Howdy, Stranger!

It looks like you're new here. If you want to get involved, click one of these buttons!

In this Discussion

Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.

    Support MFO

  • Donate through PayPal

Two High-Yield CEFs That Never Cut Their Distributions Since Inception

edited March 31 in Other Investing
Two High-Yield CEFs That Never Cut Their Distributions Since Inception

Pty utf
https://www.google.com/amp/s/seekingalpha.com/amp/article/4416493-two-high-yield-cefs-never-cut-distributions-since-inception

Mar. 30, 2021 8:30 AMPIMCO Corporate&Income Opportunity Fund (PTY)NEE, UTF

SummaryCEFs are a great tool to get a high income.CEF management matters.Today we look at two CEFs that have never cut their distribution.Through market ups and downs, you can rely on this stable income.


Couple interesting CEF
Lucky mama got pty in her portfolio/maybe add more

Comments

  • Thanks for letting us know about these. I'll have to wait: PTY is at a +29% premium right now. And UTF? +8.6% premium.
  • If a fund is paying out distributions that are a return of capital as UTG has done in the past--https://prnewswire.com/news-releases/reaves-utility-income-fund-section-19a-notice-301138164.html--then the idea that the fund has "never cut its dividend" is really an illusion. It's really kind of like Ponzi where he was just using new investors' money to pay out old ones, shuffling existing assets around without actually generating any income. The actual net asset value declines from such payouts.
  • NAV does not always decline from ROC payments And not all ROC payments are bad depending on the source of that capital.

    Closed-End Fund Return Of Capital: Good, Bad, Or Other
  • Agreed, there are nuances, but the notion that a fund has "never cut its distribution" when it's returning capital is misleading. And even if positive returns of the fund's underlying portfolio on the surface appears to counteract the NAV erosion from return of capital, that NAV would've been even higher if the capital hadn't been returned in the first place. Yet some investors buying the fund at a deep discount can still produce better returns with a return of capital.
  • edited April 1
    .
  • Thx for heads up
  • edited April 1
    From the Fidelity link:
    For example, let's say a CEF is 95% invested in one security, with the other 5% sitting in cash. That security was purchased at $100, is now worth $110, and the portfolio manager believes it is worth $120. The manager could sell some of the security to pay the distribution, which would then be attributed to a capital gain, in the distribution estimate. Or the fund could meet its distribution commitment from the 5% of cash it has, but the distribution would be attributed to return of capital.
    If a CEF had 95% invested in one security, it would cease to be a CEF and be in violation of the Investment Company Act. And if it is holding significant cash to return capital, the cash could act as a drag on its investment strategy. Moreover, excluding muni ones, many CEFs are bought for their income potential in tax deferred IRA or free Roth IRAs, so the idea of saving investors taxes usually isn't foremost in managers' or investors' minds. In other words, I think this isn't a particularly realistic example of a "constructive return of capital." The pass-through example for MLPs in CEFs is legitimate. Mostly, I think return of capital is a means to deceive investors, although purchased at a discount it has a value.
  • "Mostly, I think return of capital is a means to deceive investors, although purchased at a discount it has a value."

    Talk about unrealistic and a stretch, it's quite common especially for CEF's with a managed distribution policy. It certainly isn't hidden from investors or an attempt to deceive. Furthermore many knowledgeable CEF investors hold funds in their taxable accounts that distribute heavy ROC proportions as a means to defer taxes to a time of their choosing rather than having capital gains put upon them at year end.

  • If a CEF had 95% invested in one security, it would cease to be a CEF and be in violation of the Investment Company Act. ... In other words, I think this isn't a particularly realistic example of a "constructive return of capital."

    It's a simplifying assumption, not intended as a realistic example. I make similar simplifying assumptions when posting on bond fund statistics. I often reduce the portfolio to a single bond. One can then reach the same conclusion for the general case by summing the demonstrated effect over N securities in the portfolio.

    Side note: I took a quick look through the '40 Act because I wanted to suggest that my example likewise would violate the Act for an RIC. But while Section 5(b)(1) sets min diversification requirements for diversified funds (open- and closed-end), Section 5(b)(2) does not restrict the concentration of nondiversified funds.
    https://www.govinfo.gov/content/pkg/COMPS-1879/pdf/COMPS-1879.pdf
    https://www.sec.gov/investment/fast-answers/divisionsinvestmentinvcoreg121504htm.html

    Can you give some indication of how a highly concentrated fund would violate the Act? I would have thought that FAIRX was similarly in violation for years. (It currently holds 58% in St. Joe, and 18% in cash.) Real question.
  • edited April 1
    I'm fairly certain there are limits with regard to even nondiversified funds and concentration levels above which they lose their RIC status, but I can't find it at the moment. I see some mention but not in detail here: https://stradley.com/-/media/files/publications/2017/10/04_moderncompliance_vol-ii_17_gedrichroeber.pdf

    I think here is a 50% rule mentioned that Fairholme would still qualify as a RIC under:
    https://files.klgates.com/files/upload/dc_im_08-managing_funds_portfolio.pdf

    One exception I know though is if the fund bought the security and it appreciated beyond the position size it originally purchased it, and the rules make leeway for that. But I have seen funds that have just one or two stocks give up being funds and become regular C Corps in part for this reason. They just basically wanted to own one business.

    But for practical purposes I have rarely heard funds state they are returning capital to save the end investor on their taxes because the fund is just doing so well. The most common reason for returning capital is to maintain a distribution level.
  • Thanks. The first paper references Subchapter M (of Subtitle A) of the tax code. This is where the 50% rule, Section II(C)(1)(b)(i) in the second paper, comes from.

    Here's the tax code itself: https://www.law.cornell.edu/uscode/text/26/851

    With a 58% allocation to St. Joe, ISTM that there are just two ways that Fairholme could be squeaking in under the 50% limit:
    - As you suggested, by growing into the larger allocation, or
    - Manipulating the size of its holding, since the 50% test is applied only at the close of each quarter.

    Even if there is "constructive" return of capital with a CEF, it still strikes me as deceptive. It's used to maintain dividends. That constant stream of dividends tends to appeal to people who are averse to selling appreciated shares of a non- (or low-) dividend paying fund, because that would be eating into (appreciated) capital. Yet the two are equivalent (aside from tax treatment).

    Either way, one is taking money off the table - an investment has appreciated and some of that appreciation is cashed out. The difference is largely one of appearance.

  • Quoting Lewis: "But for practical purposes I have rarely heard funds state they are returning capital to save the end investor on their taxes because the fund is just doing so well."

    Me either, and no one said they did. I did say that it's a tactic used by some investors who hold certain CEF's in taxable accounts.
  • edited April 2
    @Mark I'm not really disagreeing with you about purchasing return of capital at a discount. There is a value to the amplification of the yield from the discount regardless what the source of the yield is. But I do think there is often an intention to mislead investors with managed distributions. Consider why CEFs exist at all. At a discount they can be great investments. But think about the time when they're first issued. Who exactly is buying these CEFs at the IPO at full price and why are they buying them? In fact, it may even historically have been more than full price for CEF IPOs as the issuer and underwriter would charge commissions. In my experience, anecdotal though it may be, new CEF IPOs are sold to not bought by unsophisticated investors, often senior citizens seeking high income for retirement. The fact that the income could come from a return of capital eludes many of them. The ETF is a far more efficient lower-cost mechanism. And I think there is a reason why in recent years there has been a decline in new CEF issuance and especially permanent-capital CEF issues, as opposed to target date ones with a liquidation date that make more sense. The new CEF is generally a ripoff, and the high payouts they have, which lures income hungry seniors, often an illusion propped up by return of capital and/or leverage, which works well on the way up and cuts badly on the way down. By contrast, the deeply discounted CEF can be a great investment, regardless whether its income comes partially from return of capital or not.

    In other words, regarding the aforementioned story this thread began with, UTG maintaining its distribution is far less interesting to me as an investor than what its current discount is to NAV, how well its manager has performed versus its category peers on a total return basis, what its fees are, how much leverage it has, and whether the manager has done shareholder-friendly things like buybacks when the discount is wide. The distribution itself when return of capital is involved becomes a somewhat illusory source of return and shouldn't be the primary selling point.
  • Using Fidelity's example of "constructive" ROC with a slight modification:

    Let's say a CEF is priced at $100/share, and the fund has set a $5/share annual managed distribution. For simplicity, we'll assume a single annual payment.

    Fidelity's example: The fund keeps $5/share (5%) in cash and invests $95/share in a security. That security appreciates 10%. The fund pays the $5 out of the cash as an ROC. The investor is left with a share that's worth 110% x $95 = $104.50, all invested in the single security. No cash remaining to repeat this process.

    Modification: The fund invests all $100/share in that security. The value rises to $110. The fund sells $5 of the $110 (recognizing a cap gain of $5/$110 x $10 = 45.45¢) to pay the distribution. The investor is left with a share that's worth $105, and a tax liability of, say 23.8 % (20% cap gains + 3.8% Medicare net investment tax). That amounts to a tax cost of less than 11¢.

    In Fidelity's original example, the investor is left with a share worth $104.50 plus an ROC of $5 for a total of $109.50.

    In the modified example, the investor is left with a share worth $105 plus an after-tax div of $4.89, for a total of $109.89.

    If the former looks better to "some investors", those investors are letting the tax tail wag the investment dog.

    ISTM constructive ROC is a post hoc rationalization. One of the selling points of CEFs is that because they don't have to deal with money flowing in and out as with OEFs, they don't have to endure cash drag. Exactly.
  • edited April 2
    One of the selling points of CEFs is that because they don't have to deal with money flowing in and out as with OEFs, they don't have to endure cash drag.
    I agree. I think in some respects CEFs would be a better structure than open end funds and ETFs were it not for what is euphemistically called the "agency problem," and less politely called "manager greed." Managers hold onto CEF assets like grim death and realize they have a captive asset base regardless of the discount the CEF trades at, so they can gouge investors with high fees. On top of that they often needlessly apply leverage to the CEF because they can charge fees on both the base assets and the leveraged assets, amplifying their fees while simultaneously increasing investors' risks. A truly honorable CEF manager charging fair fees, judiciously using or not using leverage, and mindful of the pain extended discount periods cause, could be a beautiful thing. But it's like spotting an endangered species in the wild. In some respects I think the newer interval fund structure is better, allowing periodic quarterly redemptions of about 5% of assets, but still all of the current ones charge fees that are way too high and are still gaming the system with excess leverage to amplify their fees. But the advantages in the underlying portfolio of being able to invest in illiquid assets without having to worry about shareholder redemptions is a significant one.
  • Just received this today. More info on return of capital (ROC) for those interested.

    ETY: Some Thoughts On CEF Risk And Return Of Capital
  • There are vehicles like MLPs and options in closed-ends where return of capital can make sense because of their underlying structures and tax treatment but they are a minority of closed-end funds. For another take on why such return of capital payouts might exist consider this: https://scholars.law.unlv.edu/cgi/viewcontent.cgi?article=2110&context=facpub
Sign In or Register to comment.