HQH - Buy The Dip - 2 Dividends At Bargain Prices

Summary

• CEFs trend towards a reversion to mean over time.
• We find two funds trading outside of their normal discount/premium.
• One of our picks gives high levels of tax-free income.

Co-produced with Treading Softly.

For years you have been surrounded by forces of nature without giving them as much as a second thought.

Consider gravity for a moment. It keeps you planted to the ground beneath you, and as a force, it continually pulls down on your body. Without gravity, an errant move would send you sailing off into outer space.

For centuries, humanity knew gravity existed but didn't quantify it. Now that we have, we also can note when gravity is different in other domains – like space itself, or the moon, for example.

Similarly, when it comes to the market, some forces are more like forces of nature. People trade around moving averages, Fibonacci numbers, etc., and by noting these patterns - they also help reinforce their effects.

With CEF (Closed-end Fund) trading, a common reference is a "reversion to mean" – a force that pulls a CEF back to its historical discount or premium. At times, a CEF can overcome this force and set a new normative discount or premium, but it is very difficult to do so.

Careful CEF investors or traders will attempt to use this as a method to move in and out of CEFs to maximize returns from trading or holding.

Today, I want to look at two CEFs that pay high levels of current income and are trading below their historical premiums/discounts.

Let's dive in!

Pick #1: DMB - Yield 4.3%

BNY Mellon Municipal Bond Infrastructure Fund ( DMB ) is a CEF that invests in municipal bonds. A main attraction for municipal bonds is that they are tax-exempt, making them a very tax-efficient investment.

2022 was a horrible year for bonds. In fact, most are calling it the worst year ever for bonds. DMB uses leverage and invests in municipal bonds, which are generally lower-risk than equivalently rated corporate bonds. The whole sector fell.

There were two main catalysts for a significant down year:

1. High inflation.
2. A very hawkish Fed.

Both of these have a negative impact on bond prices, and last year we saw both. What is in store for 2023?

Inflation is coming into the year on a strong downtrend. I've frequently discussed the factors that will cause CPI to continue trending downward.

The Fed is less predictable but has slowed its hikes to just 25 bps each. Last year, it was hiking 75 bps at four meetings in a row. There might be room for disagreement about whether the Fed might hike two, three, or four times this year, but unless something dramatically changes, the pace will be much slower than last year.

We don't know when the Fed will pivot, but it is a good bet that rates are much closer to the peak than the bottom. At some point in the future, rates will be reduced again. When that happens, it will be very bullish for bonds.

The time to buy is when investments are cheap and out of favor. Municipals are currently out of favor, and DMB, in particular, is trading at an attractive discount to NAV.

DMB is paying a modest 4% yield while you wait for the inevitable dovish turn from the Fed. We don't know exactly when that will happen, but we want to make sure we have holdings that will benefit when it does.

Pick #2: HQH - Yield 8.7%

Tekla Healthcare Investors ( HQH ) is a CEF that invests in the healthcare sector with an emphasis on biotech and pharmaceuticals. Its top 10 holdings include many mega-cap names like Amgen ( AMGN ), Gilead Sciences ( GILD ), and Regeneron Pharmaceuticals ( REGN ). Source .

This is a sector that is dominated by large, well-capitalized companies. Unfortunately, dividend yields for these companies are not terribly high. That's where a CEF like HQH can fit well in the HDO portfolio, converting exposure to healthcare companies into dividends.

CEFs are required to pay out most of their taxable income, including realized capital gains, as dividends. HQH handles this obligation with a variable dividend policy. HQH pays out 2% of NAV each quarter. As a result, when NAV is lower, it reduces the dividend so it doesn't have to liquidate assets at poor prices. When NAV is higher, the dividend will rise on its own, so investors don't have to wonder whether management will raise the dividend or keep capital gains unrealized.

Over the past year, the quarterly dividend gradually declined as the market sold off. This trend changed last week when HQH announced a 7.7% dividend increase to $0.42 for the first quarter.

Over the past year, HQH's price has fallen further than its NAV. The dividend is based on an annualized yield of 8%, but since we can buy at a discount, the annualized yield will be approximately 9%.

The dividend changing from a downward trend to an upward trend could be a catalyst for the price to close the gap and trade closer to NAV. We are happy to buy at this discount before the market realizes that the dividend is rising.

Conclusion

With DMB and HQH, you can buy excellent income at phenomenal discounts. DMB offers federal tax-free income, which you can buy at a discount, while Muni bond prices are at significant discounts. I will tell you there is a unique joy when you receive your 1099-DIV, and you see the income from DMB reported and are not paying an extra dime on taxes from it. HQH allows you to buy here at a discount and enjoy rising variable distributions, as HQH's NAV recovery has outpaced its market price movements.

For retirement, you need income to meet those bills that keep on coming. I learned a long time ago that in this world nothing makes money like money can.

Take your army of dollar bills, and don't let them be lazy. I love buying discounted CEFs, preferred securities, and oversold companies to grow their income.

This way, you can enjoy a financially stable and secure retirement. That's the beauty of income investing and the success of our Income Method.

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