Looking for closed-end fund income? Let this ETF do the work
For many income investors, closed-end funds are an attractive asset class. These funds typically deliver above-average returns, and there are many instances where closed-end funds trade at a discount to the net asset value (NAV), providing a sort of value proposition.
However, choosing the right closed fund is no less tricky than selecting individual stocks. Fortunately, the Invesco CEF Income Composite ETF (NYSEARCA: PCEF) makes it easier for investors to venture into this asset class.
PCEF, which is around 11.5 years old, tracks the S-Network Composite Closed-End Fund Index (CEFX). This benchmark is a basket of closed-end funds, which means that PCEF uses a fund of funds structure. In addition to the monthly income generated by closed-end funds and PCEF, there are more advantages to investing in the Invesco fund.
“To begin with, closed-end funds are exempt from corporate tax on the condition that they pass on net investment income (interest and dividends) to shareholders,” explains Alerian analyst Roxanna Islam. “Most CEFs pay these distributions monthly, although some also pay quarterly, compared to traditional fixed income instruments, which pay coupons semi-annually. “
A powerful income solution
With a 30-day SEC yield of 6.46%, the $ 932.1 million PCEF lives up to its billing as a credible income idea, especially in today’s low yield environment. As appealing as this yield and the monthly payout are, there are more benefits than you might think with PCEF, including some tax benefits.
“CEFs also pay net distributions of realized capital gains generally at the end of the year. Some equity and alternative strategy funds, however, expect to earn a large portion of their return through capital gains, rather than dividends or interest, ”adds Islam.
Another advantage offered by closed-end funds appears in the fixed income side, which represents about 64% of the PCEF range. Many closed-end fund managers use leverage – borrowing at lower short-term rates and reinvesting the proceeds at higher-yielding long-term rates. This strategy of increasing income is used by about two-thirds of closed-end funds. As Alerian’s Islam notes, the current climate is also conducive to this strategy.
“Lower interest rate environments, like our current environment, are particularly beneficial for funds that use leverage. As short-term interest rates fall, the cost of leverage (i.e. the cost of borrowing) decreases and the fund’s profits increase as the spread between the cost of borrowing and the rate of investment widens, ”the analyst said.
PCEF, which allocates 36.32% of its weighting to options income strategies, is up nearly 13% since the start of the year.
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The opinions and forecasts expressed herein are solely those of Tom Lydon and may not come to fruition. The information on this site should not be used or interpreted as an offer to sell, a solicitation of an offer to buy or a recommendation for any product.