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4 High Yield Closed-End Funds For Your Income Portfolio

Regardless of the discount or premium to NAV, I believe the more important aspect is the subsequent total return.

Many investors have heard of mutual funds and exchange-traded funds (ETFs) but aren't familiar with Closed-End Funds (CEFs). CEFs are a well-kept secret in the income community even though some of the largest investment houses from Blackrock to Fidelity offer CEF investment vehicles.

What exactly are CEFs?

A CEF is a publicly-traded investment company that invests in a variety of securities, such as stocks and bonds. A CEF will raise capital through an IPO, and the reason they are considered closed funds is that once the capital is raised, the issuance of new shares is closed to investors. After the IPO closes, shares are no longer available from the fund's sponsor. Upon completion of the IPO, CEFs are traditionally listed on a stock exchange such as the NYSE or Nasdaq, where investors can buy and sell shares with other investors.

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How do CEFs work?

Many CEFs are an actively managed selection of investment holdings that collectively create the value of a fund known as a Net Asset Value (NAV). The actual fund's share price is determined by the market, not the NAV. CEFs are designed to convert their total returns into consistent income over time. Many CEFs utilize a managed distribution program to generate regular distributions to their investors. Distributions are comprised of interest income, dividends, realized capital gains, and potentially the return of capital. Regulations require a fund to distribute most of its investment income and realized gains each year. The NAV, which originates from the original seed capital raised in the IPO, fluctuates as the holdings appreciate or depreciate, and the holdings determine the fund's total return.

What I Look For When Selecting A CEF To Invest In

There are many CEFs to choose from, so I normally start with the investment sponsor or investment company managing the fund. I will normally look for BlackRock, Cohen & Steers, Eaton Vance, or PIMCO. These are just the companies I keep an eye out for, as many other companies have CEF products, such as Wells Fargo, Morgan Stanley, Nuveen, Invesco, JHancock, and First Trust. Next, I look at the strategy and holdings of a fund. If I am looking for an energy fund, I would like to see certain companies in the holdings such as Enbridge and Enterprise bovada Partners. Then I look at the Market Cap and like to see more than $500 million on this line item. The distribution rate is one of the critical factors, and I normally want to see 5.5% or higher. If I was going to create a screen, 5.5% on the distribution and $500 million on the market cap would be two of my starting points. The last thing I want to look at is the total return of the CEF. Most people look at the discount to the premium ratio of a CEF and are under the impression that buying a CEF with a share price that's discounted to the NAV means they are getting a bargain. Regardless of the discount or premium, I believe the more important aspect is the subsequent total return.

Four CEFs I Am Interested In For Income Generation

The first fund I am interested in is the Cohen & Steers Quality Income Realty Fund (RQI). RQI invests in real estate securities with the primary investment objective of generating income. RQI has 173 holdings within its portfolio with $3 billion in managed assets. RQI has a tight correlation between its share price and NAV as it trades at a -1.29% discount. RQI generates a distribution rate of 5.70% and has a three-year annualized return on price of 22.87%. I am familiar with many of its holdings as companies such as American Tower Corporation, Public Storage, Simon Property Group, Duke Realty, and Equinix can be found within its portfolio.

The next fund I am interested in is the Cohen & Steers REIT & Preferred Income (RNP) CEF. RNP is similar to RQI but differs as it invests in diversified preferred securities in addition to real estate. RNP also has a primary investment objective of generating higher than average income for its investors. RNP provides more diversification than RQI, with 305 holdings spread across $1.8 billion in managed assets. RQI has traded in a tight range with a 1.29% discount to its NAV. RNP has provided investors with a three-year annualized return of 22.87%. There is some overlap in RNP compared to RQI as American Tower Corporation, Public Storage, Simon Property group, and Equinix are part of its largest holdings.

The next fund on my list offers a higher yield, and it's the PIMCO Dynamic Credit and Mortgage Income Fund (PCI). PCI is interesting as it utilizes an allocation strategy across multiple fixed income sectors, with an emphasis on opportunities in developed and emerging global credit markets. PCI grabbed my attention because it provides access to areas I wouldn't invest in on my own, in addition to areas I wouldn't have access to. PCI has 1,241 holdings with a current distribution rate of 9.88%. PCI trades at a premium of 5.39% to its NAV and has generated an average annualized return over the past three years of 9.43%. While the overall return is low, my main focus is income generation and getting 9.88% in a monthly distribution with some capital appreciation checks off my boxes from an income investment.

The last CEF I put on my list is the BlackRock Science & Technology Trust II (BSTZ). BSTZ is a newer CEF as its inception was in June of 2019. BSTZ's investment objectives are to provide total return and income by combining current income, gains, and long-term capital appreciation. BSTZ has $3.4 billion in managed assets with 109 holdings in its portfolio. BSTZ trades at a discount of -3.35% to its NAV, and the year to date has returned 17.61% on its price. BSTZ has a distribution rate of 5.47%, and some of the biggest tech companies, including Tesla and Square, sit within its largest holdings.

Income And Appreciation

The combination of these funds in equal shares would have generated a YTD return of 22.92% and generated a distribution rate of 6.87% in income. Many people have dismissed income investing for the lack of capital gains and made the argument that you're better off just investing in an S&P index fund and selling shares for income. Through the combination of these four CEFs, you can have the best of both worlds as you don't need to sell shares to generate income, and your initial investment in 2021 would have appreciated by 22.92%. I think CEFs can be an interesting addition to an income portfolio as they offer diversification, above-average yields, and capital appreciation prospects.

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