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CEF Portfolio Generates 9% Income With Reasonable Risk

Summary The CEF portfolio had an average distribution of 9.4% coupled with lower risk than the S&P 500. The CEF portfolio is diversified among many types of funds including bonds, preferred stocks, equities, and covered calls. Most of the selected CEFs are selling at historically large discounts. As an income focused investor, I’m a fan of Closed End Funds (CEFs), and have written many articles on Seeking Alpha discussing their risks and rewards. Many CEFs have recently taken it on the chin because of fear that the Fed may begin raising rates. To my mind, this has created CEF bargains among many asset classes. This article constructs a diversified portfolio of CEFs that are selling at large discounts and also have reasonable risk-versus-reward profiles. Below is a summary of the CEFs I have selected. I apologize in advance if I did not include your favorite CEF and I welcome alternative suggestions from readers. The data is based on the 2 October market close. BlackRock Corporate High Yield Fund (NYSE: HYT ). This is one of the largest high yield CEFs with a market cap of $1.3 billion. Over the past 5 years, this CEF has sold for a both discounts and premiums. Premiums were relatively rare and reached a high of 6% in 2012. The fund typically sells at a discount, averaging about 5% over the past 5 years but increasing to a 12% average during the past year. The current discount is 15.2%. The portfolio is a combination of high yield bonds (87%) and equities (7%). The fund utilizes 31% leverage and has an expense ratio of 1.3%. The distribution is 8.7%, funded by income with a small amount of Return of Capital (ROC). The ROC is typically only about 1% of the total distribution. Brookfield Total Return Fund (NYSE: HTR ). This fund focuses on mortgage backed securities (MBS). Over the past 5 years this CEF has sold primarily at a discount. The 5 year average discount was 5% but the discount has grown to a 9% average over the past year. The current discount is 16.5%. The portfolio consists mostly of MBS and asset backed securities with the majority coming from the commercial and residential non-agency sectors. About 40% of the bonds are investment grade. The fund utilizes 28% leverage and has an expense ratio of 1.3%. The distribution is 10.9%, funded by income with no ROC. Nuveen Credit Strategic Income Fund (NYSE: JQC ). JQC has a market cap of about $1.1 billion and is the largest CEF focused on floating rate loans. Over the past 5 years, this CEF has sold mostly at a discount. The only time this fund sold at a premium was a short period in 2013. The five year average discount is 8% and the one year average is 12%. The current discount is 15.2%. The portfolio consists of a combination of floating rate loans (68%) and corporate bonds (19%). Less than 10% of the holdings are investment grade. The fund utilizes 38% leverage and has an expense ratio of 1.8%. The distribution is 7.6%, funded by income with no ROC. AGIC Convertible and Income Fund II (NYSE: NCV ). This fund focuses on convertible securities. Over the past 5 years, this CEF has sold mostly at a premium, sometimes as high as 15%. It was not until the second half of 2015 that the fund, began selling at a discount. The five year average was a premium of 7% and the 1 year average was a premium of 5%. The current discount is 14.4%. The portfolio consists of a combination of convertible bonds (58%) and high yield bonds (41%). Less than 10% of the holdings are investment grade. The fund utilizes 33% leverage and has an expense ratio of 1.2%. The distribution was recently reduced but is still 13.3%. The distribution is funded by income with no ROC. Nuveen Preferred Income Opportunities Fund (NYSE: JPC ). This fund focused on preferred shares. Over the past 5 years this CEF has sold only for a discount. The smallest discount was about 1% in 2012. The 5 year average discount is 9% and the 1 year average discount increased to over 10%. The current discount is 11%. The portfolio consists primarily of preferred stock (88%) with a small amount of equities (6%). The fund utilizes 29% leverage and has an expense ratio of 1.7%. The distribution is 9%, funded by income with no ROC. Cohen Steers Quality Income Realty Fund (NYSE: RQI ). This fund is focused on REITs. Over the past 5 years this CEF has sold only at a discount. The discount has oscillated between less than 1% to over 14%. The 5 year average has been a discount of 8% but the 1 year average has increased to a discount of 12%. The current discount is 12.5%. The portfolio consists of a combination of REITs (80%) and preferred stock (19%). The fund utilizes 25% leverage and has an expense ratio of 1.9%. The distribution is 8.6%, funded by income with no ROC. Eaton Vance Enhanced Equity Income Fund II (NYSE: EOS ). This is a covered call fund. Over the past 5 years this CEF has sold for a both a discount and a premium, but mostly at a discount. The premium was as high as 5% in 2010. The premium turned into a discount in 2011 and has stayed at a discount ever since. The discount sunk to 15% in 2011 but has been improving in recent years. The 5 year average has been a discount of about 8% and the 1 year average is only 5%. The current discount is 8.5%. The portfolio consists equities that are used for call writing on about 50% of the portfolio. The fund managers have a flexible mandate and can invest in all size companies but most are medium to large cap. The fund does not use leverage and has an expense ratio of 1.1%. The distribution is 8.4%. The fund has a small amount of ROC but this is not unusual for covered call funds. Cohen & Steers Infrastructure Fund (NYSE: UTF ). This fund focuses on utilities. Over the past 5 years this CEF has always sold at a discount. The discount has grown larger in 2015. The 5 year average has been a discount of about 11% and the 1 year average is 13%. The current discount is 16.8%. The portfolio consists of investments in utility and infrastructure companies. The portfolio contains 80% equities, 10% bonds, and 5% preferred shares. About 60% of the holdings are domiciled in the US. The fund utilizes 29% leverage and has an expense ratio of 2%. The distribution is 8.5% funded by income and capital gains with no ROC. The characteristics of an equally weighted portfolio of these CEFs are summarized in Figure 1. The portfolio has an average distribution of 9.4%, which definitely achieves the objective of high income. The average discount is also large at 14%. (click to enlarge) Figure 1: Portfolio averages Even more important than the value of the discount is how it relates to the average discounts over the past year. This is measured by a metric called the Z-score, which is a statistic popularized by Morningstar to measure how far a discount (or premium) is from the mean discount (or premium). The Z-score is computed in terms of standard deviations from the mean so it can be used to rank CEFs. A good source for Z-scores is the CEFAnalyzer website. A Z-score more negative than minus 2 is relatively rare, occurring less than 2.25% of the time. With the exception of JPC and RQI, the selected CEFs are selling at historically large discounts as evidenced by the large negative Z-score. Both JPC and RQI have large discounts but the discounts are close to the average discount for the year. Figure 2 shows the allocation among asset classes as: bonds (50%), preferred stocks (16%), and equities (33%). Most of the equity portion is hedged by using covered calls. Thus, overall this is a defensive portfolio, which I believe is prudent given the current uncertainties in the market. (click to enlarge) Figure 2: Allocations among asset classes The portfolio looks promising in terms of income but total return and risk are also important so I plotted the annualized rate of return in excess of the risk free rate (called Excess Mu in the charts) versus the volatility for each of the component funds. The risk free rate was set at 0% so that performance could be easily assessed. I equated volatility with risk and used a 5 year look-back period from October 2, 2010 to October 2, 2015. The plot is shown in Figure 3. (click to enlarge) Figure 3. Risk versus reward for past 5 years. In the figure, the risk-versus-reward for each CEF is represented by a green diamond. The performance of the composite portfolio is shown by the blue dot. I also included the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) ETF as a comparison with the overall market. As is evident from the figure, the CEFs had a wide range of returns and volatilities. Were the returns commensurate with the increased risk? To answer this question, I calculated the Sharpe Ratio. The Sharpe Ratio is a metric, developed by Nobel laureate William Sharpe that measures risk-adjusted performance. It is calculated as the ratio of the excess return over the volatility. This reward-to-risk ratio is a good way to compare peers to assess if higher returns are due to superior investment performance or from taking additional risk. In Figure 3, I plotted a red line that represents the Sharpe Ratio associated with the composite portfolio. If an asset is above the line, it has a higher Sharpe Ratio than composite portfolio. Conversely, if an asset is below the line, the reward-to-risk is worse than the portfolio. You may be surprised that the volatility of the portfolio is smaller than the volatilities of the components. This is an illustration of an amazing discovery made by an economist named Markowitz in 1950. He found that if you combined certain types of risky assets, you could construct a portfolio that had less risk than the components. His work was so revolutionary that he was awarded the Nobel Prize. The key to constructing such a portfolio was to select components that were not highly correlated with one another. In other words, the more diversified the portfolio, the more potential volatility reduction you can receive. To be “diversified,” you want to choose assets such that when some assets are down, others are up. In mathematical terms, you want to select assets that are uncorrelated (or at least not highly correlated) with each other. I calculated the pair-wise correlations associated with the funds. The data is presented in Figure 4. All the CEFs had relatively low correlations with SPY and each other. The only large correlation is the covered call CEF with the S&P 500. This is not surprising since large and medium cap companies were used for writing covered calls. Overall, these results were consistent with a well-diversified portfolio and hence, the reduction in portfolio volatility. (click to enlarge) Figure 4. Correlations over the past 5 years. Some interesting observations are apparent from Figure 3. SPY generated a higher return than the portfolio but SPY also had a higher volatility. SPY and the portfolio had virtually the same risk-adjusted performance. Thus, I believe that the composite portfolio is a good tradeoff for the risk averse investor looking for income. To get additional views of the how the portfolio performed, I analyzed two other metrics. The first is graphed in Figure 5 and shows the growth of wealth over the 5 years period. The plot assumes that the portfolio is frequently rebalanced to maintain equal weighting. As illustrated by the graph, wealth grew at a steady pace over the 5 year period. (click to enlarge) Figure 5 Growth of wealth for CEF portfolio The value of the portfolio decreased a few times along the way. The second metric is plotted in Figure 6 and provides a measure of the draw downs that an investor would experience. The figure illustrates that you can expect periods of relatively large draw downs, which could reach as high as 14% in a few cases. Thus, the portfolio is best suited for long term investors who can weather moderate draw downs. Note that we are currently in a 10% drawdown period, which is similar to draw downs in the past. (click to enlarge) Figure 6. Draw downs associated with the CEF portfolio Bottom Line Many of the CEFs in this portfolio have recently taken price hits, which have resulted in large discounts. No one knows what the future may hold but if the future is anywhere close to the past, these CEFs will recover and the discounts will revert back to the mean. If this turns out to be true, you can receive high income while you wait. Overall I believe this portfolio provides high income with reasonable risk.

My ETF Pick List: ETFs For Risk And Value Seekers

Summary As the economy is slowing down, it is worth having a look at options to protect your portfolio such as a short ETF. People overestimate their investing skills and therefore are at risk of losing money which can be prevented. ETFs offer the opportunity to investors who simply lack the time or expertise of a certain fund, industry or country but would like to reap the benefits. The water industry has taken a hit the last few weeks, creating numerous buy opportunities. Some people advocate not to invest in ETFs because you diversify too much of your wealth, and as a result, you might diminish your return. Moreover, you pay an additional cost for buying an ETF (the expense ratio). Yet, statistics have always shown that passive traded funds have beaten active funds over an extended period of time . In the same article, it is also shown that a higher expense ratio is often linked to lower performance rates. Furthermore, investors overestimate their ability to predict market events and, therefore, take too much risk in the market. Reasons enough to have a look at what ETFs have to offer. In this article, I will keep it simple and show a wide availability of ETFs which I consider having significant potential for any kind of investor, retiree to value and risk seekers. I always divide a small portion of my portfolio to ETFs to diversify but also to improve my mathematical odds in regards to obtaining better than average returns. The mathematical probability that you pick a winner out of 30 stocks is lower than obtaining a positive return out of an ETF which tracks 30 stocks at once. Furthermore, I sometimes lack the experienced expertise in a specific sector and, therefore, an ETF is a perfect solution to that problem. ETFs for risk-seeking investors As some people are worried about the progress of economies in the world, such as Germany (and as a result slowing down growth and tumbling markets ) I picked a few ETFs which could take advantage of this situation. This is useful for investors who lack knowledge about how to use option strategies or futures to short a market. One can short the American stock market by, for example, buying the ProShares Short QQQ ETF (NYSEARCA: PSQ ) or buying the ProShares Short Dow 30 ETF (NYSEARCA: DOG ). Keep in mind that short ETFs comes at a higher price as their expense ratio is higher than a normal ETF. In Europe, one could use the ProShares UltraShort FTSE Europe ETF (NYSEARCA: EPV ) to short the stock market of England. Plenty of choices and whenever the market tumbles down I would recommend any of these ETFs if you don’t want to be exposed to higher leverage such as with options or futures. As the bull market has been strong the last few years, the short ETFs have been performing dreadfully: While the opposite ETF, the PowerShares QQQ Trust ETF (NASDAQ: QQQ ), has seen outstanding performance over the last 5 years: Just to prove an important point, this is the performance of QQQ in comparison to Ford (NYSE: F ), Boeing (NYSE: BA ), Wal-Mart (NYSE: WMT ) and Exxon Mobil (NYSE: XOM ), 4 large American multinationals: The graph clearly proves the point that holding these 4 large American multinationals would not have outperformed the market over a period of 5 years. This builds a case towards ETF-based investing, especially as the world of academia has shown many times that investors overestimate their ability to predict market events and, therefore, take too much risk on the stock market. One more argument to prove my point is an example of the economy of Brazil. Once a growth economy, now their currency is hitting a shattering low while unemployment is at a 5-year peak. The ProShares UltraShort MSCI Brazil Capped ETF (NYSEARCA: BZQ ) has been through the roof as a result: This was a much easier choice in comparison to cherry picking any of the stocks on the Brazilian market. ETFs to protect against rising interest rates Furthermore, there are products called Exchange Traded Notes, debt instruments which allow the investor to protect themselves against either rising or diminishing interest rates such as these steepeners and flatteners , the iPath U.S. Treasury Steepener ETN (NASDAQ: STPP ) and the iPath U.S. Treasury Flattener ETN (NASDAQ: FLAT ). ETFs for investors seeking value Deep value is hard to find when the stock market is priced at a high P/E. Finding a winner in a bucket of stocks is even more difficult. This is especially the case when it comes to more unknown stocks in sectors which are being ignored by most investors. One of those sectors is the water industry. The water industry comprises of firms that provide drinking water and waste-water services (including sewage water treatment) and irrigation solutions to homes, businesses and manufacturers. The Water Industry (click to enlarge) Source : Water UN The water industry does not receive as much coverage as the solar industry and electric car industry. In my view, this is because the water industry is a bit more boring than the solar and electric car industry. Yet, in my view, it shouldn’t be and there are good reasons for that. Only half a percent of fresh water is being used worldwide while over 1 billion people are still having severe water supply issues: Source : Water UN The water scarcity problem will become much more severe in the coming years: (click to enlarge) Source : Water UN There are 3 water ETFs that play their own individual role in battling the issues of water scarcity. I’ve covered all 3 on Seeking Alpha before: the First Trust ISE Water Index ETF (NYSEARCA: FIW ), the PowerShares Global Water Portfolio ETF (NYSEARCA: PIO ) and the PowerShares Water Resources Portfolio ETF (NYSEARCA: PHO ). Their overall share prices have fallen over the last few months, opening a potential entry point. Conclusion This article is important as it perfectly addresses many of the issues numerous investors currently face – not having the expertise to invest in a sector due to lack of time, wary of investing due to the bull market and the realization that many investors don’t obtain profitable returns overall. Investors tend to overestimate their skills and not every investor is successful. Yet, by following a simple basket of stocks, you enhance your chances of obtaining a positive return while lowering your overall risk. The Brazil ETF clearly indicates that you can also obtain solid above average returns with ETFs. ETFs are an important part of my portfolio due to the above-mentioned reasons. Yet I also hold numerous stocks and financial derivatives in my portfolio (as I work in that specific industry) and consider myself knowledgeable on the industry those firms are active in. When it becomes too specific, I consider ETFs as a good alternative choice. Therefore, I consider the water ETFs as a good value investment for the future. The underlying fundamentals of the water scarcity problems are so underestimated currently in the world that it’s simply a waiting game until investments in these firms will grow significantly. Now is the time to buy these firms. Scarcity of water will spur bright technologists and scientists to invent large scale new technologies in this industry. This will become a very profitable commerce in the future.

EWI: 3 Coins In The Fountain

A long established fund, with consistent dividend returns. The fund is well off its highs attained before the financial crises of 2008. Italy, as part of the larger EU, offers investors the opportunity to grow with a recovering EU economy. Among the available legions of ETFs there are only two mostly Italian weighted at better than 94% and they are closely related funds. First, is the plain vanilla iShares MSCI Italy Capped ETF (NYSEARCA: EWI ) and the currency hedged version, the iShares Currency Hedged MSCI Italy ETF (NYSEARCA: HEWI ). The currency hedged fund HEWI, as its ticker symbol suggests, is identically the EWI fund with the addition of a U.S. Dollar vs Euro currency hedge. It should be noted that a currency hedge does its best to mitigate fluctuation in currency exchange. Just briefly, when the U.S. Dollar strengthens against the Euro, Euro denominated profits will seem to shrink when translated into U.S. Dollars even if Euro denominated profits remain unchanged. Conversely, when the Dollar weakens vs the Euro, Euro denominated profits will seem to grow, even if Euro denominated profits remain unchanged. A currency hedge is designed to ‘smooth out’ these fluctuations. However, there are costs associated with currency hedge, so an investor would a long term horizon may or may not fully benefit from a currency hedge. Hence, the choice of the hedged [HEWI] or unhedged [EWI] version is left to the discretion of the investor. The benchmark index is Morgan Stanley Capital International [MSCI] Italy 25/50 Index (NYSEARCA: USD ): The MSCI Italy 25/50 Index is designed to measure the performance of the large and mid-cap segments of the Italian market. It applies certain investment limits that are imposed on regulated investment companies, or RICs, under the current U.S. Internal Revenue Code. With 26 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Italy. The fund’s cap refers to U.S. IRS tax code in that: …at the end of each quarter of its tax year no more than 25% of the value of the RIC’s assets may be invested in a single issuer and the sum of the weights of all issuers representing more than 5% of the fund should not exceed 50% of the fund’s total assets… Lastly, the MSCI cap methodology is designed to minimize turnover. (click to enlarge) ( Data From MSCI and BlackRock) The three heaviest weighted sectors are a little different. The fund weights the Energy Sector energy about 10.8% more than does the index; Financials about 4.41% lighter than the index and Utilities almost 13% heavier than the index. So the fund leans a little more defensively than does the index. In spite of the difference, the iShares Italy capped fund EWI seems to emulate the MSCI index rather well. iShares EWI vs the MSCI Index 1 Year 3 Year 5 Year 10 Year Inception MSCI Italy 25/50 Index -7.09% 7.97% -0.58% -2.83% 4.07% iShares Italy Capped EWI -7.23% 8.21% -0.59% -2.83% 4.16% (Data From BlackRock) As far as individual holdings, MSCI only list the top ten heaviest weighted holdings. A quick comparison reveals a slight difference from the fund. First, the top ten Index holdings represents 65.42% of the entire index, whereas the top ten holdings of EWI represents 68.74% of the fund’s holdings. As far as individual top ten holdings, the iShares fund carries three identical financials and Telecom Italia (NYSE: TI ) 3.6132% of the fund’s total holdings. On the other hand, the MSCI Index carries a fourth financial, Banca Monte Dei Paschi di Siena ( OTCPK:BMDPY ) 5.25%, of the index. The fund carries the bank also, but it accounts for only 2.096% of the total fund. Top ten comparison of MSCI Index vs iShares EWI Sector MSCI EWI Sector Consumer Discretionary LUXOTTICA GROUP (NYSE: LUX ): 4.66% LUXOTTICA GROUP: 4.58% Consumer Discretionary Consumer Discretionary FIAT CHRYSLER AUTOMOBILES NV (NYSE: FCAU ): 4.00% FIAT CHRYSLER AUTOMOBILES NV: 4.11% Consumer Discretionary Energy ENI (NYSE: ENI ): 11.00% ENI: 11.96% Energy Financials INTESA SANPAOLO ( OTCPK:ISNPY ): 12.13% INTESA SANPAOLO: 13.48% Financials Financials UNICREDIT ( OTC:UNCFY ): 7.57 UNICREDIT: 8.72% Financials Financials BANCA MONTE DEI PASCHI DI SIENA SP: 5.25% ASSICURAZIONI GENERALI: 4.53% Financials Financials ASSICURAZIONI GENERALI ( OTCPK:ARZGY ): 4.48% ATLANTIA: 4.56% Industrials Industrials ATLANTIA ( OTCPK:ATASY ): 4.43% TELECOM ITALIA: 3.61% Telecommunications Utilities ENEL ( OTCPK:ENLAY ): 7.73% ENEL: 8.93% Utilities Utilities SNAM ( OTCPK:SNMRY ): 4.00% SNAM: 4.26% Utilities Represents 65.42% of the Index Represents 68.74% of the Fund (Data from BlackRock and MSCI) It’s worth making note of the difference between those two top holdings. Banca Monte Dei Paschi di Siena provides corporate and consumer banking services, asset management, life insurance, pension funds and investment trust. The bank has a market cap of $5.3876 billion, has a negative EPS at -5.97 and does not pay a dividend. Lastly, the shares are rather volatile with a beta of 1.73 times the market. Telecom Italia’s primary businesses are landline and mobile telephone service, internet and internet protocol TV as well as the office product and IT provider, Olivetti , as a wholly owned subsidiary. Telecom Italia company is the leading company in its sector, with international operations in Brazil and Argentina in addition to domestic operations. Telecom Italia has a market cap of $19.87 billion, a P/E of 25.65 and a beta of 1.43 times the market, however, no dividend yield. (click to enlarge) Lastly, a few words about the Italian economy: Italy seems to have two economies: the northern, industrial economy as well as a lagging southern economy. The difference is notable. The entire economy grew at about 0.3% in 2015-Q1 with full year expectations of about 0.7%. The Eurozone economy, (EU19) as a whole, grew at 0.4% in Q1. The results were similar in Q2, with Italy growing at 0.2%, while the entire EU19 grew at 0.3%. However, according to the Economist , ” A Tale of Two Economies” , North and Central Italy grew at 2%, well ahead of the Eurozone as well as the entire EU, (EU28). To put it perspective: … Of the 943,000 Italians who became unemployed between 2007 and 2014, 70% were southerners… … Italy’s aggregate workforce contracted by 4% over that time; the south’s, by 10.7%… …Employment in the south is lower than in any country in the European Union, at 40%; in the north, it is 64%… In the North, per Capita GDP is about $35,500; in the south about $19,250. Unemployment in the North is 9.5%; in the south 20.7%. Public debt is approximately 133% of GDP. The economic obstacles in the south go beyond direct economic regions, including changing demographics. About 700,000 Italians migrated to the northern part of the country and skilled labor is in short supply in the south. Lastly, the southern region contains the islands Sardinia and Sicily where growth and recovery have been slower. Until recently, both islands have been weighed down by higher utility and transportation costs to and from the mainland. Their economies rely heavily on the Hospitality Industry. However, recent reforms and infrastructure upgrades have had very positive results. To put progressive reforms in perspective, Sicily now ranks as the 8th and Sardinia 13th of the fastest growing of the 20 regions in Italy. Sardinia is currently seeking tax haven status, and is currently free from custom duties; Sicily is developing Etna Valley, attracting electronics firms such as STMicroelectronics (NYSE: STM ) and Numonyx, a wholly owned subsidiary of Micron Technologies (NASDAQ: MU ). Key Facts Summary Net Assets Outstanding Shares Holdings x-cash or derivatives 20 Day Average Volume Expense Ratio (Industry Average 0.44%) Price/ Earnings Price/ Book Beta Annualized Yield iShares EWI Italy 25/50 Capped $1.1504 billion USD 79.5 million 26 494,696 0.48% 22.39 1.10 0.85 3.69% and 2.52% TTM (Data from BlackRock and MSCI) At first glance, an investor might shy away based on the Italian economy and to be sure, there is a risk. However, Italy is a key component state of the larger European Union. In other words, the Italian economy is not entirely left to its own devices and is subject to the rules and regulations governing its membership in the EU. True the EU has had some difficult years, but amazingly, has not only come out intact, but has even added a new member. Right now, Italy’s economy as an EU member will feel the effects of a global economic contraction. However, for those investors with patience, the potential for the Italy economy as a member of a fully recovered EU economy, may prove profitable in the long run.