Summary
- PCEF is a diversified fund of CEFs.
- PCEF provides investors with exposure to hundreds of income-producing CEFs, yields 8.4%, and has seen moderate dividend growth these past twelve months.
- An overview of the fund follows.
Author's note: This article was released to CEF/ETF Income Laboratory members on January 22nd.
The Invesco CEF Income Composite Portfolio ETF ( PCEF ) holds a diversified, multi-asset class portfolio of income-producing CEFs. PCEF's diversified holdings, strong, growing 8.4% dividend yield, and good performance track record make the fund a buy.
PCEF's key differentiator is the fund's extremely well-diversified portfolio of over 100 CEFs. Few funds offer a comparable portfolio or value proposition, an important consideration for investors looking to invest, or not, in the fund.
PCEF - Basics
- Sponsor: Invesco
- Dividend Yield: 8.42%
- PCEF Management Fee: 0.50%
- Expense Ratio: 2.34%
- Total Returns 10Y: 4.93%
- Underlying Index: S-Network Composite Closed-End Fund Index
- Holdings: 116
PCEF - Investment Thesis
PCEF's investment thesis is quite simple, and rests on the fund's:
- Diversified holdings, with investment in over 100 CEFs, and with exposure to most income-producing asset classes.
- Strong, growing 8.4% dividend yield, a benefit for all investors, especially those looking for income.
- Good performance track record, with the fund generally outperforming its peers and index.
In my opinion, the above combine to create a strong fund and investment opportunity, and one which looks particularly attractive for income investors and retirees. Let's have a closer look at each of these three points.
Diversified Holdings
PCEF is an index ETF, tracking the S-Network Composite Closed-End Fund Index , an index of income-producing CEFs. Said index includes CEFs focusing on investment-grade bonds, high-yield bonds, and equity option income/call options, meeting a basic set of inclusion and exclusion criteria. Excessively expensive funds, with management fees higher than 1.25% and/or premiums higher than 20%, are not included in the index or the fund. Security weights are dependent on NAVs and discounts. As with most indexes, there are security caps meant to ensure diversification.
PCEF generally invests in its different asset classes in roughly equal measure, as is currently the case.
PCEF generally invests in slightly over 100 funds, currently 116. Each of these invests in hundreds, some even thousands, of securities, so PCEF provides investors with indirect exposure to tens of thousands of securities, if not more. PCEF includes funds from most major CEF issuers, including PIMCO, Eaton Vance, Nuveen, and BlackRock. PCEF's largest holdings are as follows.
As should be clear from the above, PCEF is an incredibly well-diversified fund, with exposure to all the major income-producing asset classes, hundreds of funds, and tens of thousands of underlying securities.
PCEF's diversification significantly reduces all sorts of risks.
Asset class diversification reduces the magnitude of losses from losses in any one specific asset class. If equities are down, PCEF's bonds should pick up the slack, and vice versa.
Fund diversification reduces the magnitude of losses from subpar performance of any one specific fund. PCEF won't suffer significant losses if the PIMCO Dynamic Income Fund ( PDI ), its largest holding, plummets in price, as PCEF only invests 4.8% in PDI. The same principle applies for PCEF's other holdings.
Security diversification reduces the magnitude of losses from losses in any specific security, or from the bankruptcy/default of any specific issuer.
PCEF's diversification reduces risk, volatility, and the potential for significant losses or underperformance, all important benefits for the fund and its shareholders.
On a more negative note, PCEF's diversification all but precludes the possibility of significant outperformance as well. The fund simply invests in too many funds and securities to outperform the market. In a sense, the fund is the market, or, more accurately, invests in a representative sample of the same. PCEF might outperform somewhat due to discounts, underlying fund alpha, leverage, and favorable economic conditions, but significant outperformance is incredibly unlikely, in my opinion at least.
Strong, Growing 8.4% Dividend Yield
PCEF focuses on income-producing CEFs, almost all of which generate significant income. Said income is almost always distributed to PCEF, which is then distributed to PCEF's shareholders as dividends, resulting in an 8.4% dividend yield for the fund. It is an incredibly strong yield on an absolute basis, and significantly higher than that of most major asset classes.
On a slightly more negative note, the fund yields less than some of its peers, including the Amplify High Income ETF ( YYY ) and the Cohen & Steers Closed-End Opportunity Fund ( FOF ). It also yields less than some niche income-producing asset classes and funds, including BDCs and some covered call funds. PCEF's yield is incredibly high, but you do have some funds with even higher yields.
PCEF's dividends are dependent on the distributions of its underlying CEFs. Said distributions are, in turn, dependent on many factors, some of which vary fund to fund. For bond CEFs, which encompass around 2/3rds of PCEF's holdings, interest rates are a key factor. Higher Federal Reserve rates translate into higher bond rates, which mean higher income for bond funds, which, ultimately, means higher dividends for bond fund investors.
PCEF directly invests in dozens of bond funds, indirectly in thousands of bonds, so should see higher dividends as interest rates rise. As PCEF's bond exposure is indirect, the link between Fed rates and fund dividends is fraught and somewhat weak, but the link most definitely exists. PCEF's dividends grew 4.6% in 2022, a period of rapidly rising interest rates, as expected.
PCEF's dividends should see further growth in 2023, from the impact of past Fed hikes, and as the Fed is likely to hike at least a few more times in the next few months . Growth is not certain , and would almost certainly stall if the Fed pivots in the next few months, but does seem quite likely, in my opinion at least.
PCEF's strong, growing 8.4% dividend yield is a significant benefit for the fund and its shareholders, and the fund's core investment thesis.
Good Performance Track Record
PCEF's performance track record is good, although not outstanding.
The fund consistently outperforms relative to YYY, its closest peer. The fund tends to slightly underperform relative to FOF, another peer, on a NAV basis. Underperformance is more or less entirely due to a greater allocation to comparatively safe investment-grade bonds. On a price basis, the situation is generally dependent on FOF's discount, with FOF outperforming when bought at a sizable discount, underperforming if bought at a premium. FOF currently trades with a 5.0% premium, quite a bit higher than the fund's historical average, so it is not looking attractive at these prices.
Seeking Alpha - Chart by Author
PCEF's performance also looks reasonably good compared to an amalgamated index of its underlying asset classes: investment-grade bonds, high-yield bonds, and covered call equities. PCEF has outperformed an average of these three asset classes since inception and for most relevant time periods, but underperformed these past twelve months, due to widening CEF discounts.
Seeking Alpha - Chart by Author
PCEF's outperformance relative to its indexes is at least partly due to the leverage employed by the fund's underlying holdings/CEFs. A small amount of alpha seems likely and is consistent with the figures above, but it is very difficult to be certain.
In my opinion, PCEF's performance track record is reasonably good, with the fund providing some minor benefits/outperformance relative to its peers and indexes.
PCEF's Key Differentiator
PCEF offers investors a strong, growing 8.4% yield, and a good performance track record. Although this is a strong value proposition, it is also a somewhat common one. Dozens, perhaps hundreds, of CEFs have similar characteristics; PCEF itself would not have said characteristics if this were not true.
What sets PCEF apart from most income ETFs and CEFs is the fund's extremely well-diversified portfolio, with investments in over 100 funds, and with indirect exposure to at least tens of thousands of securities. The average income fund is, well, a single fund, with hundreds, perhaps thousands of securities. In the vast majority of cases, investors need exposure to several income funds to achieve a reasonable amount of diversification. PCEF, on the other hand, invests in over 100 funds, providing investors with more or less all the diversification they need in a single fund.
In my opinion, as PCEF's extremely well-diversified portfolio is the fund's key differentiator, it should be a decisive factor in an investor's final investment decision. The importance of said differentiator is ultimately dependent on each individual investor's specific circumstances and goals, and so is outside the scope of this article.
Conclusion
PCEF's diversified holdings, strong, growing 8.4% dividend yield, and reasonably good performance track record make the fund a buy.
For further details see:
PCEF: Diversified Fund Of CEFs, Strong, Growing 8.4% Dividend Yield, Good Performance Track Record