High Yields from Closed-End Funds

08/22/2018 5:00 am EST

Focus: FINANCIALS

Todd Shaver

Founder and Editor-in-Chief, BullMarket.com

John Freund, contributing editor to Todd Shaver's BullMarket.com, sees potential opportunity for investors in two specialized closed-end income vehicles — a tax-free municipal bond fund with low leverage and and an income fund yielding 8% from global credit, corporate debt and mortgage-backed securities.

Nuveen AMT-Free Municipal Credit Income Fund (NVG) offers a 5.4% tax free (a 9% taxable equivalent). As a closed-end fund (CEF), it raised a fixed amount of capital from shareholders in a public offering as opposed to a mutual fund that continually issues shares based on investor demand.

The entire industry plummeted early this year on fear that rising rates would cripple CEF managers’ ability to borrow short-term money for the purchase of long-term debt. As the yield curve flattens, the gap between the short-term interest these funds pay and the long-term interest they earn narrows, leaving them with less room for profit in between.

But Nuveen is more fundamentally sound than most of its CEF peers. The company offers consistent dividend payouts thanks mainly to relatively low leverage (only 37%). Although it’s been choppy waters, we see very little downside here given that the stock is trading near its 3-year lows. N

Nuveen AMT-Free may not ever become a breakout hit, but the reason we love it is for that stable, dependable dividend. Nuveen is a solid defensive play, and one that could indeed turn offensive very quickly.

Another opportunity is PIMCO Dynamic Income Fund (PDI), which yields 8.0%. This closed-end fund invests its $2.6 billion of assets in global credit, corporate debt and mortgage-backed securities. No sector makes up more than 4% of PIMCO Dynamic’s portfolio, which means the fund is well-diversified should any one sector take a hit. 

Even though we’ve been in a climate of rising interest rates for some time now, PIMCO’s net asset value has increased 5% over the last year thanks to a wise acquisition strategy implemented in years past. The fund scooped up non-agency MBS at deeply discounted rates in the wake of the Great Recession, when banks and institutional investors were offloading those assets to meet new regulatory requirements.

Nobody wanted this debt, but PIMCO Dynamic placed a bet that those ratings would rise once the dust settled and the economy picked up steam. Fortunately for the company, their prediction panned out as expected. That puts the firm in an enviable position, given that a full 60% of its portfolio is allocated to mortgage-related debt.

Over the last five years, the fund has increased its dividend 25%. PIMCO tends to keep a lid on dividend growth rates, but management isn’t shy about rewarding investors on its proactive MBS acquisitions strategy. This is one of the best-positioned funds out there, so there’s plenty of runway ahead as the underlying value of the MBS portfolio continues to improve. PIMCO Dynamic is a great long-term buy.

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