IGD - ETB: 8% Yielding Options Fund

2023-07-14 17:29:54 ET

Summary

• Eaton Vance Tax-Managed Buy-Write Income Fund writes call options to boost its income.
• ETB distributes 8% on the current market price to its income seeking unitholders.
• The closed-end fund has left us impressed, but we still do not recommend a buy at this point in the cycle.
• Allow us to explain.

We recently covered Voya Global Equity Dividend and Premium Opportunity Fund ( IGD ), a closed-end fund ("CEF"), that met its primary objective of a high current income for its unitholders by taking the aid of options. This one also had a secondary objective of achieving capital appreciation, but with its 2005, IPO net asset value of $19, whittled down to $5.20, the going has been impossible on that front. There were quite a few things we liked about this fund based on its recent data. It does not take leverage, is tilted in favor of value sectors, has a good holding level diversification, and it trades at a discount to NAV. Then there were a few things we found hard to wrap our head around, one of them by the type of options versus the returns they generated for this closed-end fund. We left it with a holding rating.

Some might argue that the yield 9.23% is really a great way to play defense today. We agree in part and think the fund is sticking to "value" at the right time. But imagine what your yield on cost would be if you bought in at the IPO. It would be down to 2.4% currently (48 cents on $20.00). That does not inspire confidence. At present, we think the fund could still offer some alpha relative to SPY which consists of massive bloatware. But we cannot get behind this for a buy rating.

Source : "Voya Global Equity Dividend: 9.2% Yield, What's Not To Like."

Today, we cover another closed-end fund that too employs the call writing strategy: Eaton Vance Tax-Managed Buy-Write Income Fund ( ETB ). This fund also caters to the high current income need of its unitholders and has been more successful in comparison to IGD.

Capital appreciation has eluded ETB, just like IGD, but here again, it has come out looking better than the latter. ETB started off with a NAV of $19.06 and at last check traded at $13.95, while its NAV is a bit higher at $14.34.

In contrast, IGD has lost close to $70% of its inception NAV, which was the same $19.06 as ETB. There is a reason that most of these funds have a goal of capital appreciation, but it is explicitly stated as a secondary one. Income generation trumps everything else for both the fund and its unitholders, and no one loses much sleep over the preservation of capital. Fair enough. ETB benchmarks its performance against two indices, the S&P 500 Index (SP500) for its equity holdings and the CBOE S&P 500 BuyWrite Index for the options it writes. We explore the portfolio composition and its options strategy in the next two sections.

Portfolio Composition

Just like IGD, with $421 million in assets, ETB is of modest size and uses no leverage. The lack of leverage is evident from the figure below, where we can see that the total investments are equal to the total common assets.

IGD has lower management fees (0.85% versus 1.00%), but overall, the annual expenses of both are typical for funds of these types. Impressively, as we saw in the earlier section, ETB has outperformed IGD. Accomplishing this, despite a slightly higher comparative expense ratio, is no mean feat. Perhaps the composition of its portfolio will provide a eureka moment.

As we can see, ETB follows the sector allocations of its index, the S&P 500, which has been riding high over the last several months. Also, we are using the numbers as at March 31 here, as those are the most recent ones available on the fund website. This fund has a low turnover of 21% (2%-8% in 2018-2021), so there should not have been a lot of churn since then.

Coming back to the portfolio, with close to 170 holdings, the top 10 are fairly concentrated, taking up over one-third of the total asset value.

"The cream rises to the top" is a popular saying, and that will be evident when one looks at the top names in the above list, with their AI-powered VR headsets. To just call them crème de la crème is an understatement in today's climate. We do have a few solid names as we go down this list. ETB is comprised almost entirely of U.S. securities, unlike IGD that follows the global developed markets index methodology and has about a third of its assets in non-U.S. securities.

Options

Call writing for income generation is an excellent strategy to earn extra income and at the same time reduce portfolio volatility. This strategy is one that we can get behind at the concept level, but not when done mechanically. It is possible to rinse and repeatedly pocket the option premiums if you pick and choose how and when to take advantage of the market volatility. Call writing, however, gets harder in strong bull markets, which we have been enjoying for the last several months now. ETB acknowledges that and attributes its relative outperformance in 2022 against the S&P 500 index to it.

The Fund's options overlay strategy (the options strategy) -- designed to help limit the Fund's exposure to market volatility and contribute to current income -- was the largest single contributor to Fund performance relative to the Index during the period. The options strategy may be beneficial during times of market weakness, but may also detract from performance during periods of market strength. When the market was volatile and trending downward, as it was for much of the period, the option strategy of writing -- that is, selling -- stock index call options on the Fund's underlying common stock portfolio helped performance versus the Index, as premium income was relatively strong and these covered calls ended in profits

Source: 2022 Annual Report .

While ETB lagged its equity index over the longer time frames, 2022 was a different story. Although the fund had negative returns, its NAV outperformed the S&P 500 index by close to 5%.

Coming back to the buy-write or calling writing strategy the fund employs, ETB aims to sell call options on 100% of the value of its common stock holdings. Under normal circumstances, the equity holdings comprise at least 80% of total asset value, with most of them being components of the equity index. The options are short-term in nature and written on the index. We present the December 31 holdings to illustrate.

The disadvantage of index options is that they cannot be covered by buying the underlying index. They have to be settled in cash and in a bull market, often the index appreciates to a value higher than the strike and the difference constitutes a loss for the party that wrote the option, which in this case would be ETB. We have to give credit where credit is due. ETB has done brilliantly this year, tossing aside that handicap and only underperforming the S&P 500 by less than 4%. A job well done.

IGD's OTC option selling exercise left us scratching our head. It did not yield any substantial income to even write home about. ETB, in stark contrast, does it right, and options do bring the bulk of the bacon home.

Despite that, it has not been able to fund its distributions without depleting its NAV, and we can see the numbers for the last few years below.

Verdict

Sure, Eaton Vance Tax-Managed Buy-Write Income Fund has had a leg up on IGD as it follows the S&P 500 index, whereas IGD does anything but that. However, ETB has left us impressed with its performance in 2023. And yes, a portion of its distribution is return of your own capital, but even in that sphere it has done much better than IGD. Based on its last price of around $13.95, it yields a little over 8% ($0.0932/month), whereas IGD yields over 9%.

ETB is better than IGD in many aspects, although its underlying holdings are too close to the SPDR® S&P 500 ETF Trust ( SPY ) for us to give it a firm go ahead at this point. Its bear market performance is acceptable for what it does, but we were able to do a bit better by using far deeper in the money options trades. We might add this to our portfolio if we see a wide enough discount and some good correction in the technology sector. For now, we rate it as a hold.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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