As dividend investors — and closed-end fund (CEF) investors, specifically — we know to stay the course when market corrections hit: we don’t want to sell and cut off our precious payouts, notes Michael Foster, investment strategist for Contrarian Outlook.
By staying the course with our CEFs’ high yields, we can sit tight during rocky times, happily collecting our payouts until things calm down. Our high-yield closed-end funds (CEFs) give us a big advantage because we always demand a discount when we buy.
That’s because a CEF with a deep discount to net asset value (NAV, or the value of the fund’s portfolio) can act as a “shock absorber” for our portfolio, as it’s tough for a deep-discounted fund to get cheaper!
We saw that in action with two of our recommended healthcare CEFs — the Tekla Life Sciences (HQL) and Tekla Healthcare Investors (HQH) funds, which both traded at discounts around 11% in early March 2020.
This duo didn’t fall as far as the S&P 500 when the crash hit, and they bounced back faster (and higher) than the market as their discounts narrowed to around 7% by the end of the year. What’s more, both funds historically yield from 7% to north of 9%. And as the return above includes dividends, much of it was in cash.
We can also give ourselves another layer of protection by adding funds that actively reduce their own volatility (and boost our income, too). Take CEFs that hold municipal bonds, which are much less volatile than stocks and offer high dividends that are tax-free for most investors. Both of those strengths make them great options in tough times.
Consider the BlackRock Municipal Income Trust (BLE) and the BlackRock MuniYield Quality Fund (MQY). Both survived the last two recessions (they haven’t been around to see more than that) and made money along the way.
And we shouldn’t discount the value of that tax-free-income benefit. Right now, BLE yields 5.3%, which is healthy enough on its own, but that could be the taxable equivalent of an 8.8% payout for you if you’re in the highest tax bracket. Similarly, MQY’s 5.1% yield could be the same as an 8.1% payout on a taxable stock or fund for a high earner.
Another option is a covered-call CEF, which sells call options (contracts that give buyers the option to buy the fund’s assets at a fixed price in the future in exchange for cash now).
That’s a smart way to generate income because the stock either gets sold at the fixed price—called the “strike price”—or it doesn’t. Either way, the fund keeps the payment the buyer makes for this right, called the premium, and hands it to shareholders as part of their dividend. This strategy does particularly well in volatile times like today.
A popular covered-call CEF is the Nuveen S&P 500 Dynamic Overwrite Fund (SPXX). As the name suggests, it holds the stocks in the S&P 500, so its portfolio looks much like that of a popular index fund, such as the SPDR S&P 500 ETF Trust (SPY), with Apple (AAPL), as its top holding, followed by Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN) and Tesla (TSLA).
But unlike SPY, which yields a minuscule 1.3%, SPXX gives you a serious dividend payout of 5.8%, thanks to its smart dividend strategy.
