DGI Adventure – 05-25-16  Closed End Fund Watch List – Part 1 of 3

Last week I mentioned that once my inherited IRA is transferred over to Interactive Brokers (IB) I will need to replace my “fixed income” investments, and I’m looking at closed end funds (CEFs) to do it. The funds I used to hold at the old Raymond James account aren’t supported on IB’s platform, so I’m liquidating and starting from scratch. That process takes a number of days for everything to settle, so it’s all in flux at the moment. As of this writing, I haven’t updated the portfolio back at the mother ship, but I expect it should be sorted out before it’s time to do May’s monthly summary. I will probably be sitting on gobs of cash when I analyze the allocation snapshot at that point. I don’t want to dilly dally too much with the fixed income stuff, so my watch list efforts are focused on bond CEFs right now.

In last week’s post, I went through the metrics that I am focusing on for comparing CEFs. You may have noticed some new tabs on the watch list. I’ll talk about those funds a little bit more today.

I’ve added two tabs which is where this first watch list is coming from. For now I’m focusing on funds that are not classified as “high yield”. I ran the Closed End Fund Association’s (CEFA) fund screener on the “General Bond Fund” and the “Corporate – BBB Rated Debt” categories, looking for funds with an expense ratio less than 1.5%. I’m including leveraged and non-leveraged funds. I also included the one US Mortgage fund that had an expense ratio below 1%: BKT. It’s on the “General Bond Fund” tab in the watch list google sheet. It didn’t make sense to make a whole tab for one fund even though it is technically a different CEFA category.

It’s also worth looking at what I’m trying to replace. My old funds were open ended mutual funds, so it’s a little like apples to oranges, but I’d like to keep the general risk allocation relatively steady. Here’s a table of the 4 funds I had:

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Since these are all open ended funds, none are leveraged, so there isn’t really any delta on the “income yield” versus “distribution yield”. Also they don’t ever trade at a discount to NAV.

WHIAX and IHIYX are what you would call “high yield” funds, based on their average credit qualities being well below investment grade. We’ll look at their replacements in the next watch list. In other words this watch list is focused on funds that would theoretically be replacing LDLAX and IDITX.

So without further ado…here is the:

CEF Watch List Part 1 of 3: General and BBB Rated Debt Funds

1. MFS Intermediate Income Trust (MIN)

The things that jump out at me are the investment grade credit quality (AA) along with relatively short duration (3.42) and maturity (3.65). Also…no leverage. I’m not at all surprised to see that the income yield is only 2.22%…that sounds about right for the kind of income that would be generated by zero leverage investments in such short duration, high quality debt. So why is the distribution yield 9.31%??? It’s a managed distribution fund, that targets 8.5% of NAV. So 9.31% is what you get after the 5.5% discount between market price and NAV. Seems too good to be true, no? On paper it looks like it would be a huge upgrade from LDLAX: Slightly longer duration, but much higher average credit quality with a much lower expense ratio (0.64% vs 1.25%), and a MUCH higher distribution yield. They have to be trading those bonds to make up the yield delta (between income yield and distribution yield) with capital gains I guess. But even if the managed distribution were lowered because of a tough bond market, the fundamental assets should hold their value. I’m not ready to just swap LDLAX for MIN dollar for dollar in terms of allocation, but I definitely want me some MIN right?

CEFA summary page can be found here.

Fund fact sheet can be found here.

2. BlackRock Enhanced Government Fund (EGF)

Even after adjusting for leverage, the average effective duration is only 3.25 years (2.53 unadjusted). The maturity is quite long though. For some reason, Morningstar doesn’t calculate the weighted average maturity for every fund, but you can get a pretty good sense just looking at their graphical breakdown:

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Source: EGF Portfolio Summary at Morningstar.com

I don’t love the leverage but at least it’s relatively low (23.1%), I also like that the income yield and distribution yield are a little closer together (2.83% and 4.42% respectively). Compared to LDLAX, the credit quality is just a touch lower (BBB-) and the duration a touch higher (unadjusted for leverage it is only 2.53 years. But the yield seems to be appropriately higher given the added risk, and again 25 basis points lower expense ratio…Also like the diversity added by the government debt.

CEFA summary page can be found here.

Fund fact sheet can be found here.

3. Putnam Premier Income Trust (PPT)

One of only two “General Bond Fund” CEFs that met my expense ratio criteria and don’t use leverage. With average credit quality of BB, IDITX is probably the more appropriate comparison here. Expense ratio is about the same (0.87%). I don’t understand how they get their average duration down to 0.60 years and still have an income yield of 4.74%…but no leverage probably helps. Plus about 52% of the assets are securitized and the average maturity is longer (8.55), but not crazy longer. There is some kind of black magic going on there, but they’ve been doing this since 1988, so it’s not like there isn’t a track record.

CEFA summary page can be found here.

Fund fact sheet can be found here.

4. Putnam Master Intermediate Income (PIM)

The other non-leveraged “General Bond Fund”. Run by the same people, with a pretty similar profile to PPT, just a higher expense ratio? Discount to NAV would be the biggest differentiation between PPT and PIM.

CEFA summary page can be found here.

Fund fact sheet can be found here.

5. Pimco Income Strategy (PFL)

Another “General Bond Fund” with average weighted quality of BB, but this one uses leverage (20.84%). The duration is a bit more “normal” and comparable to IDITX at 3.49 years…again that is leverage adjusted. Unadjusted is lower at 2.84. The expense ratio is high at 1.30%, but good Lord look at that distribution yield: 10.81%!!?! If they’re going to pay that kind of managed distribution, the managers should be getting paid pretty well.

CEFA summary page can be found here.

Fund fact sheet can be found here.

6. Wells Fargo Multisector Income Fund (ERC)

Similar metrics to PFL, but with more weighting on corporate debt, and no global diversity. Also a bit more leverage, and still a high expense ratio. IDK. Not that impressed, but it’s on the watch list I guess? A lot of these CEFs have pretty high durations, so if you want to keep that down, the pickins are slim.

CEFA summary page can be found here.

Fund fact sheet can be found here.

7. BlackRock Income Trust (BKT)

With 93% of its assets in mortgage backed securities, this fund doesn’t really compare to any of the funds I was holding before. I like the high credit quality (AA-). I don’t love the duration or leverage. The expense ratio is pretty average for this type of specialized fund. I think it’s worth considering as a relatively small “experimental” position.

CEFA summary page can be found here.

Fund fact sheet can be found here.

Conclusion

I’m not sure if I want to get into all of these funds or not, but these are the “non high yield” CEFs that piqued my interest and are comparable to LDLAX and IDITX (except BKT of course). Fortunately with the low trading commissions charged by IB, I can split my fixed income investments up into a broader mix of funds with smaller positions in each one. Not only was my previous broker focused on selling me funds that were in his ecosystem so he could get commissions, but any position I did take had to be relatively big to keep the up front commissions down.

Coming up next: CEF Watch List Part 2 of 3: High Yield Bond Funds

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