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All Contents © 2019The Kiplinger Washington Editors
By Michael Foster, Contributing Writer
| February 20, 2018
It might be difficult to top 2017’s performance by closed-end funds. Last year, CEFs — which typically invest in stocks, bonds or a blend of both — returned 12.4% on average, according to data compiled by CEF Insider. Since the average distribution rate for these funds is 6.6%, that means investors were enjoying both significant income and some portfolio growth.
Many CEFs are poised to keep up the performance in 2018. The best closed-end funds for this year have a perfect blend of investment themes that are set up for success, as well as high distributions that put similar exchange-traded funds to shame.
Not everyone is on the closed-end fund bandwagon quite yet, as is apparent considering that most closed-end funds’ assets can be counted in the millions, while the ETF world has dozens of billion-dollar funds. Much of that can be chalked up to the higher fees charged by CEFs, which tend to be actively managed; many ETFs are passively managed and thus can afford to levy much smaller expenses. But as Contrarian Outlook’s Brett Owens notes, smart buying can offset those fees.
“It’s easy to get the fee “comped” if you simply buy a fund when it trades for a discount to its net asset value,” Owens says. “For example, if a fund charges a 1.5% management fee, and you can buy it at a 7.5% discount, you’ve got your management fee comped. Plus, you’ve secured another 6% in ‘free money upside.’”
The best CEFs for 2018 don’t have much in common. They span numerous categories, from international stocks to tech and even bonds. And while most of them are high-yielding in nature (up to 13%), a few are growth-focused. But the one thing these picks all share is that they all should be supported by a few favorable tailwinds for the rest of this year.
Data is as of Feb. 16, 2018. Distribution rate can be a combination of dividends, interest income, realized capital gains and return of capital, and is an annualized reflection of the most recent payout. Distribution rate is a standard measure for CEFs. Fund expenses provided by Morningstar. Click on ticker-symbol links in each slide for current share prices and more.
Market value: $322.0 million
Distribution rate: 3.7%
The New Germany Fund (GF, $20.24) is, as the name implies, a closed-end fund that’s focused on investing in German equities. It’s also the kind of CEF that’s on almost no one’s radar, even if it should be.
There are plenty of reasons to be bullish on Germany. The U.S. dollar had an awful 2017, with the ICE Dollar Index (it measures the USD against six other global currencies) falling nearly 10% in 2017, which makes foreign assets more valuable in dollar terms. That trend continues in 2018, and looks likely to carry through for the rest of the year given the American government’s moves to both slash taxes while increasing spending.
On top of that, Germany is a rare gem in Europe, with the political and economic stability of the north and the higher growth rates of the south. German GDP growth accelerated to 2.8% in the third quarter of 2017, an acceleration from the prior quarter and far above 2016’s 1.9% growth rate. GDP expansion eased to 2.5% in Q4, which still was considered a strong pace, and Germany upgraded its 2018 outlook from 1.9% to 2018.
This tiny fund (around $300 million in assets) understandably had an unstoppable 2017 — the fund’s net asset value went up by 48.5%, and its total market return was a whopping 54.5%! The fund is continuing its momentum into 2018, up more than 5% year-to-date. But it’s not too late to get in. GF still is trading at a nearly 10% discount to its NAV, which is near its three-year average, though it has traded at less than a 5% discount several times in the past decade.
Market value: $150.0 million
Distribution rate: 2.0%
The Asia Pacific Fund (APB, $14.52), like the New Germany Fund, is an international equity CEF that soared in 2017, including a 37% gain in NAV. And just like GF, its gains could just be getting started.
APB is long some of the most important stocks in Asia, such as Korean tech conglomerate Samsung Electronics (SSNLF), China Construction Bank (CICHF) and Taiwan Semiconductor (TSM). Broadly speaking, it’s weighed heavily in China (33%), Hong Kong (26%) and South Korea (18%), with smaller allocations to Taiwan, Indonesia and others. Noticeably absent is Japanese companies.
This fund is a lot better than your average Asia ETF for a couple reasons. First, a nearly 6% discount to NAV means you’re paying a little less than you should for its attractive holdings. Secondly (and much more importantly), APB’s portfolio isn’t limited to common stocks – it also may invest in preferred stocks, which tend to be less volatile and yield more than common shares.
Historically, emerging-market equities tend to be much more volatile than their American counterparts. However, the flexibility to buy preferreds in addition to common stock allows APB to take advantage of bull markets, but guard itself from short-term market shocks, too.
Market value: $673.3 million
Distribution rate: 5.2%
BlackRock Science and Technology Fund (BST, $30.13) wasn’t just one of the best tech funds of 2017 – it was one of the top CEFs overall last year, gaining more than 57% on a 45% pop in its net asset value.
Part of BST’s appeal is its sector tilt, as it’s filled with companies whose technologies are becoming an ever more important part of our everyday lives. In addition to its strong positioning in FAANG stocks including Apple (AAPL), Google parent Alphabet (GOOGL), Amazon (AMZN) and Facebook (FB), it also held big 2017 winners including Chinese e-commerce play Alibaba (BABA), cloud giant Salesforce.com (CRM) and video game maker Activision Blizzard (ATVI).
What also makes BlackRock Science and Technology stand out is its high distribution rate of more than 5%, which is far better than you get out of most tech-focused funds. BST can swing that kind of yield because in addition to holding the aforementioned stocks, it can also sell covered calls – an income-generating trading strategy – against its portfolio.
This has helped the BST outperform major technology funds such as the Technology Select Sector SPDR Fund (XLK) in its short life (the fund started trading in October 2014). Over the past three years, BST has delivered a 23.9% average annual total return, versus 17% for the XLK.
Market value: $156.4 million
Distribution rate: 8.2%
Liberty All-Star Growth (ASG, $5.86) has a paltry $155 million in assets under management. That’s a shame, because the fund gained 27.9% on a NAV basis in 2017 – and it may be set up for continued success in 2018.
ASG was one of the top-performing U.S. equity closed-end funds last year, and you can thank the CEF’s strong and diversified management for that. All-Star’s managers utilize large-, mid- and small-cap expertise to create a versatile growth portfolio whose top holdings include the likes of J.B. Hunt (JBHT), Wayfair (W) and Chegg (CHGG).
Shareholders also love ASG for its dividends. The fund is able to generate a yield of more than 8% without sacrificing its growth opportunity. Fund management have supported the payout thanks to their strong stock picking acumen. Just note that the payout does vary from year to year, so while the payout typically is high, it’s not a fixed amount.
Market value: $358.4 million
Distribution rate: 11.3%
If you want international exposure and a robust income stream, look toward Clough Global Opportunities (GLO, $11.11).
Investors should note the important difference between “global” and “international” funds: The former usually includes U.S. stocks, while the latter typically does not. Thus, GLO not only provides access to some of the best American companies, including Bank of America (BAC) and Apple, but also international stocks such as Samsung, Alibaba and Ping An Insurance Group.
The fund is driven by Warren Buffett-style fundamental analysis, seeking out attractively priced companies with strong cash flow and future growth potential. That helps negate some of the risk of investing in emerging-market countries such as India (7.4% of the fund) and China (1.3%).
The fund currently trades at a 9.5% discount to its NAV, which is less than its three-year average, but less “frothy” than it has been at points over the past year. Just one note: GLO does offer an outstanding 11%-plus distribution, but the fund utilizes leverage; in other words, it borrows money to invest even more in its target holdings, which can amplify returns and distributions, but also creates interest-rate risk. A current leverage ratio of 47% means that for every dollar of investable capital, 47 cents is derived from leverage.
Market value: $292.2 million
Distribution rate: 6.4%
Global infrastructure was a fruitful area of the market in 2017, with the iShares Global Infrastructure ETF (IGF) returning 19.3%. However, the Macquarie Global Infrastructure Total Return Fund (MGU, $23.44) – which invests in pipelines, utilities, toll roads and other infrastructure plays – stood out with a nearly 39% return, including 24.6% growth in its NAV. That’s thanks in part to savvy selections on the managers’ part, including being in the right area at the right time: foreign stocks.
MGU’s heavy Canadian focus (roughly 10%) was helpful in 2017, as was its additional diversification in Australia, Spain, Italy, China and the U.K. (all major spots for the fund’s investments) drove the fund higher and offset the weakness in some of the fund’s U.S. investments, which make up a heavy 33% of the portfolio.
This year is setting up to be a solid one for Macquarie Global Infrastructure’s American assets, however. U.S. pipeline and other energy firms were hit hard amid the plunge in crude of the past few years. However, prices are on the rebound, and end-of-year tax reform has helped buoy energy companies (and most other firms headquartered in the U.S.). That should give the pipeline slice of MGU’s pie – roughly a quarter of the fund’s holdings – a good shot at success in 2018.
Market value: $1.9 billion
Distribution rate: 8.4%
While the names might be similar, The Cohen & Steers Infrastructure Fund (UTF, $22.21) does differ somewhat from Macquarie’s infrastructure fund. The biggest difference is that utilities are the largest part of the portfolio at 17%, and midstream energy is far less emphasized at just 12% of assets.
Utilities are famously lumped in with other “widows and orphans” stocks because they provide some of the most reliable, growing income streams in the world. UTF takes advantage of that cash flow, mixing in a conservative use of leverage (a 29% ratio) to provide an even higher income stream than you’d typically get out of its utility stocks and other holdings.
While it’s far from a perfect proxy, the Utilities Select Sector SPDR Fund (XLU) yields just 3.4% – less than half of UTF’s generous distribution. Moreover, this CEF has grown its distribution since its initial public offering.
It’s working. UTF’s dividend yield is 6.9%, double that of XLU. It’s also one of the few closed-end funds that has grown its distribution since its IPO. Payouts are up 57.7% since its 2003 debut, and the fund has even paid out a few special distributions along the way. Those payouts have helped total returns – the fund is up an impressive 260% since its IPO.
In a fair world, UTF’s strong income stream and impressive returns would be rewarded with a lot of market demand. In reality, UTF is trading at an 8.3% discount to NAV—making it a bargain, especially when peer utility funds like the Gabelli Utility Trust (GUT) are trading at a premium to NAV. Can UTF one day be priced at a 45% premium to NAV like GUT is? I don’t know – but a premium price for this fund isn’t impossible, and could come this year.
Market value: $229.1 million
Distribution rate: 9.3%
The market aggressively bought into Gabelli Multimedia Fund’s (GGT, $9.44) wheelhouse: online media and entertainment. Facebook grew like a weed, Sony Corp’s (SNE) recovery continued to multiyear highs, and Altaba (AABA) – the investment company that holds Yahoo! Japan – rocketed higher.
A few things stand out about GGT. For one, it’s extremely diversified both by industry and by geography. Its holdings span a range of worlds, from hotels/gaming and video games to satellite and cable companies to even telecommunications stocks. Moreover, just more than three-quarters of this CEF’s holdings are held in the U.S., but it also provides decent exposure to Europe (10.8%) and Japan (5.8%), among other regions.
What’s also interesting about Gabelli Multimedia Fund is that it put up 26.5% gains in NAV last year while sitting on a very large position in bonds. Roughly 17% of the fund’s portfolio was in short-term U.S. Treasuries as of Sept. 30, the end date of its last report.
Why is GGT keeping so much dry powder available? Funds usually hold cash when they expect stocks to become very undervalued. Gabelli may have put that money to work during the recent market correction.
Market value: $81.2 million
Distribution rate: 8.3%
Another Gabelli fund with a strong 2017, the Gabelli Convertible & Income Securities Fund (GCV, $5.77) is invested in a wide swath of convertible corporate bonds, stocks and other securities. Corporate debt is the largest part of this fund, at about 52% of the portfolio.
GCV undoubtedly is for income hunters. The 8% distribution rate has more or less stayed steady for the past six years, and is a reliable fund for investors who care about cash flow. Also, the corporate bond market firmed up in 2017 thanks in part to a reduction in defaults, so GCV’s portfolio naturally climbed, too; despite its reliance on bonds, the fund still grew its net asset value by 14% last year, and returned 37% on a price basis.
Yes, 2018’s climb in interest rates has cut into corporate bonds’ returns, but the corporate tax cut should bolster profits and economic growth, which should continue to shrink defaults. That’s enough of a positive tailwind that makes GCV worth considering for the new year.
Market value: $951.4 million
Distribution rate: 13.1%
Pimco High Income Fund (PHK, $7.39) is perhaps the most controversial closed-end fund in existence, and once was the most premium-priced CEF on the planet. In mid-2009, when PHK began to recover from the financial crisis faster than stocks, its premium to NAV shot to nosebleed 87%. More recently, its premium has spiked to above 50% in 2012, 2015 and 2016, and its average premium over the past three years is 33%.
But 2017 was a particularly bad year for Pimco High Income, and its premium to NAV has fallen to below 11% – a level it had plumbed just once before in the past few years. The reason? Distribution cuts. PHK lowered its distributions in late 2015, then again in early 2017.
Distribution cuts aren’t unusual in the CEF world, but there was a time when the market thought it couldn’t happen to PHK, which even kept its payouts steady during the 2007-09 Great Recession. But two dings in just more than two years has made the market sour on this pick.
Don’t give up on this fund. Pimco High Income’s market-based return was -8.1% in 2017, yet its NAV rose an incredible 21.5%. The fact that PHK is growing its NAV and sustaining a 13%-plus yield should not be ignored. There is risk here, but if this CEF can keep up its payouts in 2018, the market may have a change of heart and return into this fund.
Consider this a speculative income play for the new year – one with a massive distribution, not to mention the potential for a rebound rally.