priced in before. Still, this time around, the bonds market did not act wild at all – especially the long-term bonds – as it did in taper-trodden 2013. On December 16 – the day the Fed announced the hike, the two-year benchmark Treasury yield jumped 4 bps to 1.02% – a five-and-a-half year high. The yield on the 10-year Treasury note rose just 2 bps to 2.30% and yield on the long-term 30-year bonds saw a 2-bps nudge to 3.02%. But yields on the benchmark 10-year Treasury bond fell 11 bps to 2.19% in the next two days accompanied by a 12-bps slump in 30-year Treasury bond, 5-bps dip in the two-year benchmark Treasury yield and a 7-bps decline in the ultra-short three-month benchmark Treasury yield. Why the Dip in Bond Yields? Investors must be looking for reasons why the bond market went against the rulebook, which says when interest rates rise, bond yields jump and bond prices fall. Several investors thought that the bull era of bonds will come to an end with the Fed tightening its policies. However, the Fed’s repeated assurance to go ‘gradual’ with the rate hike policies might have soothed bond investors’ nerves. Plus, while a healing job market strengthened the prospect of the next hike again in March 2016, a still-subdued inflationary backdrop led investors to mull over a near-term deflation possibility amid a rising rate environment. Added to this, global growth worries, the possibility of a scarier plunge in greenback-linked oil prices (as the U.S. dollar soars post Fed hike), weakening overall commodity market and possibility of lower U.S. corporate profits in the upcoming quarters might have propelled a flight to safety. Investors should also take note of the Fed funds rate projection. The estimated median funds rate was maintained at 0.4% for 2015 and 1.4% for 2016, while the same for 2017 and 2018 were lowered from 2.6% to 2.4% and 3.4% to 3.3%. The projected range for 2015, 2016 and 2017 was changed from negative 0.1-positive 0.9% to 0.1-0.4%, from negative 0.1-positive 2.9% to 0.9-2.1% and from 1.0-3.9% to 1.9-3.4%, respectively. All these show no material threat to long-term bonds and the related ETFs after the first Fed hike. 25+ Year Zero Coupon U.S. Treasury Index Fund (NYSEARCA: ZROZ ) This ETF follows the BofA Merrill Lynch Long US Treasury Principal STRIPS Index, which focuses on Treasury principal STRIPS that have 25 years or more remaining to final maturity. The product holds 20 securities in its basket. Both the effective maturity and effective duration of the fund is 27.22 years. This fund is often overlooked by investors as evident from an AUM of $158.5 million. The product charges 15 bps in annual fees and returned 2.1% on December 17, 2015. The fund is down 4.2% so far this year. The fund yields 2.70% annually and has a Zacks ETF Rank #2. Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) For a long-term play on the bond market, investors have EDV, a fund that seeks to match the performance of the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. This means that this benchmark zeroes in on fixed income securities that are sold at a discount to face value, and then the investor is paid the face value upon maturity. This particular 74 bond basket has an average maturity of 25.1 years. The effective duration of the ETF stands at 24.7 years, suggesting high interest rate risks. The fund has amassed about $371.1 million in assets. Investors should also note that this is a cheap product, as it charges just 12 basis points a year, so it will be a very low cost way to get into long duration bonds. The fund has lost about 5.4% in the year-to-date time frame on rising rate worries but gained 1.8% on December 17. This Zacks Rank #2 ETF yields 2.86% annually. iShares 20+ Year Treasury Bond (NYSEARCA: TLT ) This iShares product provides exposure to long-term Treasury bonds by tracking the Barclays Capital U.S. 20+ Year Treasury Bond Index. It is one of the most popular and liquid ETFs in the bond space having amassed over $5.7 billion in its asset base and more than 8.4 million shares in average daily volume. Its expense ratio stands at 0.15%. The fund holds 31 securities in its basket. The average maturity comes in at 26.65 years and the effective duration is 17.37 years. The fund gained over 1.1% on December 17. TLT has a Zacks ETF Rank #2 with a High risk outlook. Original Post