CEFs: Pre-2008 Inception Funds That Never Cut Distributions

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Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published on June 6th, 2022. The market has been incredibly volatile this year, please check the latest data and your own due diligence before making any investment decision.

Closed-end funds are known for their higher distribution yields. Though a particular focus on the word “distribution” here. That word sets it apart from a “dividend,” dividend would indicate that the payout is solely from income. For distributions, sources can be from other sources such as capital gains (long and short) and return of capital (destructive or non-destructive.)

Since our previous update, discounts have been widening in the CEF space. This is common with the volatility that we’ve been experiencing. When there is more uncertainty, discounts widen as investors overreact. However, the fact that they are often leveraged instruments plays a role too. When an environment becomes riskier, it makes sense to sell riskier investment vehicles.

Often this creates opportunities for the CEF investor in the long run. I note this because we discussed how much valuations in the space were tightening up in our previous update. There just weren’t a ton of great deals in almost the entirety of 2021 – in CEFs or otherwise!

CEFs are also just a wrapper for other investments. They aren’t an asset class or sector in themselves. They will perform just as their underlying holdings will. A big part of their returns will be dictated by how a sector or asset class they invest in is overall.

What I’ve been doing is keeping track of funds that have a long history of maintaining or increasing their distributions since their inception. And by a long history, I mean those funds that have done so while having an inception date previous to the 2008/09 great financial crisis. At that time, many funds that existed were cutting their distributions. In 2020, the downturn wasn’t prolonged enough, so a significant number of CEFs have maintained their payouts.

This is the latest update on this subject. The reason for bringing it up is we’ve been in a somewhat prolonged downturn. Certainly longer than our last two experiences. The COVID pandemic might have been a more rapid decline, but it was short-lived. The 2018 market correction was also fairly short-lived.

The more prolonged the downturn, the greater the chance that these funds with incredible distribution histories might be at risk. That being said, we know they survived the 2008/09 GFC downturn. So they have a track record of success. None of the six funds have changed since our previous update, so we will be taking a particular look at coverage for the distributions.

PIMCO Corporate & Income Strategy Fund (PCN)

This is the only PIMCO fund on the list after PKO merged with PIMCO Dynamic Income Fund (PDI). Here’s a look at the distribution history of PCN.

PCN Distribution History

PCN Distribution History (CEFConnect)

This fund made it through the distribution adjustments PIMCO put in place last fall, cutting several of their other funds. At the time, their distribution coverage was short. Meaning that it wasn’t looking good.

Since then, they’ve turned this around completely. That is despite the fact that fixed income has remained under significant pressure and the fund’s distribution yield actually increased quite substantially, from 7.40% to now 9.20%. On a NAV basis, this was 9.28% and has now climbed to an alarming 10.71%.

Still, even though the numbers are alarming, we have to follow the coverage. The coverage says we are sitting pretty and seems there isn’t a need to cut at this time.

PIMCO Coverage

PIMCO Coverage (PIMCO (highlight from author))

I think it is important to remember that just because bond prices fall, that doesn’t change what they’re actually paying.

Guggenheim Strategic Opportunities Fund (GOF)

GOF was going through a merger with its sister funds (GGM and GPM) when we last updated this article.

GOF Distribution History

GOF Distribution History (CEFConnect)

GOF’s distribution yield remains the juiciest at 12.37%. On a NAV basis, we are sitting at a shocking 15.27%. At an over 23% premium, I fear this fund is the most set up for hurting shareholders. Although, I was skeptical last time, they have continued to pay. So, party on while it lasts, I guess!

Their last Semi-Annual Report is for the period ending November 30th, 2021. With the mergers closing on October 25th, 2021, it was only showing a very limited period of the new GOF.

However, we know that given the number of shares outstanding of 104,279,415 and multiplying by the $2.1852 annual payout, they will require nearly $228 million to fund the distribution.

This will only be made more difficult given the fact that the fund was invested in nearly 20% cash at the end of April. I don’t follow this fund closely, but this seems to be odd to have this much cash. It could have potentially been only for several days while they were making a quick transition. However, this will be something to watch.

GOF Asset Breakdown

GOF Asset Breakdown (Guggenheim)

To conclude, I remain skeptical that GOF can continue this payout without being destructive to the fund. That will make it more difficult to continue paying their current distribution.

BlackRock Health Sciences Trust (BME)

PCN and GOF were our two fixed-income funds. Watching their coverage is straightforward because they should be able to cover the distribution through income. Moving onto the equity funds, this becomes a much more difficult challenge because they will rely on capital gains to a significant degree. All we can really do is make an educated guess.

(CEFConnect is currently showing an error that the latest distribution is $0.012.)

BME Distribution History

BME Distribution History (CEFConnect)

The last time we touched on this fund, we were able to praise the fund as they had boosted its distribution to shareholders after many years of holding it steady.

BME Annual Report

BME Annual Report (BlackRock)

For BME, we can see they collect very little in the way of net investment income. The actual decline year-over-year in NII was significant on a relative percentage basis. Since it isn’t meaningful to the coverage, it isn’t a concern.

In this case, they rely almost entirely on capital gains to fund the distribution. With the fund’s current distribution yield of 5.88% and NAV rate of 6.03%, despite the losses YTD, I don’t see them cutting at this time.

The Utility Funds

With little surprise, the defensive nature of utilities makes it a natural fit for predictability and stability. We have three funds of the six here that are utility-focused funds.

Gabelli Global Utility & Income Trust (GLU)

GLU is one of the utility funds that I haven’t really looked at too much. The fund’s deep discount could make it an interesting candidate at this time. That would be beyond just the steady distribution that the fund has been able to maintain since its 2004 launch. That is until I really start digging into the fund.

They’ve never raised and never cut. That’s something to envy in the CEF space. One reason is that CEFs don’t retain their earnings like a corporation would. They pay almost everything out to shareholders. In fact, a lot of funds pay out even more than they earn in a year. Thus, why there are only a select few names that have never cut their distributions with really long histories.

GLU Distribution History

GLU Distribution History (CEFConnect)

The fund is small, but if you can look past that, this fund could be worth exploring further. The fund’s distribution rate comes to 7.02% and a NAV rate of 6.31%. That alone tells me that we are looking at rather sustainable levels.

Interestingly though, GLU hasn’t been performing very well YTD. This is surprising because the utility space has been doing well. Here is a comparison of GLU to the SPDR Utility Sector (XLU) and DNP and UTG, which we will cover after GLU.

Chart

YCharts

This type of underperformance is what keeps me less interested in GLU overall. It isn’t just a YTD thing; this is a longer-term trend. Think it is only a global tilt that is hurting them? I’ve added Cohen & Steers Infrastructure Fund (UTF) to the comparison for looking at the last ten years’ performance. UTF came out as the best-performing fund with its regular 40%+ allocation outside the United States.

Chart

YCharts

GLU listed nearly 86% of its portfolio is in equities in its last Annual Report. An unusual 14.3% was in U.S. Treasury Bills. That is probably hurting them, and it wasn’t only this year. Going back to several other Annual Reports, they also had a larger allocation to Treasury Bills. 2017 had 13.5%, and 2019 had a weighting of 17.8%. This doesn’t seem to be just a year-end thing either. In their last Semi-Annual Report, we also see 14.2% in Treasury Bills.

With this being said, I guess this is where the “income” part of their name comes in. With that, it makes sense that they’ve been underperforming. They earn between 0.037% to 0.105% on this sleeve of the portfolio while paying 3.80% and 4% on their preferred stock. That’s pretty simple math to tell us that it isn’t going to work out. If I wanted to own Treasury Bills, I’d invest via an ETF.

Going forward, if yields rise rapidly, it could make a more compelling investment. For now, despite the deep discount, it doesn’t make a compelling investment choice. However, the distribution doesn’t seem to be at risk either.

DNP Select Income Fund (DNP)

The last two names to cover here hold particularly interesting crowns amongst these stellar CEF payers already.

DNP has the crown for the longest consistency of all the payers here. A fund that goes back to its inception in 1987. Unfortunately, I haven’t been able to find a data provider that shows distributions all the way back then. CEFConnect shows back to 1995. Seeking Alpha goes back to 1992, showing the $0.06 being paid.

Suffice it to say, though, they have a long history of consistency. Even if they cut in the first couple of years of their existence, I’m willing to look past it and include them on this list.

DNP Distribution History

DNP Distribution History (CEFConnect)

The fund’s current distribution yield comes to 7%, and the NAV rate is 7.51%. The fund is up just over 9% on a YTD total NAV return basis. With that, I don’t see the need for a cut anytime soon.

Reaves Utility Income Fund (UTG)

Finally, last but certainly not least to cover is UTG. This fund holds the crown of not only being a steady payer but one that has consistently raised its distribution to shareholders since it launched. The last time being in 2021, from $0.18 to the $0.19 they pay per month now.

UTG Distribution History

UTG Distribution History (CEFConnect)

While this fund is down slightly YTD, the 6.75% distribution yield and NAV rate of 6.80%, I believe, puts it at a sustainable level. Given their history, I believe they are committed to the distribution and would have to see things deteriorate significantly before cutting the payout.

Utilities have performed well on a YTD basis, being one of the only positive sectors behind energy’s staggering lead on a YTD basis. However, they had a higher weighting to REITs that haven’t performed as well relative to utilities. I believe that is one of the causes that has brought the fund’s performance down. With the latest update, the REIT exposure has declined, or it has simply been a function of the relative performances bringing down the allocations.

UTG Breakdown

UTG Breakdown (Reaves)

Conclusion

Despite the general weakness in the markets on a YTD basis, most of our CEFs that haven’t cut with longer histories are doing well. I continue to remain skeptical of GOF. However, the improvement in coverage on PCN is encouraging. BME might be down on a YTD basis and rely on capital gains to fund their distribution, but given the distribution rates, I don’t believe we are in concern territory yet.

For the utility funds, well, utilities have been performing well. With that being the case, the fear of distribution cuts there is quite limited. All three utility funds on this list have yields well within reasonable levels.

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