This Is The Biggest Fear CEF Investors Have In This Market

Loads of CEF buyers fear about dividend cuts. And for positive, they’re one thing to bear in mind. However CEFs are not the identical as shares. After we spend money on high-quality CEFs, there are a pair different issues we have to bear in mind after we catch wind of a minimize:

1. Excessive-quality CEFs will generally scale back payouts by a small quantity to allow them to redeploy capital into oversold bargains. I’ll have extra to say on this in a second, however the upshot is that it holds the potential for us to make extra in positive aspects from this transfer than we lose in dividends.
2. As talked about, these cuts are often small, lowering the yield solely a small quantity (once more, we’ll display this under).

Earlier than we go additional, we actually ought to cease for a second and discuss concerning the significance of diversification. Throughout a portfolio of a number of CEFs, you may guarantee your earnings received’t change a lot when you select funds which might be worthwhile, have large reductions to web asset worth (NAV, or the investments of their portfolios) and strong fundamentals that can make them worthwhile over the long run.

Take, for instance, two very totally different funds: the Nuveen Actual Asset Earnings and Progress Fund (JRI), a holding of my CEF Insider service that primarily holds shares of actual property funding trusts (REITs), utilities and pipelines, in addition to bonds issued by these companies; and the company bond–targeted PIMCO Excessive Earnings Fund (PHK). Each funds have minimize dividends previously.

What we’re seeing here’s a historical past of very small payout cuts over time, together with a penny-per-share minimize most not too long ago launched by JRI firstly of this yr. PHK’s cuts are larger however seemingly behind it as dividends have stayed steady since early 2020.

Now contemplate this.

Though PHK’s dividend has been steady for 3 years, it has earned buyers much less cash. To make sure, JRI’s current penny-per-share minimize does decrease distributions a hair, bringing the present yield to eight.7% from 9.6%. However that’s nonetheless a really excessive earnings stream.

And when you aren’t pleased with JRI’s dividend minimize from early 2020, you may nonetheless promote, then redirect the income into one other CEF with the next yield.

Furthermore, JRI’s penny-per-share minimize units it up for additional positive aspects as a result of it lets the fund redeploy its capital into REITs, that are significantly oversold now. An eye fixed for worth like that’s the reason JRI continues to be a robust performer. Including to its attraction is the truth that regardless of this, it trades at an enormous 13.3% low cost to NAV—whereas the poorer-performing PHK sports activities an 11% premium!

To delve just a little deeper into CEF dividend cuts, let’s return to JRI’s payout discount in October 2017, when dividends have been minimize by half a penny per share. This minimize was one purpose why I advisable JRI to CEF Insider members. Talking of Nuveen, I wrote within the October 2017 challenge that: “The agency will minimize dividends if it thinks that’s good for the fund as a complete—and in JRI’s case, it has been.” That was true in October 2017 and it’s nonetheless true in 2023.

It’s additionally true for lots of closed-end funds. Of the ten top-performing CEFs of all-time, all 10 have minimize dividends sooner or later of their historical past, and 7 have minimize dividends during the last decade.

Nonetheless, these funds have additionally outperformed their benchmark index funds over the identical interval whereas yielding about 5 occasions as a lot because the S&P 500, due to their 8.6% common yield. In brief, these funds get you a excessive earnings stream that stays excessive, even after small cuts right here and there, in addition to market outperformance.

Try how simply a kind of celebrity CEFs, the Columbia Seligman Premium Know-how Progress Fund (STK), has outrun the S&P 500 for a decade.

It simply goes to indicate that with CEFs, once you deal with long-term whole returns as a substitute of a penny dividend minimize right here or there, and once you diversify into a group of top-quality funds with excessive earnings streams and market-beating potential, you may create true wealth.

Michael Foster is the Lead Analysis Analyst for Contrarian Outlook. For extra nice earnings concepts, click on right here for our newest report “Indestructible Income: 5 Bargain Funds with Steady 10.2% Dividends.”

Disclosure: none