FPF - PCEF: A 9% Yield ETF With A Concerning Track Record

2023-04-19 15:53:10 ET

Summary

• Invesco CEF Income Composite ETF is a fund of closed-end funds.
• PCEF has outperformed its competitor Amplify High Income ETF in the last 10 years.
• However, historical return, distribution growth and holding discount are concerning.
• Bonus: A solution to avoid capital decay in CEFs.

This article series aims at evaluating ETFs, or exchange-traded funds, regarding the past performance of their strategies and quality of their current portfolios. As holdings and weights change over time, updated reviews are posted when necessary.

PCEF strategy and portfolio

Invesco CEF Income Composite ETF (PCEF) is a fund of funds. It has been tracking the S-Network Composite Closed-End Fund Index since 02/19/2010. It has a portfolio of 115 closed-end funds and a 12-month distribution yield of 9.2%. Distributions are paid monthly. The total expense ratio is 1.99%: 0.50% in ETF management fees, plus 1.49% in held fund expenses.

Eligible funds are screened on several factors. In particular, premium to net asset value must be under 20%. Weights are based on net asset value and adjusted to favor funds with a discount and penalize those with a premium. Constituent weight is capped at 8%. The top 10 holdings, listed below, represent 28.5% of asset value.

Closed-end funds are often chosen by investors for their distribution yield. They also have a few metrics that are not applicable to stocks and ETFs. Two of them are more important than the yield:

• Discount to NAV (higher is better).
• Relative discount = Discount to NAV minus its 12-month average (higher is better).

The next table compares PCEF holdings with the full CEF universe regarding these metrics. Out of 115 holdings, 108 with available data have been taken into account in the calculation. Their averages are inferior to the universe averages.

Calculation using Portfolio123.

Performance

In the last 10 years, PCEF has beaten its closest competitor, the Amplify High Income ETF (YYY), another ETF of CEFs.

The next table compares PCEF since inception (February 2010) with U.S. large cap equities ( SPY ), the total U.S. bond market ( BND ) and a 60/40 mix. Dividends are reinvested to calculate the total return.

Data calculated with Portfolio123.

In fact, SPY, BND or even a 60/40 mix are not appropriate benchmarks. I will suggest a better one. The next table compares PCEF since inception with a subset of the closed-end fund universe: the 100 CEFs with higher yields among those with an average trading volume above $100'000 per day and a positive discount to net asset value. To make it comparable with a passive index, the subset is reconstituted in equal weights every quarter.

Past performance is not a guarantee of future returns. Data Source: Portfolio123.

This benchmark, much simpler than PCEF's underlying index, beats it by 25% in total return. A note of caution: the fund's return is real, whereas the subset is simulated.

PCEF annualized return reinvesting all distributions is below the current distribution rate, which is a clue that the fund may pay a high yield at the cost of capital decay. This is confirmed by the share price history (next chart): it has lost almost 29% since inception:

The next chart plots the annual sum of distributions in the last 11 years. It has been slowly decreasing by 12.9% between 2012 and 2022. In the same time, the cumulative inflation has been about 30% (based on CPI). Besides a decay in capital (share price), the fund has also suffered a decay in income stream.

Takeaway

Invesco CEF Income Composite ETF selects closed-end funds using a rule-based strategy. It has outperformed its close competitor YYY in the last 10 years. However, Invesco CEF Income Composite ETF historical price return, distribution growth, average holding discount and total expense ratio are concerning. PCEF may be a useful instrument for tactical allocation, swing trading or capturing some market anomalies, but I don't see it as a long-term investment to preserve income and capital.

Bonus: A solution to avoid capital decay in CEFs

Most ETFs with a yield above 6% suffer from capital and distribution decay, not only PCEF. It is also an issue in many closed-end funds. However, capital decay may be avoided or mitigated by rotational strategies. I designed a 5-factor ranking system in 2016, and monitored its performance during several years. I started publishing the eight best ranked CEFs in Quantitative Risk & Value (QRV) after the March 2020 meltdown. The list is updated every week. It isn't a model portfolio: trading the list every week is too costly in spreads and slippage. Its purpose is helping investors find funds with a good entry point. In the table below, I give the hypothetical example of starting a portfolio on 3/25/2020 with my initial "Best 8 Ranked CEFs" list and updating it every 3 months, ignoring intermediate updates. Return is calculated with holdings in equal weight and reinvesting dividends at the beginning of every 3-month period.

This simulation is not a real portfolio and not a guarantee of future return

Of course, past performance (real or simulated) is not representative of future return. However, I think a time-tested rotational strategy in CEFs has a much better chance to protect both capital and income stream against erosion and inflation than a high-yield ETF.

For further details see: