This article was originally published on December 2nd, 2019.
Cohen & Steers Closed-End Opportunity Fund (FOF) is a pretty popular go-to fund of funds, investing in other CEFs and ETFs. This can be a convenient fund for those that may not want to actively manage their CEF portfolio and provide a broad amount of diversification. The fund has had several top ten portfolio changes that I find interesting. This CEF and ETF fund has had quite attractive returns on a YTD basis. However, valuations have become quite high for this name.
FOF has been enjoying attractive total returns on both a NAV and market basis for 2019. The NAV return is sitting at 20.75%, on a total market return basis, we come to an even more impressive 27.54% return. This appears to be par for the course in 2019, in general. There has been an exceptional amount of funds this year showing much higher market returns compared to their NAV returns. Of course, this has led to many funds’ valuations becoming quite steep. FOF is no exception, the fund is sitting at a lowly 1.72% discount. In fact, since this year has seen so many discounts contracting, FOF has been pushed to levels not hit for over 10-years.
(Source – CEFConnect)
This could be for good reason too, as we have seen yields on other income-producing investments plummet. This has actually impacted the whole CEF space. As the Fed cuts rates we find investor’s search for yield starting to expand outside the risk-free places to put cash. Of course, there were plenty of years interest rates were pegged close to zero and we didn’t experience the same phenomenon. Another part of disappearing discounts for 2019 can also be attributed to a surge in both equities and safety plays such as fixed-income, preferreds and REIT investments. In fact, one of the only sectors to be left behind has been energy in the last year. Although, healthcare has also been lagging for a flurry of political issues.
(Source – Fidelity)
I believe these two reasons are a strong contributing factor to the disappearance of discounts for the year.
FOF has an investment objective of “seeking to achieve total return consisting of high current income and potential capital appreciation.” They will investment “in the common stock of closed-end management investment companies that invest significantly in equity or income-producing securities.” This broad-based approach really sets management up for an endless amount of flexibility. Also interesting that they don’t include ETFs in that description, but still hold ETFs anyway.
The fund utilizes no leverage and has an expense appropriate expense ratio of 0.96%. It should be noted that since it is a fund of funds, this also leads to expenses on expenses. So, the underlying holdings will also have expenses taken out. This could cause underperformance relative to its benchmark. However, FOF has been able to outperform its “Linked Index” over the long-term or come very close on a more short-term basis.
(Source – FOF Fact Sheet)
The Fact Sheet is for the quarter ending September 30, 2019.
FOF is a bit on the smaller size for a CEF, coming in at around $365.5 million in assets. With this in mind, a limit order would be suggested to make sure to pick up shares at an appropriate price.
The fund currently employs a monthly distribution at a healthy rate of 7.95%. This puts the current monthly rate at $0.087 per share. The NAV yield works out to a manageable 7.81%. For a period after 2008, they had cut the distribution through a change from a monthly to a quarterly payout. Since that time we haven’t witnessed another cut.
(Source – CEFConnect)
A monthly distribution is quite an attractive feature as the more frequent payout is preferable. However, that shouldn’t make an investor shun the quarterly payers altogether. Since FOF is a monthly payer and uses a fund of funds approach, we end up having exposure to some other names that are quarterly payers. In fact, their current largest holding doesn’t even pay a regular distribution at all.
(Source – FOF Fact Sheet)
This was their top ten holdings as of March 31st, 2019. Fast forward six months later and we see a different makeup of the fund.
(Source – FOF Fact Sheet)
Two things immediately jumped out at me that I wanted to mention. First, the sector breakdown is more simplified as either “fixed-income,” “equity funds” and “commodity funds.” This can be convenient for a quick glance, as they have followed through with this change on the pie graph they provide in the Fact Sheet as well.
(Source – FOF Fact Sheet)
And don’t worry, on the fund’s website this is still broken down to reflect the actual sectors that the fund is invested in. But, this is quite convenient for a quick reference, which I believe is what the Fact Sheet is perfect for anyway.
The second thing I noticed, was the significant premiums that the funds are trading at in their top holdings. Of course, in March we were still recovering from last December’s slump. Also, they are still holding two ETFs that don’t typically experience discount/premiums that are common among CEFs.
To replace those funds they added Sprott Physical Gold And Silver Trust (CEF), Adams Express Co (ADX) (which is actually Adams Diversified Equity Fund, Inc. as it was renamed to reflect a more accurate description) and Kayne Anderson MLP/Midstream Investment Company (KYN).
Since the ticker of CEF is also the popular acronym for CEFs, the next few paragraphs may get a bit confusing.
CEF, the fund, is definitely an interesting one here. It holds only physical gold and silver assets in a highly liquid way. A highly liquid way meaning when you can buy or sell shares on the open market. This is opposed to, I’m not sure, selling physical gold out of a briefcase? I’m not sure exactly how convenient it is to actually buy physical gold and silver in large quantities.
However, that isn’t the interesting part. What piques my interest is the fact that the fund trades at a slight discount of 3.63%. This would indicate an investor can actually buy precious metals at a discount. The other interesting point is that the fund has never paid out a distribution. Although, they state that annually they will pay out capital gains as this is required by every CEF. If they don’t do any buying or selling though, the underlying portfolio will never accumulate capital gains to be paid out. So, I wouldn’t expect to receive any distributions from CEF. However, FOF does pay a monthly distribution, an indirect way to get cash flow from a holding that doesn’t have a payout.
Of course, the primary draw here would be price appreciation of the CEF fund itself. This would happen during periods of panic. My worry here is that FOF management bought this name in August when we were experiencing volatility. Now, the market has since rebounded quite sharply on hopes of a Phase One trade deal out of Washington and Beijing. Since gold and silver are so defensive, I would like to see and expect to see, the name dropped from FOF on the next update.
This was taken from their Fact Sheet that ends September of this year, so it could have already been dropped.
Although, when taking a look at the NAV total return for the last three months, I fear that they hadn’t dropped their defensiveness.
The next holding of interest is Adams Diversified Equities Fund Inc. (ADX). This is also a fund I have recently picked up for its longevity and steep discount. This discount has been present for a considerable amount of time though, I’m not anticipating a sharp move to tighten that discount anytime soon.
ADX has an inception date of 1929 and brags of 80+ years of distributions. They currently commit to paying out 6% annually at a minimum. However, the strong bull market for the last 11 years has put them in a position to significantly pay out more.
(Source – CEFConnect)
One may quickly notice that the fund pays out a minimal $0.05 per share, per quarter. They then juice this up with a large year-end payout. The latest 2019 special payout came to a total of $1.27, they also include the regular $0.05 payout in this. The ex-date for this was November 22, 2019.
The expense ratio for ADX is a very manageable 0.61%. The fund has been able to beat out the S&P 500 Index as well for the last 5-year annualized period. They have slightly lagged on a 10-year basis though.
(Source – ADX Fact Sheet)
ADX is another example of FOF “converting” these less frequent payouts, and making them a monthly distribution.
Lastly, Kayne Anderson MLP/Midstream Investment Company (KYN), is a fund operating in the severely lagging energy space. As a reminder, CEF/ETF Income Laboratory holds Kayne Anderson Midstream Energy Fund (KMF) in the Tactical Income- 100 portfolio. KMF is registered as a RIC, whereas KYN is structured as a C-Corp. This is so that KYN can hold greater than 25% exposure to MLPs.
I also hold KYN in my personal portfolio. Along with the other energy-related CEFs, it has been tough to watch. This is where I’m glad to have a diversified portfolio that includes all the other sectors, such as REITs and utilities that have performed exceptionally well this year. There will be a time when energy can turn around and become the outperformer. This had actually happened in 2016 and 2007. Of course, 2016 was more of a rebound from very depressed levels that we saw in 2014 and 2015. In fact, 2014 and 2015 saw the energy sector as the worst-performing sector.
An important consideration is that KYN is trading at a 9.45% discount. Historically, the fund has traded at premium levels.
KYN is likely to experience tax-loss harvesting too as we approach year-end. This is along with all the other funds and names in the energy space. The other consideration is that Kayne Anderson doesn’t usually mess around with paying unsustainable distributions. So, we may very well experience a distribution cut when they announce the next distributions for the period of Jan, Feb and March. The fund had been paying out $0.15 per share monthly in 2018, this was then cut to $0.12 per share for 2019.
Although, this isn’t a certainty and the distribution yield had crept up even higher at the end of 2018, thanks again to December’s selloff.
Overall, the portfolio of FOF is well diversified – giving an investor a well-rounded diversified portfolio in one purchase. Another benefit is that the fund can take quarterly and irregular paying distributions – and smooth this out through their own monthly distribution.
For CEF/ETF Income Laboratory members; we hold PIMCO Dynamic Credit and Mortgage Income Fund (PCI) in our Income Generator portfolio. We also hold John Hancock Tax-Advantaged Dividend Income Fund (HTD) in our Taxable Income portfolio. PCI is rated as a “HOLD,” while HTD is rated as a “HOLD/SELL.” This is primarily as we are continuing to see our high-quality problem – in that, we hold high-quality names in those two particular portfolios. I believe these are still attractive investments, just very pricey at the moment!
FOF offers investors a broadly diversified portfolio with the benefit of only having to purchase one fund. Although, at the CEF/ETF Income Laboratory we have been able to outperform the performance of FOF through our own CEF selections.
The movement of the fund to hold CEF, the fund, is a peculiar one. It is likely that the managers saw the volatility in August and might have panicked a bit, adding to such a defensive name. This misstep definitely didn’t help them with their performance over the last three months.
This is especially true as the S&P 500 SPDR ETF (SPY) has been able to return 7.47% for the same time period, compared to FOF’s 2.22% NAV total return.
I wouldn’t be too critical of such a move though, as they have been able to show quite attractive returns over a longer-term time. Overall, I think FOF is a fine long-term investment and it is always interesting to take a look at their holdings. Mostly as I’m trying to construct a portfolio too, that can outperform the market. Taking a look at a professionally managed fund’s holdings can be a great place to brainstorm for investment ideas.
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Disclosure: I am/we are long FOF, ADX, HTD, KMF, UTG, PCI, PFN KYN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.