CEF general discussion

[motley]

I have a basic understanding of these but nothing invested and thinking about it; am curious to hear from others who have and how/why or other insights...

 

[pb4uski]

I don't own any, but do own some preferred stock issued by CEFs.

My take is they are like an ETF where the underlying assets are a portfolio of whatever based on the fund's objective. I guess the difference between a CEF and ETF is to my knowledge ETFs don't use leverage but CEFs can and many do (but the leverage is limited).

 

[MichaelB]

There are key differences between CEFs and ETFs. The ETF creates baskets of assets based on a specific index, the market value of the ETF is the same (of very close) to the market value of the basket of assets. When demand rises for the ETF more shares are created, anda vice versa. Certain investors can exchange shares of the ETF for baskets of the underlying assets, and vice versa. This mechanism keeps the market price of the ETF very close to the market price of the assets.

A CEF starts with a basket of assets, goes to market with a price equal to the value of those assets, and then closes, meaning there will be no future changes to fund assets or the number of fund shares. From that point the value of the CEF share and the value of the underlying assets can diverge, and there is no mechanism to bring them back in line. This is the norm.

Some CEFs use leverage, but not all do.

 

[gcgang]

https://www.cefconnect.com/

One way to invest in CEFs is to buy when the discount to NAV is unusually high, and to sell when the discount shrinks to below average. The above site provides info, going back over the life on the fund.

 

[Ian S]

There are key differences between CEFs and ETFs. The ETF creates baskets of assets based on a specific index, the market value of the ETF is the same (of very close) to the market value of the basket of assets. When demand rises for the ETF more shares are created, anda vice versa. Certain investors can exchange shares of the ETF for baskets of the underlying assets, and vice versa. This mechanism keeps the market price of the ETF very close to the market price of the assets.

A CEF starts with a basket of assets, goes to market with a price equal to the value of those assets, and then closes, meaning there will be no future changes to fund assets or the number of fund shares. From that point the value of the CEF share and the value of the underlying assets can diverge, and there is no mechanism to bring them back in line. This is the norm.

Some CEFs use leverage, but not all do.

Actually, I believe the assets within a CEF can be changed i.e. bought and sold: it's the number of fund shares that stays the same. That leads to a mismatch between the share price and the underlying value of the assets per share. The discount to net asset value can be large e.g. 15% or more. Large premiums to net asset value are less common but still possible. After playing with CEF's for many years, I've got rid of most of mine. I would suggest that anyone investing in them pay attention to historical discounts: large discounts can be a means of achieving some capital gains... or not as some of these CEF's go for years with high discounts. Also be wary of buying those that have significant premiums as they can drop in value if investor sentiment goes negative. Also, there are examples of CEF's converting to open end funds or ETF's, sometimes under pressure from activist shareholders who want to make a quick buck such as detailed here.

 

[Koolau]

I would have no interest in such an investment as I don't understand it that well. Nor do I want leverage in my investments. Too many other mundane and well understood investments available rather than to go this route but YMMV.

 

[marko]

I have a small-ish set (~5%) of PIMCO CEF holdings that have reliably brought in an average of 13% in dividends.

Against my "policy", I must admit that I don't really understand them well but I view them as a small but risky piece of the portfolio.

Having said that, they've paid consistently every month for several years now and I don't worry too much about them.

 

[jim584672]

CEFs existed before ETFs were created. ETFs prices are kept honest because large players are able to create or redeem creation units (large blocks of securities) when prices diverge. CEFs have no such mechanism and since many CEFs have high expense ratios the prices tend to fall into deep discounts vs the actual market prices their holdings.

 

[Flyfish1]

Yes, CEF's have been around for a long time, ADX started in 1929 and is still going strong. This Big Dividend Has Been Around Since 1929
Yet, the knee jerk reflex is to call them risky. They are just a different methodology to achieve income. I certainly don't consider my PIMCO CEF's to be risky investments. PIMCO is a widely respected investment firm and their funds have reliably paid good yields for years.
So, back to the original question: I use them in my dividend portfolios and am very happy with the income generated. Don't buy CEF's thinking you are going to get share price appreciation, they tend to move sideways. Buy them for the income, and always try to buy on a big discount.

 

[Ian S]

Just be aware that CEF distributions often include significant return of capital.

 

[marko]

Just be aware that CEF distributions often include significant return of capital.

Serious question: Why is that a bad thing? ROC is not taxed right? And the number of shares stay the same?

 

[pb4uski]

I think it means that there is less money at work because some of your principal has been returned you. If it is a big deal to you you can just buy more shares.

It is important in looking at a true "yield" that you exclude that return of capital.

 

[marko]

I think it means that there is less money at work because some of your principal has been returned you. If it is a big deal to you you can just buy more shares.

It is important in looking at a true "yield" that you exclude that return of capital.

OK but as someone noted people are attracted to CEFs for income. The income is based on number of shares which don't go down from a ROC.

I'd think an ideal situation would be to keep the shares/income and have ALL my capital eventually returned. This sounds silly as I write it, so I'm obviously missing something.

Yes, I see that it does skew the yield but depending on the fund it could be negligible.

Update: Made me look. My particular CEF hasn't had a ROC ever....or at least since 2012.

 

[RobLJ]

I have a basket of CEFs in my taxable brokerage, about 2/3 munis, although I also have Pimco's PDI and PDO. The RealEstate CEF and Infrastructure were throwing off enough taxable income, that I switched them out for muni CEFs and I put the taxables (except the Pimco Funds) in DW's smaller IRA. All together, the CEFs are throwing off now almost 12000 in income a year, most but not all non-taxable. Eventually I'll place the Pimco funds in the IRA, maybe in 2026. I"m also shifting the low duration muni CEFs to mid and longer duration CEFs, although I think I finished that process. Longer duration should benefit from Fed cuts, but we'll see how that works. I've been stashing unspent IRA/403b withdrawals (I withdraw close to the 12% taxable top) in the brokerage, so it's starting to get as large as DW's smaller IRA. I used to call the brokerage the emergency fund (we bought the RAV in cash with it, 4 years ago) but now it's more a BTD account.

CEF leverage, if the fund uses leverage, will accelerate both gains and dips, and is mainly why the management fee is so high.

 

[Ian S]

Serious question: Why is that a bad thing? ROC is not taxed right? And the number of shares stay the same?

Two points: first, it can make the "yield" look greater than it actually is and that could mislead you when you are comparing several CEF's. Second, ROC reduces your basis in the investment so you may be hit with higher capital gains tax when you sell. It's probably better now, but in the olden days, it could be a pain to calculate that change in basis.

 

[surprising]

Two points: first, it can make the "yield" look greater than it actually is and that could mislead you when you are comparing several CEF's. Second, ROC reduces your basis in the investment so you may be hit with higher capital gains tax when you sell. It's probably better now, but in the olden days, it could be a pain to calculate that change in basis.

ROC is bad for bond CEFs but can be OK for stock CEFs. For bond CEFs, ROC is used if the underlying bond dividends can't cover the CEF distribution. For stock CEFs, if the underlying stocks have appreciated a lot, they can use ROC instead of selling and incurring capital gains. In either case if used destructively it is basically a Ponzi scheme.

 

[triangle]

I have had small positions in a few different ones. Most pay monthly which can make them enticing when thinking about generating cash for basic expenses. Like dividend stocks they seem to fluctuate in part based on interest rates.

Some concerns I have is that

• Newly issued ones seem to always drop in value the first year or two after issuance.
• Some of the bigger and more well know ones such as PDI or PTY seem to always trade at a premium, making them harder to purchase.
• A more understandable fund such as UTG (Reaves Utility Income) seems like a easy way to turn the slice of your portfolio that you might otherwise invest into slow moving utilities into a higher payout vehicle. But the better price appreciation and dividend treatment of a common utility stock makes the higher yield of a CEF questionable when considering a longer timeline, at least if held in an after tax account. This could probably be said about the other sector CEFs.

I don't view them as a really long term buy and hold, even though I have a few small long term positions active. But I think they can be an attractive way to generate some income during retirement, where the investor is looking for income rather than growth.

 

[rayvt]

One thing about CEFs is that a large portion of the investors in them are small non-professional investors. This group tends to be driven by emotion. Which can mean that the price sometimes gets way out of whack with the NAV.
Which means that sometimes you can buy a CEF for a large discount. Imagine buying a $100 stock for $85. And then waiting for the crowd stampede in the other direction and drive the price to $110 for a $100 stock.

All too many of these investors look only at the yield and completely ignore everything else.
Case in point is GOF. It currently is at 31% premium with yield is 13.8%. You are paying $15.94 for something that is worth $12.02. This can only end badly. That yield is unsustainable.

So....don't do that. Go opposite the naive crowd.
Go with something like CHW. Buy at -9.9% discount with 8.4% yield. Buy something worth $7.97 for $7.23.

 

[adamadabek]

I have been retired for eight years and have invested in closed end funds for over eight years to provide steady monthly cash flow . This is how I pay my expenses and the income is predicatble and reliable no matter what the market value is. The best source I found to get a basic understanding is to read the book by Steve Selengut Retirement Money Secrets A Financial Insider's Guide to Income Independence. His motto is market value fuels the ego, income fuels the yacht. Cefconnect.com is a free source provided by nuveen. Steve has his own facegroup group which is helpful to learn more. Hope this helps.

 

[rayvt]

the income is predicatble and reliable no matter what the market value is.

Are you a bot? or a shill?

Plenty of CEFs have cut their dividends at various times. Sometimes by a little, sometimes by a lot.
For example, CLM has gone from .70 to .56. Then 0.51, 0.44, 0.38, 0.37, 0.28, 0.23, 0.19, 0.12, and now 0.11.

I know what the reply is. "Don't buy one that is going to go down."

 

[Texas Proud]

One thing to remember... the discount can stay a lot longer than you can...

Way back when I was young my brother bought some at a discount... they stayed at a discount 10 to 20 years later.. they had good returns but he was also hoping that he would get the gain back to NPV...

 

[rayvt]

Very true. STEW (previously known as BIF) case in point. It stays about -15% to -18% discount.

That's why it is important to check the premium/discount history. Ex: ETJ swings between +10% and -10%. Buy when it's a large discount and sell when it swings to a premium. Or when the discount narrows.

CEFs are not really for buy-and-hold-forever. They are buy-and-hold-for-dozens-of-months.

 

[surprising]

Are you a bot? or a shill?

Plenty of CEFs have cut their dividends at various times. Sometimes by a little, sometimes by a lot.
For example, CLM has gone from .70 to .56. Then 0.51, 0.44, 0.38, 0.37, 0.28, 0.23, 0.19, 0.12, and now 0.11.

I know what the reply is. "Don't buy one that is going to go down."

I have CEFs that partly fund my basic living expenses in retirement. Like all things, there are good CEFs and bad CEFs and you have to do your research and not just choose one based on yield. The benefits of CEFs over ETFs are numerous, many already mentioned:

• Higher yields compared to ETF counterparts. This is mainly due to CEF ability to use leverage. It is a good idea to find CEFs that don't over-lever. One of mine has 0 leverage. My overall portfolio of CEFs and dividend stocks pay 10% on cost.
• Monthly distributions. Many CEFs pay monthly, making it more useful as income for retirement.
• Fixed share count. The big institutions don't bother touching CEFs because of the fixed low share count. This means CEFs generally don't get caught up in sector rotations and other schemes.
• Fixed share count also has the benefit of shielding from NAV fluctuations during selloffs or rallies. ETFs need to continually buy/sell shares, which can happen at inopportune times. For example, selling off bonds that are safe and paying well because interest rates are changing. The fund manager can have a long-term vision and not worry about being forced to buy or sell.
• A negative is share price can and will move irrationally just like other stocks and ETFs, probably more so as most investors are non-professional. My CEFs lost 50% or more during the covid drop, but not a single CEF I own reduced or eliminated their distributions. I own exclusively bond CEFs though. Stock based CEFs might have been a different story.

 

[hotwired]

I have a basic understanding of these but nothing invested and thinking about it; am curious to hear from others who have and how/why or other insights...

I've got a few and probably always will. But you have to be active. It's not enough to just buy the ones that are trading at a discount. Each one has a premium to discount range, and the trick is to buy when they're unusually discounted and sell (maybe temporarily) once they reach full value or premium. They are a little scary. They are usually leveraged, so when everything else goes down 25 percent, many of these quiet little income investments plunge 40 to 50

 

[Flyfish1]

I disagree that they are a short term buy and hold. I guess it depends on your strategy, but if you are retired and using most of that income then buying and selling can disrupt your cash flow. Having said that I do monitor the situation and have moved in and out of some funds. I totally agree try to buy at a historic discount. I retired on income from CEF's and dividend stocks and interest from bonds. I also reinvest a portion of that income monthly, so that my cash flow is growing, albeit slowly, but still growing.
Lots of good resources out there like the book mentioned above and cefconnect among others. It's funny I was just looking at ADX and it's inception date is 10/1/1929 and at present has no leverage.