ECAT - 5 Closed-End Fund Buys In The Month Of October 2023 (And 1 ETF)

2023-11-15 17:51:50 ET

Summary

• October was a challenging month for the equity and fixed-income markets, with surging risk-free rates in the Treasury market putting pressure across the board.
• I've added to positions with utility, REIT, and municipal bond exposure, taking advantage of some extraordinary discounts in the closed-end fund space.
• The key theme was to continue to limit adding any significant fund-level leverage to my portfolio in the current month, as I've been doing throughout this year.

October turned out to be another sour month for the overall equity market and for the fixed-income market as well. The biggest theme was surging risk-free rates in the Treasury market that put pressure across the board.

Over time, I look for this portfolio to grow my monthly cash flow. This works through putting new capital to work and reinvesting the steady cash that comes in monthly as well. This has a compounding snowball effect over time. The more capital that is put to work, the larger the ball of monthly cash becomes.

Besides looking to continue to add non-leveraged exposure to take down leverage in my overall investments, last month's theme was also interest rate sensitivity. As the market was pushed into correction territory with rapidly rising interest rates, there are areas that are even more sensitive.

Those areas are utilities and REITs that have been getting slammed, which is where I've added, along with adding to my municipal bond exposure. This has pushed CEFs in these areas to extraordinary discounts - whether these funds carry leverage on the fund level or not. In fact, the whole closed-end fund space is trading at some historically deep discounts.

Eaton Vance Enhanced Equity Income Fund II ( EOS )

I started the month off by adding to my EOS position, something I haven't been able to do in a while but that I've wanted to. The last time I added was going back to June of 2021. However, with the tech correction and discount opening up on the fund, it felt like a pretty good opportunity in October. The discount is still appealing now, and I did end up buying it earlier in the month, that was before the Nasdaq actually hit correction territory later in the month.

Of course, tech stocks are important to EOS because that's what its portfolio is dominated by at around 40% of the fund's investment allocation.

The fund benchmarks against the Russell 1000 Growth Index. However, it also then applies an overwrite strategy writing covered calls on its underlying portfolio. They target overwriting around 50% of the fund and write just a few percentages out-of-the-money. The latest data put the percentage overwritten was 47% and 3.8% OTM, average days to expiration was 24.

This does mean that in a raging bull market, that upside can be capped if the management team isn't careful. With a fairly concentrated portfolio of only 56 positions, they are making some significant bets on a relatively small number of holdings.

In fact, that's why the fund lost $17 million in the first half of this year on its option writing strategy as tech stocks surged, bouncing off last year's significant drop. Fortunately, those losses were more than offset by the fund's $73.34 million in realized gains and the $132.5 million in unrealized appreciation.

Nuveen AMT-Free Municipal Value Fund ( NUW )

NUW I ended up buying on two occasions, earlier in the month of October and then in the latter half as rates continued to pummel this fund. As a municipal bond fund with a duration of 8.33 years, it is incredibly interest-rate sensitive.

That's part of the play here is the fund's interest rate sensitivity. The idea is that when the Fed does pause, there should be some stabilization. Then, finally, when the Fed cuts rates in the next recession, we could get some sizeable capital appreciation.

The discount is another area that we could see narrowing, adding further upside potential. The fund is trading near the all-time lowest discount since it launched, excluding the sharp Covid drop.

Collecting some tax-free income while waiting isn't the worst thing to be doing either, in my opinion. The yield itself isn't anything to brag about at around ~4%.

However, they just bumped up the payout as expected due to seeing NII rise a touch. The raise, though going from $0.0405 per month to $0.0425, has caused the payout coverage to fall a touch below being fully covered at ~98.5%. Still, as their portfolio turns over ever so slowly with long maturities, they should be able to invest that in higher yields elsewhere with a higher rate environment.

This is the second raise the fund had this year, as they had another smaller one earlier in the year. Since the fund isn't leveraged like most muni CEFs, it hasn't had to deal with that headwind that saw those peers slashing their distributions.

A number of leveraged Nuveen muni funds did recently raise their payouts. Nuveen AMT-Free Quality Municipal Income Fund ( NEA ) is one example. However, they simply just went from overpaying to now overpaying even more. The payout ratio in July for NEA was 98.5%, and it's now ~95.7%. So the raises there didn't seem warranted; however, perhaps they are anticipating that rates are going to stabilize here - which isn't the worst guess - and therefore, going forward, their NII will also start to inch a bit higher.

abrdn Global Infrastructure Income Fund ( ASGI )

Similar to NUW, ASGI is actually quite interest rate-sensitive as well . In this case, though, it's because of its utility exposure, which competes with fixed-rate investments as income-oriented investments.

Utilities also often have huge debt piles, and as interest rates go higher and stay higher, those costs to fund such high CAPEX with debt are going to rise. Still, in the long run, utilities and infrastructure aren't going away and will always be required for society to function. For those reasons, these companies tend to have steady and predictable cash flows.

I covered ASGI quite recently , and the main takeaway is that the fund is trading at a massive discount, and the latest drop made for an excellent opportunity to average down.

Also, ASGI isn't a leveraged fund with borrowings. That's an additional headwind that most of the other leveraged closed-end funds are having to deal with at this time. The fund also favors a heavy weighting to industrial stocks that are related to infrastructure rather than going with the more traditional utility and energy plays that most infrastructure funds provide. For those reasons, the fund's performance this year has held up relatively well.

Cohen & Steers Quality Income Realty Fund ( RQI ) And Hoya Capital High Dividend Yield ETF ( RIET )

These two I'm putting together in combination to discuss because it fits my theme of avoiding adding too much leverage to my portfolio. I've also covered both of these funds in more depth in a recent piece.

RQI dropped significantly as, once again, it is an interest-rate-sensitive area of the market.

Similar to ASGI and its utility exposure, REITs are also competing against risk-free rates as they generate attention from income-oriented investors. On top of this is the leverage that is used at the REIT level, and that's another factor as refinancings come in during a higher rate environment; hence, still fitting my mission this year is to avoid adding to highly leveraged funds with the idea that it's leverage on leverage.

With that being said, RQI was too good of a deal with the price drop and discount expansion. Perhaps this is warranted, given the environment, but this is back near Covid-low levels. It's not exactly the lows in terms of price, but it's getting closer.

With that, RQI currently has a leverage ratio of over 30%, which I believe is high, and it's primarily due to the significant drop the fund has seen. For that reason, I've also paired it up with adding RIET, a non-leveraged ETF focused on REIT investments as well.

RIET is also a good complementary REIT fund, in my opinion, because it also provides exposure to quite a different set of investments in the REIT space. That includes mREITs, which I don't invest in. I feel that if it's a basket of them, it helps with diversification and adds significant yield. Additionally, it holds exposure to some office REITs that I would also otherwise avoid individually.

BlackRock ESG Capital Allocation Term Trust ( ECAT )

I further built a larger position in ECAT. This is my tactical play due to being an activist target. Saba Capital has now built up over a 17% stake in the fund as of the latest filing . Given the significant discount present, there is still an opportunity here.

At the end of the day, if nothing happens, one is still invested in a highly diversified portfolio that is roughly split between 70/30 in equity and fixed income. The fund also employs no leverage in the form of borrowings.

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