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PJP: Will Big Pharma Continue To Outperform In 2016?

Summary This $1.59 Bln ETF has been a steady performer this year. Was December’s shareholder distribution a nice holiday gift? Will a defensive strategy for investors and further healthcare reform benefit investors going forward? We answer these questions and provide our recommendation on this attractive sector fund. The PowerShares Dynamic Pharmaceuticals Portfolio ETF (NYSEARCA: PJP ) is a well established, (June 23, 2005), pure pharmaceutical ETF, with a small but well capitalized portfolio of 23 companies, that are equal weighted. The underlying index, the Dynamix Pharmaceutical Intellidex Index with the symbol {DZR} has 2X holdings. Both the Fund and the Index are rebalanced and reconstituted in February, May, August and November. Many of the most well known firms in the pharmaceutical industry are within this ETF and it has attracted a fair sized institutional following and would be considered a “satellite” holding, as per Morningstar. We decided to analyze this attractive fund to see if the returns it has exhibited in 2015 will continue and how it will perform in a rising rate environment in 2016. As expected, our market capitalization did not have any surprises but is informative. PJP Market Cap Market Capitalization Weight Large cap 63.60% Small cap 24.40% Micro-cap 12.00% This is courtesy of xtf.com. Morningstar, as we previously noted uses a slightly different categorization. They state Giant at 43.95%, Large 20.21%, Medium: 4.45%, Small: 23.77% and Micro: 7.62%. In general it would be considered a large capitalized growth fund. It is interesting that there are no medium sized firms in this ETF, in terms of capitalization. We will explain why shortly after reviewing the industry sectors of the ETF. In terms of the style of the firms in the ETF, this is confirmed in our analysis. PJP Style Style Objective Weight Growth 65.30% Blend 17.60% Pure Growth 8.20% Pure Value 0.00% Value 8.90% These numbers concur with the fund sponsor, PowerShares (Invesco), who uses Large-Cap Growth at 36.15%, Large-Cap Blend at 22.48%, and Small-cap Growth at 32.08%. Only Large-Cap Value and Mid-cap Growth are a distant 4.99% and 4.29%, respectively. Though the fund is based upon U.S. securities, there is a rather small exposure to the euro. PJP Country/Currency Exposure Country Weight Currency Weight United States 96.108% USD 96.108% Ireland 3.892% euro 3.892% This euro weighting applies to well known Ireland based firm, Perrigo Company PLC (NYSE: PRGO ). PRGO was in the news in 2015 when Mylan Labs (NASDAQ: MYL ) failed in an attempted takeover of Perrigo. This exposure, even with a large move in the dollar-euro, should be negligible to this ETF in 2016. Our sector weight is obviously 100% Healthcare, but the industry weightings within the sector is informative. PJP Industry exposure Industry Weight Pharmaceuticals 61.75% Biotechnology 30.27% Medical Equipment/Health Care Equipment & Supplies 7.98% Our industry weighting here sheds light on the nature of the market cap and style of the firms in the ETF. The majority of the Biotech firms would fit into the Small-Cap Growth market cap. Once a firm reaches scale within Biotech either through product developed or approval on a new drug or medical device, it is either acquired or “rolled-up” into another biotech or pharmaceutical firm. As such, there is little room both in the ETF and in the marketplace for a Mid-cap Biotech firm. As noted, with over 30% of the ETF in Biotech and with a long business cycle it is safe to assume that develops will continue in the sector, regardless of the economy in 2016. Using this ETF as a defensive position in 2016 is quite appropriate. This was our similar interpretation when we recently analyzed the First Trust NYSE Arca Biotechnology Index ETF (NYSEARCA: FBT ) . In order to determine the overall risks and rewards, we decided to analyze the entire portfolio. Due to its small size it was not overwhelming, but simply whelming. We analyzed all 23 components, their symbols, ratings, (Moody’s and S&P), if any, and their weight within the ETF and the underlying index {DZR}. In this fund’s case we will also show their individual year to date and 12 month performance. PJP Portfolio Name/Symbol 12 month return Ratings, (Moody’s/S&P) Weight- PJP Weight- Index, {DZR} Eli Lilly & Co. (NYSE: LLY ) 21.96% A2/AA- 5.108% 5.00% Bristol-Myers Squibb Co. (NYSE: BMY ) 15.76% A2/A+ 5.060% 5.00% Johnson & Johnson (NYSE: JNJ ) -1.28% Aaa/AAA 5.043% 5.00% Amgen Inc (NASDAQ: AMGN ) 0.06% Baa1/A 4.978% 5.00% Pfizer Inc. (NYSE: PFE ) 3.06% A1/AA 4.952% 5.00% Merck & Co Inc (NYSE: MRK ) -8.53% A1/AA 4.875% 5.00% Allergan plc (NYSE: AGN ) 21.06% Baa1/BBB- 4.845% 5.00% Gilead Sciences Inc. (NASDAQ: GILD ) 10.44% A3/A- 4.774% 5.00% Akorn Inc. (NASDAQ: AKRX ) 1.17% B1/B 4.446% 4.00% Lannett Co. Inc. (NYSE: LCI ) -3.47% B2/B+ 4.379% 4.00% Novavax Inc. (NASDAQ: NVAX ) 43.24% NR/NR 4.326% 4.00% Celgene Inc. (NASDAQ: CELG ) 7.75% Baa2/BBB+ 4.316% 4.00% Mylan NV -4.83% Baa3/BBB- 4.219% 4.00% Biogen Inc. (NASDAQ: BIIB ) -11.71% Baa1/A- 4.105% 4.00% Ligand Pharmaceuticals LGND 104.61% NR/NR 4.072% 4.00% Baxter International Inc. (NYSE: BAX ) -5.80% Baa2/A- 4.032% 4.00% Abbott Laboratories (NYSE: ABT ) -1.64% A2/A+ 3.954% 4.00% Depomed Inc (NASDAQ: DEPO ) 20.08% NR/NR 3.922% 4.00% Perrigo Co. PLC. -11.10% Baa3/BBB 3.904% 4.00% Impax Laboratories Inc. (NASDAQ: IPXL ) 35.76% B1/BB 3.880% 4.00% Prestige Brands Holdings Inc. (NYSE: PBH ) 43.56% B2/B+ 3.710% 4.00% Heron Therapeutics Inc. ( OTC:HRTX ) 183.38% NR/NR 3.695% 4.00% Medicines Co/The (NASDAQ: MDCO ) 33.17% NR/NR 3.403% 4.00% As per the fund’s prospectus, the fund invests in proportion to the weightings of the index. These weightings shift often due to changes in share value over time. Our top 10 holdings represent 48.46%, while the bottom 13 represent 51.538%. The index is fairly evenly fixed at either 5.00% or 4.00% weights. The performance of the individual holdings are of course slightly muted due to no position having an overweight influence. Fortunately, the outsized performance of Heron Therapeutics at 183.38% for the year easily eclipses any loss from Biogen at -11.71% or Perrigo at -11.10%. A few of the companies in the fund have been mentioned as takeover targets after the failed acquisition of Perrrigo by Mylan, MYL. One company mentioned in Bloomberg is Impax Laboratories. It will be interesting to see how the Pharmaceutical and Biotech landscape changes in 2016 as continued talk on healthcare and pharmaceutical price reform influence the sector. One thing we are fairly certain of is that the sector will not be quiet no matter how robust or sluggish the U.S. or global economy is. As noted above we also did a credit rating analysis on the portfolio. The breakdown is informative. PJP Underlying Credit Ratings S&P Weight Moody’s Weight Upper Investment Grade 33.766% Upper Investment Grade 41.853% Aaa 5.043% AAA 5.043% A1 9.827% AA 9.827% A2 14.122% A+ 9.014% A3 4.774% A/A- 4.978%/12.991% Lower Investment Grade 30.399% Lower Investment Grade 13.380% Baa1 13.928% BBB+ 4.316% Baa2 8.348% BBB- 9.064% Baa3 8.123% Non Investment Grade 16.415% Non Investment Grade 16.415% BB 3.880% B1 8.326% B+ 8.089% B2 8.089% B 4.446% Nonrated 19.418% Nonrated 19.418% While it is noteworthy that the some of the highest rated, (in terms of debt) securities such as JNJ (-1.28% 12 month performance) didn’t break even, it is not surprising. The companies in this ETF that have taken the greatest risks and have some of the poorest balance sheets and lowest credit ratings, produced outstanding results. With a combined 35.833% of the ETF’s underlying credits in non-investment grade and non-rated securities we expect the outsized returns to continue in the NR or lower rated securities. Fortunately, due to the opportunities and continued growth in the marketplace, established companies such as Eli Lilly still outperform (+21.96% 12 month) the general market and are highly likely to do so in 2016. Regardless of the underlying credit ratings, the performance of the holdings should be quite impressive for shareholders in 2016. Based upon the components and structure we analyzed the overall performance of the ETF and the index. PJP’s Performance, Fees and Recommendation Category PJP {ETF} DZR {Index} Net Expense Ratio .56% NA Turnover Ratio 47.00% NA YTD Return 10.68% 11.19% 1-Year Total Return 9.58% 9.97% Dividend Yield/SEC Yield 3.85%/0.56% NA Beta (Shares vs. Morningstar U.S. Healthcare Tr)/holdings 1.18, (11/30/15)/ .90 NA P/E Ratio FY1/current 22.42/20.04 NA Price/Book Ratio FY1/current 4.42/3.82 NA Our net expense ratio of 0.56% compares favorably against an asset median of 0.51%. Our turnover ratio of 47% is much higher than the asset class median of 18.00%. It basically reflects the quick discarding of poor performers and acquisitions. The divided yield was 3.85% for the year and reflects quarterly income with the majority, ($2.47021 per share) paid in December. The annual short term gains paid this year on December 31 are $1.13178 per share. This is a large reduction from 2014’s total of $1.65068, which included $0.34712 in long term gains along with $1.30356 in short term gains. Overall we are quick satisfied with the 2015 distribution but do realize there are tax implications from some share holders who reinvest their gains. Taking into consideration the market year to date return and the total distributions we calculated a total return of approximately 14.28% for the year. The constant discussion of healthcare reform and price gouging actions, (whether morally or commercially justified) will continue in 2016. In any event, we expect the underlying large and growing components to continue significant growth into 2016. We do expect some of the names in this ETF to be acquired over the next year and new products that are in the pipeline to be approved. In addition, institutions only own 19.32% of this fund, according to Fidelity. While we would expect more participation from institutions, we feel that the majority of shareholders here will be quite patient with this ETF as a “satellite” holding and not sell on a whim. As it is an election year, and there has already been significant pontificating on pharmaceutical prices and the general nature of the pharmaceutical business, we do not expect volatility in the sector to subside. One positive for this sector is whether the economy contracts in the U.S. or globally, this sector will maintain its defensive status going forward. We recommend a strong buy of this attractive sector fund into 2016 and beyond.

Consolidated Edison – An Unsettling Look At Shareholder Yield

In a prior commentary I looked at the “shareholder yield,” that is dividends and share repurchases, for Coca-Cola and Exxon Mobil. In both instances the shareholder yield was greater than the dividend yield. Alternatively, a company like Consolidated Edison has a shareholder yield that has been routinely lower than its dividend yield. In a previous article I compared the “shareholder yield” of both Coca-Cola (NYSE: KO ) and Exxon Mobil (NYSE: XOM ). The idea was to take it a step further than simply looking at dividend yield, and instead focus on funds used for both dividends and share repurchases. As a part owner, share repurchases are commonplace. Yet if you owned the entire business, there would be no need to repurchase shares and thus these funds could be diverted elsewhere. For Coca-Cola and Exxon Mobil, this meant that the “shareholder yield” – dividends plus buybacks – was reasonably higher than the ordinary dividend yield that you commonly see quoted. Exxon Mobil turned out to have a higher shareholder yield than Coca-Cola (it’s share repurchase program has more room and a lower valuation of purchased shares) but the takeaway was that both companies had the ability to send away more cash without impairing the business. Which brings us to a company like Consolidated Edison (NYSE: ED ). Unlike Coca-Cola or Exxon Mobil or any number of well-known dividend paying companies, Consolidated Edison’s share count has been increasing over the years rather than decreasing. Thus conversely the shareholder yield tends to be lower than the quoted dividend yield. Let’s look at the past decade to see what I mean: Year Divs Sh Re Shares Total / Sh Price Sh Yield 2005 $518 -$78 245 $1.79 $46.33 3.9% 2006 $533 -$510 257 $0.09 $48.07 0.2% 2007 $582 -$685 272 -$0.38 $48.85 -0.8% 2008 $618 -$51 274 $2.07 $38.93 5.3% 2009 $612 -$257 281 $1.26 $45.43 2.8% 2010 $640 -$439 292 $0.69 $49.57 1.4% 2011 $704 -$31 293 $2.30 $62.03 3.7% 2012 $712 $0 293 $2.43 $55.54 4.4% 2013 $721 $0 293 $2.46 $55.28 4.5% 2014 $739 $0 293 $2.52 $66.01 3.8% The first three numerical columns are in millions, while the next two represent a per share basis. On the dividend front we can see that Consolidated Edison has been paying more and more total dividends, as to be expected from a company with a long history of regularly increasing its payout . What’s not readily obvious until you take a closer look is that the company had been issuing a good amount shares during the 2005 through 2011 period. This makes sense when think about it – the business is inherently capital intensive – but it might not be something that you would instantly notice. As such, the share count has been increasing. The company had 245 million shares outstanding in 2005, which has now become 293 million. This makes a difference when you’re thinking like an owner rather than a small shareholder. Here’s a comparison of the shareholder yield and the dividend yield over the years: Year Div Yield Sh Yield Difference 2005 4.6% 3.9% 0.7% 2006 4.3% 0.2% 4.1% 2007 4.4% -0.8% 5.2% 2008 5.8% 5.3% 0.5% 2009 4.8% 2.8% 2.0% 2010 4.4% 1.4% 3.0% 2011 3.9% 3.7% 0.2% 2012 4.4% 4.4% 0.0% 2013 4.5% 4.5% 0.0% 2014 3.8% 3.8% 0.0% The first number is what you’re accustomed to seeing quoted on any financial website – a dividend yield in the 3.5% to 5% range. The next column – shareholder yield – illustrates what magnitude of cash is actually being returned to shareholders. Consolidated Edison was indeed paying the full dividend, but it was also receiving cash back from shareholders to increase the share count. If you owned Coca-Cola or Exxon Mobil or any number of other firms in their entirety, the amount of cash that would be available to you would likely be greater than the current dividend yield. When a company both pays a dividend and buys back shares, the shareholder yield is greater than the dividend yield. With Consolidated Edison you have the opposite effect take place. The amount of cash that can be extracted from utility-like business models (without impairment) is lessened when you think about owning the entire thing. Issuing shares is common practice in the utility world (and other worlds for that matter) but it likely wouldn’t be occurring if there was just one owner. (You wouldn’t buy more shares yourself, or you could, but that would simply be inputting more capital). Thus you have a couple other options: issue more debt or reduce the dividend payment. The second option is what is being illustrated in a “shareholder yield” way, but the first one is much more common. Incidentally, whether you own all of it or not, this is exactly what we have seen with Consolidated Edison in the past decade. Notice the difference in the 2005 through 2011 period and the 2012 through 2014 timeframe. In the first period you had an increasing dividend to go along with a good deal of shares being issued. In 2007 shareholders received $582 million in dividend payments, but gave back $685 million to add to the share count. You can call the dividend payment yield, but in the aggregate the company was actually a net beneficiary of cash received. The amount of funds available had been quite a bit lower than what the dividend yield alone would indicate. Notably, Consolidated Edison did not issue shares in 2012, 2013 or 2014. Which means that the shareholder yield was equal to the dividend yield in those periods. Yet there was still impairment during this time. The company had net debt issuances of $1.1 billion, $1.4 billion and $1.1 billion during those years. Instead of issuing shares, debt was used – much like what might be required if you owned the business in its entirety. The shareholder yield gives a reasonable gauge as to the type of cash flow that could be extracted from the business, but naturally it’s just a first step in the process. In this instance, it shows that while the dividend has been above average and increasing, the amount of cash than can be taken out of the business without impairment has been consistently lower than this yield. Warren Buffett had a particularly revealing commentary related to this concept (and incidentally Consolidated Edison itself) back in the 1970’s: “In recent years the electric-utility industry has had little or no dividend-paying capacity. Or, rather, it has had the power to pay dividends if investors agree to buy stock from them. In 1975 electric utilities paid common dividends of $3.3 billion and asked investors to return $3.4 billion. Of course, they mixed in a little solicit-Peter-to-pay-Paul technique so as not to acquire a Con Ed reputation. Con Ed, you will remember, was unwise enough in 1974 to simply tell its shareholders it didn’t have the money to pay the dividend. Candor was rewarded with calamity in the marketplace.” “The more sophisticated utility maintains – perhaps increases – the quarterly dividend and then ask shareholders (either old or new) to mail back the money. In other words, the company issues new stock. This procedure diverts massive amounts of capital to the tax collector and substantial sums to underwriters. Everyone, however, seems to remain in good spirits (particularly the underwriters).” Naturally today you can make a bevy of arguments (rock bottom interest rates, for one) that did not qualify back then. However, the concept is similar: the amount of money that can be taken out from owning the entire business is apt to be lower, not higher, than the stated dividend yield. Ideally you’d like to think in “owner’s earnings” terms, but the shareholder yield provides a short cut to get you started. Whereas a company that regularly repurchases shares has a bit of wiggle room (those repurchase funds could be diverted toward sustaining the dividend in dire times) a company issuing shares has the opposite effect occurring. A company that regularly issues shares has “negative” wiggle room. Now I’m not suggesting that Consolidated Edison is a poor business or that it’s bound for doom – far from it. Utilities tend to exist out of necessity and have been churning out cash for decades. However, looking at shareholder yield (and ultimately owner earnings) is a bit of a different way to think about it. If you owned all of Exxon Mobil you could pay yourself a 5% or 8% dividend in regular times and not put an added burden on the business. That is, the quoted dividend yield understates the amount of cash that could be extracted without impairing the company. With Consolidated Edison, this likely isn’t the case. If you owned all of Consolidated Edison, you’d be more likely to see a lower not higher percentage of cash being paid out. No longer would you be issuing shares and thus the focus would turn to added debt or a reduced payout. The debt could go on indefinitely, but the capital necessities are such that the current dividend payment coexists with other pressing requirements. When they say that you’re “buying it for the dividend” this could be even more applicable than it first appears.

CEFL: A Year In Review, And A Prediction Of What’s Ahead

Summary 2015 has not been a good year for CEFL unitholders: income declined by 20% while price declined by 33%. This article presents a review of CEFL happenings in 2015, and a forecast of what’s ahead for 2016. Based on the publicly available index methodology, the CEFs to be added or removed are predicted. Introduction The ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ) is a 2x leveraged exchange-traded note [ETN] that tracks twice the monthly performance of the ISE High Income Index [symbol YLDA]. The YieldShares High Income ETF (NYSEARCA: YYY ) tracks the same index, but is unleveraged. CEFL is a popular investment vehicle among retail investors due to its high income (24.52% trailing twelve months yield), which is paid monthly. With 2015 nearly behind us, I thought I would review the characteristics of this year’s iteration of CEFL, and also look ahead at what might be in store for us in 2016. (Source: Main Street Investor ) 2015 portfolio YLDA holds 30 closed-end funds [CEFs], and is rebalanced annually. As I have previously discussed in my three-part “X-raying CEFL” series, this year’s iteration of CEFL (and thus also YYY) had the following characteristics: CEFL is comprised of approximately one-third equity and two-thirds debt, is effectively leveraged by 240% and has a total expense ratio of 4.92% per dollar invested in the fund (or 2.05% per dollar of assets controlled) (discussed in ” X-Raying CEFL: Leverage And Expense Ratio Statistics “). CEFL contained around two-thirds of North American (primarily U.S.) assets, with the rest being international. Moreover, the North American component of CEFL contains a higher allocation to debt vs. equity than the European component of CEFL (discussed in ” X-Raying CEFL (Part 2): Geographical Distribution “). CEFL is not very interest-rate sensitive as most of the holdings of CEFL are most-correlated with high-yield debt (discussed in ” X-Raying CEFL (Part 3): Interest Rate Sensitivity “). Actually, I might have been inaccurate in my last prediction. Over the last year, the price action of CEFL has actually moved in the same direction to interest rates, which is exactly opposite to what would be expected for a traditional bond fund. But this is not entirely surprising for CEFL, because high-yield debt usually tend to trade in tandem with equities and in the opposite direction to treasuries. Indeed, CEFL had a positive +0.71 correlation with U.S. equities (via SPDR S&P 500 ETF (NYSEARCA: SPY ) over the past year, but a negative -0.24 correlation with treasuries (via the iShares 20+ Year Treasury Bond ETF) (NYSEARCA: TLT ) (source: InvestSpy ). Thus, readers who worried that higher interest rates would lower the price of CEFL may actually have been pleasantly surprised that the opposite has held true this year. Decreasing yield Seeking Alpha author Professor Lance Brofman has done a wonderful job predicting the upcoming distributions for CEFL (see his latest article here ), while also providing expert commentary in his area of expertise. The distribution history for CEFL, which now has paid out 24 months of dividends, is presented below. Unfortunately, we see that the distributions paid out by CEFL have been in decline. In 2014, each share of CEFL paid out $4.74 of distributions, but in 2015, each share of CEFL only paid out $3.82 of distributions. This means that the distribution of CEFL has declined by 19.5% year on year. I believe that a large reason for the distribution decline can be attributed to the rebalancing debacle that occurred at the turn of this year (see below). CEFL has a current trailing twelve months yield of 24.52%. Rebalancing debacle The annual rebalancing in the index YLDA was disastrous for CEFL and YYY holders. The reasons for this have been summarized in my recent article ” Are You Ready For CEFL’s Year-End Rebalancing ?” In short, up to 10% of the net asset value of CEFL may have been lost due to traders (including, perhaps, UBS themselves) buying and selling the CEFs to be added or removed from the index ahead of the actual rebalancing date (a form of “front-running,” see this Bloomberg article for more information on this phenomenon). For further study on the rebalancing issue, consult my previous articles on this issue in the below links: Predicting the 2016 portfolio How might the portfolio of CEFL change upon the next rebalancing event, which is scheduled to occur in the next few days? As discussed in my most recent CEFL article, the index provider has decided that upcoming index will not be announced 5 days in advance. This was intended to prevent “front-running” of the index. However, with the index methodology published and available to all, I had little doubt that professional investors would be able to use the selection rules to determine which stocks would be added or removed from the index. Therefore, in an attempt to level the playing field for everyone else, I have tried to approximate the index methodology in order to predict CEFL’s portfolio for 2016. The selection methodology for the index is reproduced below (source: ISE ). 1. Restrict selection universe to closed-end funds with market cap > $500M and six month daily average volume > $1M. 2. Rank each fund by the following three criteria: i. Fund yield (descending) ii. Fund share price Premium / Discount to Net Asset Value (ascending) iii. Fund Average Daily Value (ADV) of shares traded (descending) 3. Calculate an overall rank for each fund by taking the weighted average of the three ranks with the following weightings: yield: 50%, premium/discount: 25%, average daily value: 25%. 4. Select the 30 funds with the highest overall rank. Using CEFAnalyzer , I obtained a list of the 141 CEFs with market cap > $500M. Unfortunately, I was unable to apply a volume filter because I was not sure what specific time period CEFAnalyzer reports volume data for. I then replicated the index methodology for the 141 CEFs on this list. The below table shows the top 30 CEFs for either distribution yield or discount among the CEFs with market cap > $500M. Rank Ticker Yield Rank Ticker Discount 1 GGN 17.14% 1 BCX -16.92% 2 PHK 14.58% 2 AOD -16.88% 3 KYN 14.44% 3 AWP -16.29% 4 NHF 14.23% 4 IGR -16.19% 5 HIX 13.06% 5 FAX -16.09% 6 TDF 13.03% 6 RNP -15.64% 7 IGD 12.67% 7 GLO -15.33% 8 RVT 12.40% 8 RVT -15.07% 9 CEM 11.73% 9 NFJ -15.04% 10 PTY 11.69% 10 DPG -15.04% 11 GLO 11.37% 11 UTF -14.93% 12 GAB 11.21% 12 ADX -14.92% 13 EXG 11.17% 13 TY -14.81% 14 BCX 11.12% 14 WIW -14.79% 15 CHI 11.11% 15 TDF -14.63% 16 ETJ 11.05% 16 NXJ -14.58% 17 EAD 10.94% 17 NHF -14.57% 18 DSL 10.89% 18 NIE -13.63% 19 CHY 10.89% 19 NQP -13.40% 20 PFN 10.75% 20 USA -13.32% 21 PCI 10.74% 21 FSD -13.31% 22 FEI 10.44% 22 BIT -13.04% 23 ETW 10.36% 23 GDV -12.81% 24 AWP 10.24% 24 JQC -12.70% 25 NTG 9.95% 25 CAF -12.50% 26 PCN 9.86% 26 IGD -12.41% 27 CSQ 9.81% 27 VTA -12.33% 28 PDI 9.62% 28 RQI -12.27% 29 NFJ 9.62% 29 BDJ -12.10% 30 EVV 9.59% 30 NQU -12.04% The yield ranking was then weighted by 50% while the discount ranking was weighted by 25% (the rankings are assigned to all 141 CEFs, and not only to the top 30). The ranking for volume is not shown above because I was not sure about the time period used by CEFAnalyzer to calculate volume, as alluded to earlier. However, because I did not have time to manually calculate the ADV for 141 CEFs, the CEFAnalyzer data was still used to obtain a volume ranking for the funds, which was weighted by 25%. The weighted rankings were then summed, and the top 30 CEFs with the highest overall ranking are shown below, along with their composite individual ranks. A quick check on Yahoo Finance indicated that the 3-month ADV of these 30 CEFs was above the $1M cut-off (which is actually for the 6-month ADV, but I did not calculate this). Rank Ticker Yield Discount Volume Overall 1 (NYSE: RVT ) 8 8 18 10.50 2 (NYSE: BCX ) 14 1 25 13.50 3 (NYSEMKT: GGN ) 1 42 16 15.00 4 (NYSEMKT: GLO ) 11 7 39 17.00 5 (NYSE: NFJ ) 29 9 15 20.50 6 (NYSE: IGD ) 7 26 48 22.00 7 (NYSE: EXG ) 13 50 13 22.25 8 (NYSE: PCI ) 21 39 11 23.00 9 (NYSE: HIX ) 5 79 12 25.25 10 (NYSEMKT: EVV ) 30 35 17 28.00 11 (NYSE: DPG ) 33 10 38 28.50 12 (NYSE: AOD ) 44 2 24 28.50 13 (NYSE: NHF ) 4 17 96 30.25 14 (NYSE: DSL ) 18 77 8 30.25 15 (NYSE: CEM ) 9 100 5 30.75 16 (NASDAQ: CSQ ) 27 52 19 31.25 17 (NYSE: KYN ) 3 119 2 31.75 18 (NASDAQ: CHI ) 15 96 1 31.75 19 (NYSE: TDF ) 6 15 104 32.75 20 (NYSE: AWP ) 24 3 83 33.50 21 (NYSE: USA ) 31 20 58 35.00 22 (NYSE: BGB ) 36 46 26 36.00 23 (NYSE: NTG ) 25 88 6 36.00 24 (NYSE: FEI ) 22 97 7 37.00 25 (NYSE: BIT ) 47 22 32 37.00 26 (NYSE: UTF ) 54 11 29 37.00 27 (NYSE: BOE ) 40 41 30 37.75 28 (NYSE: GHY ) 39 47 27 38.00 29 (NYSE: ETJ ) 16 56 71 39.75 30 (NYSEMKT: FAX ) 41 5 72 39.75 At this point, I would like to compare notes with reader waldschm85 : I’ve attempted to follow the index methodology and came up with the below holdings from largest to smallest as of the open. How does this compare to your list Stanford Chemist?: BCX, TDF, GGN, RVT, KYN, PCI, NFJ, NTG, IGD, NHF, EXG, CSQ, GLO, DPG, CEM, , FEI, CHY, DSL, CHI, USA, HIX, PHK, GAB, TYG, EAD, ETJ, PTY, ETW, PFN, PCN Comparison of our two lists show that we have 20 out of 30 CEFs in common, which is quite high considering that [i] we did our analyses every days apart and [ii] I used an unspecified volume figure for ADV ranking while waldschm85 may have used a more accurate method. While the weighting methodology is too complex to be reproduced here, it can be noted that last year’s rebalance produced the CEF distribution shown below. The methodology states that no CEF can comprise more than 4.25% of the index. Additionally, the top 15 largest CEFs after last year’s rebalance all had weights of above 4%. I expect the weighting distribution of the 30 CEFs after this year’s rebalance to be quite similar to the last. Additions and deletions (predicted) Here we get to the interesting part! Which funds are completely new, and which will be completely removed? Which CEFs are in both 2015 and 2016 (predicted) portfolios? The following will be performed with my list of top 30 CEFs – obviously results will differ using waldschm85’s list or that of another person’s. CEFs are presented in alphabetical order. Added CEFs: BCX, BOE, CEM, CHI, CSQ, DPG, ETJ, FEI, IGD, KYN, NFJ, NHF, NTG, PCI, RVT, TDF, USA, UTF Removed CEFs: BGY, CHW, EAD, EDD, ERC, ESD, ETY, FPF, HYT, IGD, ISD, JPC, MRC, MMT, NCV, NCZ, PCI CEFs that remain from last year: AOD, AWP, BGB, BIT, DSL, EVV, EXG, FAX, GGN, GHY, GLO, HIX. The information above shows that 18 CEFs will be added to the index and 18 will be removed. 12 CEFs will remain in the index. This is a relatively high turnover but it is not unexpected given the fact that both the distributions and premium/discount values of CEFs can vary wildly. Moreover, given that I did not calculate weightings for the 2016 portfolio, I was unable to predict which CEFs will undergo the highest increases or decreases in allocation. However, it should be stressed that the above lists are only approximate. This is because I only performed a crude replication of the index methodology (specifically, I did not use the six-month ADV for either screening or ranking), and also because of the fact that the actual selection and ranking algorithm will be performed on CEF data at year-end rather than from today. Therefore, I am hesitant to recommend the buying of the CEFs to be added and the selling of CEFs to be removed as a potential strategy to profit from the upcoming rebalance. Use the information above at your own risk. Summary 2015 has not been a good year for CEFL unitholders. First, the botched rebalancing mechanism cause permanent loss of value in the index. Second, CEFL holders received 19.5% less income in 2015 compared to last year (this may be related to the first point). Third, CEFL shifted from a 60:40 equity:bond split in 2014 to a 33:67 equity:bond split this year, just in time for the oil-induced credit contagion to wreck havoc with the high-yield debt CEFs in the index. Certainly, a -32.7% YTD price return and -18.4% YTD total return cannot be described as anything other than disappointing for CEFL unitholders. CEFL data by YCharts Will 2016 bring brighter skies for CEFL? This I cannot say for certain. However, it is interesting to note that the predicted portfolio for 2016 contains several MLP CEFs, namely KYN, CEM, NTG, and FEI, whereas this year’s index contained none. Moreover, a myriad of high-yield bond funds will remain or are newly added to the predicted 2016 portfolio. Thus, it remains likely that the fate of CEFL will remain closely tied with the fortunes of the high-yield credit market for the foreseeable future.