Closed-end funds that pays out a reliable stream of income can help in the planning for retirement, explains Rida Morwa; in this special 5-part report, the editor High Dividend Opportunities highlights his favorite ideas for retirees and other income investors.
Flaherty & Crumrine Dynamic Preferred and Income Fund (DFP) has one of the best CEF managers in the field. Being actively managed, unlike a passive ETF that tracks an index blindly, a CEF manager and its management of the fund's assets are critical to the performance of the fund.
DFP is a closed-end fund generating current income with a heavy emphasis on the preferred securities of financial companies. These industries represent almost 82% of the fund's holdings.
Click here to read The Best Closed-End Income Funds, Part 1: Municipal Bonds
Click here to read The Best Closed-End Income Funds, Part 2: Real Estate
With the increase in interest rates over the last year, the NAV of DFP is down. This is to be expected and isn't automatically a bad thing. New assets with higher yields can be purchased as rates go up. 90% of current assets are fix-to-float which will also eventually benefit from increasing interest rates.
While investors have been trained to automatically think that rising prices are better than falling prices, being a net buyer means that lower prices can be an opportunity. That is the case today with funds that hold preferred shares. DFP is positioned to benefit from rising rates but is now priced at a bargain.
DFP fully covered its distribution last year with interest and dividend income from its holdings. It did not need to use any capital gains (long or short) to cover the distribution, nor did it have to use ROC (Return of Capital). So far this year, that has continued to be the case. While it has had to trim the distribution some, that means that it is well positioned when its fix-to-float coupons increase due to higher interest rates.
Financial companies rarely run into trouble. That might not seem obvious given how many financial companies did run into problems during the Great Recession, but that was one of the more unusual features of that recession.
Banks and insurance companies are some of the most regulated entities and they rarely get into trouble. And when they do, most often they are just bought up by other stronger companies, which makes their preferred shares very safe to own. Other financial companies aren't as tightly regulated, but they still tend to be fairly safe.
Right now, the fear of the impact of higher interest rates is having an outsized impact on the price of preferreds and funds like DFP that invest in them. This makes for a very good opportunity to pick up a fairly safe investment with a high yield. Even with the announcement on July 21, projecting the most recent distribution for a year gives a forward yield of 7.15%, about the 5-year average.
With about 45% of its portfolio in investment grade securities (and another 40%+ in companies with investment grade), the 90% fixed-to-float nature of the holdings makes this a good buy for solid safe income in uncertain times.
