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Listen in as Teeka Tiwari, Chris Rowe, Costas Bocelli, Ed Pawelec and special guests give you the world financial news that you need to be profitable every market day... Sign up today to receive audio commentary every morning from some of the brightest minds in the industry.
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By Ed Pawelec - Creator: Price Shock Trader
From retirees who are looking for income, to younger investors looking for a safe place to hide out as the market gyrates on every headline, everyone is looking for yield.Blue chip stocks have been a favorite. Boring old stocks like AT&T (T) and Verizon (VZ) have been tearing it up in 2012 while kicking out a greater than 4% dividend yield.
But there are even bigger yields to be had. With some offering double-digit payouts, investors are diving in without a second thought. If you're among them, you may have put a ticking time bomb in your portfolio.
Some of these investment vehicles appear egregious, whereas others are simply questionable. Either way, you need to be aware of what you are buying and realize this: If an investment is yielding more than 10%, you need to know why.
Clearing the Air
Here at IFII we usually write about stocks, ETFs, and options, but the majority of investors still use mutual funds heavily. Perhaps that is fine for many who don’t have the time to dig into a stock either fundamentally or technically, but with the aforementioned widespread search for yield, active and passive investors alike can get sucked in to another type of fund.
What I am talking about are exchange traded closed-end funds (CEFs). They are generally classified like mutual funds: equity, bond, or balanced. There are more than 100 equity CEFs available, with 95 sporting a trailing 12 month yield of more than 5%. The top 10 highest yielding equity CEFs are listed below...
First, since CEFs are exchange traded, they can trade at a discount or premium to net asset value (NAV). For example, if a CEF is trading at $14.50 but has a NAV of $15, it is said to be trading at a discount. Conversely, if the same fund is trading at $15.50, it is trading at a premium to NAV. A mutual fund trades at its NAV because you can only purchase or redeem shares at the end of the day when the NAV is known. ETF shares are created or redeemed on a regular basis to keep the ETF closely aligned with its NAV.
Second, nearly all CEFs use some form of leverage, whether it is options, futures or margin. Use of leverage in typical mutual funds is severely limited. The fact that leverage is used means that there are additional risks that may not be apparent at first blush.
Finally, and most importantly, mutual fund distributions are composed of interest earned on fixed income or cash, dividends paid by any equity holdings, and short or long term capital gains from the sale of securities. CEF distributions have the same components, plus the ability to return capital. That means that part of the “dividend” is your own money, not gains produced from the assets held. When a CEF returns capital, it reduces the NAV of the fund and your cost basis.
Suspicious Minds
Let’s take a look at those top 10 yielding equity CEFs with an eye to the return of capital (ROC) portion of the distribution. They are displayed in the table below ranked alphabetically just as in the table above.
In every case there is a heavy reliance on ROC in order to meet these staggering “yields”. Most egregious is the ironically named Cornerstone Total Return Fund (CRF) in the third row. 100% of its distribution has been a return of capital. It hasn’t paid out any interest income, dividends, or capital gains in four years! All they do is collect fees (and they are comparatively steep) for holding your money, and then give it back to you four times per year!
This would be fine if the fund actually increased in value during that time, but it hasn’t. So what does that mean to someone unlucky enough to own this piece of garbage? Let’s take a look...
Assume that you purchased 100 shares of CRF on December 28, 2007 allowing you to collect all the distributions since then. Over that time you would have received $9.16 per share in distributions, of which $9.042 was a return of capital. Back in 2008 $.1225 of the distribution was income.
This brings your cost basis down to $11.04, meaning that is where you break even on your investment should it ever recover that level. At a recent price of $6.33, which is a premium to the NAV of around $5.40, you are still 57% underwater.
The real problem here is that with each return of capital the NAV is reduced, meaning that the manager has fewer assets to earn anything with. Oh, and by the way, you would have been paying a combination of fees and expenses of nearly 2% every year for the privilege of this manager abusing your money!
Suspicions Confirmed!
If we look at the top yielder at 21.38% over the last 12 months, the Cornerstone Progressive Return Fund (CFP) doesn’t seem to be as bad, averaging only 61% ROC over the years. The problem here is that 92% of CFPs holdings are other closed-end funds. Most of these other funds have total expenses and fees totaling around 1.5% of assets, but Cornerstone is charging more than 2.5% for buying these other funds for you.
The bottom line is that these Cornerstone funds are bad news. They don’t even have a website! So stay away.
If you insist on dabbling in closed-end funds, or are already in one because someone gave you a tip on some incredible yield, do your homework. The big name CEFs, like Wells Fargo, Gabelli, etc., have readily available information and websites so it is easy to check on the breakdown of their distributions.
The bottom line is that closed-end funds can have some tasty looking “yields”, but I personally don’t count giving me my money back as yield. Big yields like these can be something completely different when you look under the hood, so make sure you know what you are getting into.
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Ed Pawelec has been active in the options markets for nearly 2 decades. His interest in options began when he studied economics and finance at Washington University in St. Louis. At that time, options were a very new instrument among listed financial products. He began his trading career on the Philadelphia Stock Exchange (PHLX) in 1993 as an equity options clerk, and quickly worked his way up, eventually becoming a successful market maker. In addition to working as an options market maker on the PHLX, Ed also acted as portfolio manager on the buy side, and as an options execution specialist and strategist on the sell side. At IFII, Ed merges his passion for financial education with his enthusiasm for options trading and passes along to individual investors tricks and secrets they usually have access to nowhere else. |
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Today's Laugh Line
Q: How many economists does it take to change a light bulb?
A: None. If it really needed changing, market forces would have caused it to happen.
(Got Jokes? Send your best jokes or funny videos to editor@tycoonresearch.com ... if it makes us laugh, you might just see it in The Tycoon Report some day!)
1894 : Pullman Strike Turns Deadly
1894 : Pullman Strike Turns Deadly
During the summer of 1894, the Pullman Palace Car Company was embroiled in what proved to be one of the most bitter strikes in American history. The strike was a direct response to company chief George Pullman and his hardball tactics, most notably his decision in the midst of the Depression of 1893 to preserve profits by slashing wages and hiking up workers' rents. A band of frustrated employees implored Pullman to ease rents and restore wages; Pullman responded by firing three of the workers. In May, the workers fired back at their avaricious boss by calling a strike. Backed by the organizational muscle of Eugene Debs and the mighty American Railway Union (ARU), the workers touched off a round of sympathy strikes and boycotts that effectively crippled the Chicago-based company. However, Pullman had has own network of powerful allies, including other rail honchos and a number government officials. In hopes of enlisting the ai d of the federal military, Pullman and his cronies convinced the government that the strikes and boycotts were inhibiting the delivery of America's mail. Though Pullman's cars didn't carry any mail, the scheme proved effective: in early July, the government banned the boycotts and swiftly shipped troops to Chicago. Fighting broke out shortly after the government forces hit the scene; by the time the militia left Chicago on July 20, the "war" between the troops and the strikers had left thirty-four men dead. But, the damage had already been done to the Pullman strikers: their ranks and clout had been depleted, and, when American Federation of Labor chief Samuel Gompers' refusal to lend them any substantial support, the rail workers were forced to capitulate to management. In the wake of the settlement, many of the strikers were barred from working in the rail industry.
Source: www.history.com
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