HFRO - The 'High-High-Low' Closed-End Fund Report August 2023

2023-09-04 11:49:19 ET

Summary

• Only funds with yields over 8%, coverage higher than 90%, and trading at a discount are considered.
• Top lists of discount, yield, DxY, and DxYxZ are given.
• The top DxYxZ funds from this month's report are HFRO, BANX, and FPF.

"High-High-Low" Closed-End Fund Report

Quantitative screens help to rapidly narrow down attractive candidates from the database of 500+ closed-end funds [CEFs] for further due diligence and investigation. The "High-High-Low" report was inspired by a member of CEF/ETF Income Laboratory, who wrote:

Stanford, you should do a follow up article on CEF that distribute 8%+, have 90% or more coverage and trade under NAV. What does that look like in today's world? How many funds are doing that? What are the Z scores? I think many investors would be interested who are pushing for higher yield to identify best in class of aggressive funds that are coming close to covering dividends. Allows people to reevaluate risk/reward.

The "High-High-Low" report screens for the following three attributes that we would like to screen for:

1. High distributions (>8%) (i.e., 8% or higher yields)
2. High coverage (>90%) (i.e., 90% or better coverage)
3. Low premium/discount value (<0%) (i.e., trading at a discount)

How is coverage calculated?

For some of the major fund houses (PIMCO, BlackRock, etc.), the latest trailing coverage numbers from the fund's latest unaudited monthly estimates are used. For the remaining funds, the coverage ratios are calculated using earnings data from their most recent annual/semi-annual reports. As these reports are released only twice a year, the coverage ratios will show more of a lag (of up to 6 months) compared to those fund families that release monthly earnings estimates.

I hope that these rankings of "high-high-low" CEFs will provide fertile grounds for further exploration and due diligence. As a reminder, these top lists are meant to be preliminary shortlists for further research, not meant to be the final analysis for a buy or sell decision.

Key to table headings:

P/D = premium/discount

Z = 1-year z-score

Cov = coverage

1Y NAV = 1-year NAV total return

Lev = leverage

BE = baseline expense

Data were taken from the close of August 25th, 2023.

1. Top 10 widest "high-high-low" discounts

The following data show the 10 CEFs with the widest discounts, yield >8% and coverage >90%. Z-scores, leverage and baseline expense are shown for comparison.

2. Top 10 lowest "high-high-low" z-scores

The following data show the 10 CEFs with the lowest 1-year z-scores, yield >8%, coverage >90% and premium/discount <0%. The more negative the z-score, the cheaper the fund is relative to its recent average discount. Leverage and baseline expense are shown for comparison.

3. Top 10 highest "high-high-low" yields

The following data show the 10 CEFs with the highest yields, coverage >90% and premium/discount <0%. z-scores, leverage, and baseline expense are shown for comparison.

4. Top 10 best combination of "high-high-low" yield and discount

Buying a CEF with both a high yield and discount not only gives you the opportunity to capitalize from discount contraction, but you also get "free" alpha every time the distribution is paid out. This is because paying out a distribution is effectively the same as liquidating the fund at NAV and returning the capital to the unitholders. The "DxY" metric multiples yield and discount together; the more negative the "DxY" metric, the better. Only funds with >8% yield, >90% coverage and <0% premium/discount are considered.

5 . Top 10 best combination of "high-high-low" yield, discount and z-score

This metric because it takes into account all three factors of yield, discount and z-score. The composite metric simply multiplies the three quantities together. A screen is applied to only include CEFs with a negative one-year z-score. As both discount and z-score are negative while yield is positive, the more positive the "DxYxZ" metric, the better. Only funds with >8% yield, >90% coverage and <0% premium/discount are considered.

Top DxYxZ funds

The top DxYxZ funds from this month's High-High-Low report are HFRO, BANX and FPF.

The Highland Income Fund ( HFRO ) is a relatively complex, hedge fund-like CEF that invests in a few, highly-concentrated positions. It has an attractive set of valuation metrics, including a discount of -39.60%, yield of 11.28% and z-score of -1.7, however investors should consider HFRO's history and management before investing (see HFRO: Thoughts On The Conversion Proposal ).

ArrowMark Financial Corp ( BANX ) is a unique CEF focusing on regulatory capital relief securities and other banking debt securities (see Nick's latest article on BANX here ). It yields 9.40% with a -22.70% discount and -1.1 z-score, however, note that the current discount is based on the 7/31 NAV.

First Trust Intermediate Duration Preferred & Income Fund ( FPF ) is a fairly standard preferred fund from First Trust. It trades at a discount of -13.27% with a 1-year z-score of -1.7, and yields 8.51%.

Strategy Statement

Our goal aims to provide consistent income with enhanced total returns. Our CEF rotation strategy includes trading between CEFs to exploit fluctuations in valuations. This is because CEF prices are inefficient, with investors often overreacting to both the upside or downside, or being unaware of upcoming corporate actions. This could help capture alpha from CEFs for the nimble investor.

Remember, it's really easy to put together a high-yielding CEF portfolio, but to do so profitably is another matter! Our experience has been that it is very possible to earn profitable returns in CEFs. While there are numerous opportunities in the closed-end fund sector, it is essential to remain vigilant of the associated risks. Blindly chasing yield is not a prudent strategy.

For further details see: