DGI Adventure – 05-16-16 – Leap of Faith

Well after talking about it for the past several months, I finally filed the paperwork to transfer my beneficiary IRA from a high cost Raymond James brokered account to a self-directed, very low cost Interactive Brokers (IB) account. IB doesn’t recognize any of the mutual funds that I have at Raymond James, so this means liquidating everything. Hopefully the market doesn’t take a shit next week.

I also put in the paperwork to transfer the traditional IRA and the regular taxable mutual fund accounts from Raymond James. So sections 1, 2, and 3 of the portfolio are going to look VASTLY different next month.

The traditional IRA and the taxable mutual fund accounts (sections 2 and 3) aren’t going to IB. They’re going to Charles Schwab, because Capital One Investing (sections 6-8) doesn’t support any of those mutual funds on their platform either. I don’t want to sell the FESGX shares (section 3) because it would incur a pretty big capital gain. Maybe I will later this year if I can harvest some losses to offset it. The traditional IRA (section 2) went to Schwab so I don’t have to liquidate right away, but I will relatively soon. It doesn’t make sense to go to IB with only $10K in assets. If you don’t generate $10/month in trading fees, they charge you that much as a minimum. I don’t think it makes sense to do that much trading with $10K (that’s only enough for maybe one or two cash-secured put positions?) I’ll probably just do some strategic buying and holding with those assets, which Schwab’s $8 trades will work beautifully for.

But section 1…the beneficiary IRA…is getting liquidated and I’ll have +/- $190K to put to work. Holy shit! What did I get myself into? IDK, but it’s time to start thinking about what to buy!

Of that $190K, ~$100K of it has been tied up in “fixed income” funds (WHIAX, LDLAX, IDITX, IHIYX), which collectively generate ~$4,100 annual income. The idea was for these funds to generate the cash I need for the required minimum distribution (RMD), so I wouldn’t have to sell assets to cover it. That’s why I’ve been classifying those distributions as “taxable” on my dividend income tracking googlesheet. Even though those distributions take place in a tax deferred account, they were meant to be withdrawn as RMD, which is taxed as regular income.

LDLAX actually kind of served a dual purpose. It doubled as our “emergency fund” (6 months of living expenses). It’s a short duration, high grade debt fund (2 year average duration, BBB average credit quality). Pretty low beta, but also relatively low yield…better than a savings account though.

Looking back at it, the idea that I needed $100K invested in fixed income assets to generate a measly $4K in cash is a testament to how retarded my financial advisor was. Or a testament to the crappiness of open-end mutual funds? IDK. The point is I don’t think it will take quite that much now, but I still plan to allocate a significant chunk of the beneficiary IRA to “fixed income” assets. And I would like to still keep ~$25K in short duration, high grade bonds as a combination emergency fund/income source. The rest of my “fixed income” allocation will go to higher yield (riskier and/or longer term) bonds. I’m thinking another $50-60K ish.

I’m looking at closed end funds to meet these investment objectives. The primary reason is that I don’t feel like I have the time, experience, skill or resources to go looking around for individual bonds to buy. Plus $75K just isn’t enough to be adequately diversified while buying individual bonds.

So that means I need to invest in some kind of a bond fund to get bond exposure. I think closed-end funds are the best way to invest in bonds, because managers don’t have to worry about meeting redemption requests. The market price of the fund shares floats independently of the net asset value (NAV), so if investors want out, they can get out by selling shares on the open market, but it doesn’t affect what the fund managers are doing or what the assets under management are invested in. Since bonds aren’t as liquid as stocks, I feel like there’s a big risk associated with an open-end mutual fund that has to offer daily liquidity at the NAV, but is still invested in relatively illiquid assets. That’s probably why the fixed income funds I currently own (WHIAX, IDITX, IHIYX) have such crappy yields for how much risk they take. A big chunk of the fund’s resources have to be worried about liquidity, which reduces the amount of yield they can safely pay out.

ETF’s have a little bit of a buffer built into them in that shares are also bought and sold on the market rather than redeemed from fund assets, but they can’t drift too far away from their index. In order for the NAV to stay pegged to whatever index, they still have to buy and sell bonds depending on which way the market winds are blowing. I think ETFs are probably fine for very liquid underlying assets (like treasuries), but short duration, treasury ETFs have HORRIBLE yield…LDLAX is going to be hard to replace…I actually really liked that fund.

Since there are several types of funds I’m interested in, I’m going to break my research up into multiple watch lists. The Closed End Fund Association (CEFA) provided my “universe” of funds to search through. Their advanced search tool allows you to filter by a number of different variables.

When looking at closed-end bond funds, my key metrics are:

Expense Ratio

One of the primary reasons I wanted to go to a self-directed account was to get away from high fee mutual funds that are only offered to me because my broker gets a commission for every customer he sells them to. Now that I’m free to pick whatever funds I want, I’m going to be especially picky about expense ratios. That said, there aren’t a ton of closed-end bond funds, and they are actively managed so you’re going to have fees. Yes there are bond ETFs with .05% ratios, but they have that pesky liquidity problem. Fortunately these closed-end funds are able to pay very high yields because of their structure, so they earn higher expense ratios. But not too high. 1.5% is probably too high of a ceiling, but it returned a reasonable number of funds. 1% was probably a little too restrictive.


Since the market price floats independently of the NAV, you can buy shares at a discount or premium to NAV. I am not interested in buying at a premium. It’s also worth comparing current discount to historical average discounts…kind of like comparing current P/E of a stock to its 5 year average. Some funds just trade at a discount or premium, so it can be valuable to compare the current situation to its “average”.


Since CEFs don’t have to worry about redemptions, they can use leverage to boost their returns. I’m wary of leverage, and I’d prefer non-leveraged funds, but there aren’t that many of them. I guess I can live with a little bit in small doses.

Average Bond Duration

The longer the effective duration, the more sensitive a bond portfolio’s value is to rising interest rates. Longer durations should equate to higher yields, but you trade that for interest rate risk. It’s a balance, but ideally the lower the duration the better.

Average Bond Maturity

There actually is a difference between duration and maturity, but Morningstar’s explanation is a little hand wavy… From what I can tell, effective duration is a more complicated calculation than maturity. So if there’s a big difference between the two, I’m thinking it means the managers are using callable bonds, spreads/swaps/options/black magic to get their effective duration down.

Average Credit Quality

Self-explanatory I would think? Lower credit quality assets pay higher yields, but present higher risks. Morningstar uses a convoluted weighted average equation to calculate this. WHIAX and IHIYX holdings each had a weighted average quality of B…and that’s about as low as I’m willing to go.


Don’t chase yield, children. The yield is a consideration, but really more a side effect of all the other parameters. The yield is what it is. Don’t chase yield.

Closed-end funds have two kinds of yield: Income Only Yield and Distribution Yield. Income Only Yield is the amount of income the assets under management generate divided by the NAV. Distribution Yield is the amount that is actually paid out divided by the NAV. A lot of CEFs have a “managed” distribution, meaning they always try to pay out roughly the same amount. The actual income produced by the assets may not cover this, so they may sell assets, or use some other kind of hokum to come up with the delta. I’m a little wary of a fund paying the same amount regardless of what the underlying assets can “afford”, but most CEFs seem to have a managed distribution structure, so I guess I’ll just learn to live with it…or learn more about how they do it maybe.

I realize I never did post a stock watch list in April. There is an aborted “Billionaires Watch List” on the google sheet that never got completed or written up. The universe of stocks was supposed to be Bill Gates and Warren Buffet’s portfolios. The sheet is labeled 2016 Buh Buh Billionaires…you’ll have to make your own conclusions I guess.

Well dear disappointed reader, do not give up hope. The month of May will have several watch lists of the closed-end variety. Stay tuned!

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