If you are an income-focused value investor, some CEFs are currently offering highly attractive “double discounts” heading into 2018. CEF investors should be aware of the distribution income sources, including dividends as well as capital gains, for example. This article reviews our current CEF holdings and several top ideas for 2018.

Closed-End Funds are NOT for everyone, but for income-focused value investors some CEFs are currently offering highly attractive “double discounts” heading into 2018. This article reviews our current CEF holdings and several top ideas for the new year.

For starters, here is a color-coded list of CEFs organized by category:

Choosing the right CEF can be daunting, but when we look for attractive closed-end funds, we look for the following:

Attractively-priced, compelling strategies
Attractive discounts versus Net Asset Value (“NAV”)
Healthy yields
Conservative leverage ratios
Prudent management

Before getting into our new ideas, here are our Current CEF holdings:

Adams Diversified Equity Fund (ADX)

Yield: 9.8%

ADP walloped the S&P 500 this year (congrats if you owned it, like us) for three main reasons. First, ADX just paid its big year-end annual dividend, and it was even larger than expected (as described in this press release) thereby bringing its annual yield to an impressive 9.8%. Second, ADX held several of the impressive growth technology companies (Facebook, Amazon, Apple, Microsoft) that lead the market higher. And third, ADX’s discount versus NAV shrunk (see chart below) thereby boosting the price return to shareholders (remember, attractive discounts versus NAV is one of the things we look for in an attractive CEF).

ADX was a big positive contributor to our performance this year.

Royce Small Cap CEFs (RMT) and (RVT)
Yields, 8.5 and 8.7%

We own these two funds too, and they were also big positive contributors to performance this year, for similar reasons to why ADX was a big positive contributor. Specifically, both funds offer big distribution yields, and both funds benefited from a shrinking discount to NAV this year. The holdings in these CEFs are also attractive from an asset allocation standpoint, as we believe small cap still has a lot more room to run. Plus the funds are relatively low-cost (low expense ratios) for a CEF, especially considering we like the management team at Royce. We’ll likely continue to own these funds for the yield and the attractive holdings. You can read more from Morningstar about these funds using the links at the end of this article.

Tekla World Healthcare Fund (THW)

Yield: 10.3%

These fund delivered positive price returns plus big income distributions in 2017, and we expect to keep holding it considering the discount versus NAV remains very attractive. We also like this fund for the relatively low management fee and the prudent use of leverage. You can read more from Morningstar about THW using this link.

New CEF Ideas:

In addition to the CEFs we currently own (as described above), here are several additional CEF’s that we consider very attractive heading into 2018 if you are an income-focused value investor.

Real Estate CEFs (RQI) (JRS) (IGR)

We like publicly traded real estate (e.g. REITs) heading into 2018 from both a contrarian value investor standpoint and a tax reform standpoint (i.e. REITs benefit under the new Tax Cuts and Jobs Act). If you’re an income-focused value investor, here are three Real Estate CEFs that we believe are worth considering because of their strategies, high income distributions, discounted prices (versus NAV) and prudent use of leverage.

Cohen & Steers Qty Inc Realty (RQI), Yield: 7.8%: The Fund seeks high current income and capital appreciation through investment in common and preferred stock issued by REITs. Its total adjusted expense ratio (1.22%) is reasonable for a CEF, it trades at an attractively discounted price, we like the top holdings in the fund (e.g. SPG, EQIX, and PLD), and we believe the leverage ratio is prudent. More information from Morningstar on this fund is available here.
Nuveen Real Estate Income (JRS), Yield: 9.1%: The Fund seeks high current income and capital appreciation through investment in income producing common stocks, preferred stocks and debt securities issued by real estate companies. And like RQI, JRS’s total adjusted expense ratio (1.31%) is reasonable for a CEF, it trades at an attractively discounted price, we like the top holdings in the fund (e.g. SPG, PLD and GGP), and we believe the leverage ratio is prudent. More information from Morningstar on this fund is available here.
CBRE Clarion Global Real Est Income (IGR), 7.7%: The Fund seeks high current income with capital appreciation through investments in income producing real estate equity securities. And like RQI and JRS, IGR’s total adjusted expense ratio (1.09%) is reasonable for a CEF, it trades at an attractively discounted price, we like the top holdings in the fund (e.g. SPG, PLD and GGP), and we believe the leverage ratio is prudent. More information from Morningstar on this fund is available here.

Worth mentioning, real estate has underperformed the S&P 500 this year (2017), but it has still delivered positive returns, big income, and looks attractive going forward from a contrarian standpoint, in our view.

Gabelli Family of Funds

Mario Gabelli is a highly successful New York based investor, and from the looks of some of the CEFs offered by his firm, you may see why. We’ve highlighted (below) three attractive Gabelli Funds with compelling strategies, high income distributions, attractively discounted prices (versus NAV), reasonable CEF expense ratios, and prudent use of leverage.

Gabelli Equity Trust (GAB), Yield 10.3%: The Fund seeks long term capital growth with current income through investment in equity securities. And like the other CEFs we like, GAB’s total adjusted expense ratio (1.10%) is reasonable for a CEF, it trades at an attractively discounted price, we like the holdings (large cap growth and value), and we believe the leverage ratio is prudent. More information from Morningstar on this fund is available here.
Gabelli Dividend & Income (GDV), Yield: 5.7%: The Fund seeks high total return through investment in dividend paying equity and debt securities. And like the other CEFs we like, GDV’s total adjusted expense ratio (1.39%) is reasonable for a CEF, it trades at an attractively discounted price, we like the holdings (large cap value), and we believe the leverage ratio is prudent. More information from Morningstar on this fund is available here.
GAMCO Glb Gold Natural Res & Income (GGN), Yield: 11.5% : The Fund seeks high current income with capital appreciation through investment in equity securities issued by gold and natural resources industries and through utilizing an options strategy. This strategy has delivered positive returns this year, though the returns have been lower than the S&P 500. However, the fund is attractive from a contrarian standpoint, and it also provides some unique expose to the out-of-favor natural resources industry. The yield is also attractive, and so is the discount to NAV. More information from Morningstar on this fund is available here.

Contrarian, High-Income, BDC, CEF:

First Trust Specialty Finance (FGB), Yield: 11.2%: Business Development Companies (“BDCs”) are known for their high yields, and they are extremely out of favor this year, which makes this BDC-focused strategy more attractive from a contrarian standpoint. BDCs have recently been adjusting their strategies considering the high yielding post-financial-crisis investments they have been benefiting from are finally rolling off the books and being replaced by new lower-yielding opportunities. It makes sense that there’d be opportunities in this space considering it is strongly out of favor right now, and the management team running this fund keeps the overall expense ratio (1.54%) reasonable. Our main caveat with this fund is that even though it offers a very high yield (11.2%) it is risky considering the fund uses leverage and so do the underlying BDCs. Plus the expenses are higher than they seem because the management teams of the individual BDCs within this fund are also charging their own fees (in addition to the First Trust fee). Nontheless, if you’re looking for an actively managed, high-income, BDC-focused (because BDCs are so out-of-favor right now) CEF, this fund is worth considering. Especially considering the holdings fall into the deep-value and small (and micro) cap space, an area that has historically performed very well over the long-term and is due for a significant rebound.

Risks:

Two important risks to consider with CEF investing are leverage and return of capital. Regarding leverage, we believe it is prudent to use a small amount of leverage, and then scale up (to a reasonable level) depending on the type/riskiness of the underlying holdings and your personal risk aversion. CEFs often use a small amount of leverage just to cover their operating costs while maintaining full exposure to the market.

Regarding return of capital, investors should understand that many CEFs generate some of their income distributions via a "return of capital" instead of simply via dividends and income. For example, if the fund appreciates more in value (i.e. generates more capital gains), then it may pay a higher distribution (sourcing some of the distribution payments from capital gains) as was the case with the Adams Diversified Equity Fund (ADX), as described earlier in this report. For this reason, we believe CEFs are often more appropriate for income-focused investors. You can see the distribution source breakdown (between dividends and capital gains) using the Morningstar links provided at the end of this article.

Conclusion:

CEFs are not for everyone. However, if you’re looking for a diversified, actively-managed strategy that offers high income distributions, then CEF’s may be worth considering. We own several BDCs (as described in this article), and we’ve also highlighted a few more that we believe are currently attractive based on their discounted prices, attractive strategies, relatively reasonable expense ratios, and prudent use of leverage. In particular, we believe the CEFs we have highlighted currently offer double discounts via their attractive contrarian/value strategies and their attractive discounts versus NAV.

For reference, you can view all of our current holdings here. And you can access detailed Morningstar information for all 530 CEFs in our earlier table using the links provided below.

Top Big-Distribution CEF Ideas for 2018

Adams Diversified Equity Fund (ADX)

Yield: 9.8%

Royce Small Cap CEFs (RMT) and (RVT)
Yields, 8.5 and 8.7%

Tekla World Healthcare Fund (THW)

Yield: 10.3%

New CEF Ideas:

Real Estate CEFs (RQI) (JRS) (IGR)

Gabelli Family of Funds

Contrarian, High-Income, BDC, CEF:

Risks:

Conclusion:

Disclaimer: Everything on this website is for informational purposes only. No information contained herein is intended to be an offer or recommendation to buy or sell any investment. Investing is risky. Consult an investment and/or tax professional before investing.

Adams Diversified Equity Fund (ADX)

Yield: 9.8%

Royce Small Cap CEFs (RMT) and (RVT)Yields, 8.5 and 8.7%

Tekla World Healthcare Fund (THW)

Yield: 10.3%

New CEF Ideas:

Real Estate CEFs (RQI) (JRS) (IGR)

Gabelli Family of Funds

Contrarian, High-Income, BDC, CEF:

Risks:

Conclusion:

Disclaimer: Everything on this website is for informational purposes only. No information contained herein is intended to be an offer or recommendation to buy or sell any investment. Investing is risky. Consult an investment and/or tax professional before investing.

Royce Small Cap CEFs (RMT) and (RVT)
Yields, 8.5 and 8.7%