Written by Nick Ackerman, co-produced by Stanford Chemist
A ‘fund of funds’ approach to investing can give investors a huge boost to diversification, through just one investment. With this approach, a fund is investing in other funds. This can potentially give access to 1,000s of investments all in one buy. An investor using this approach can make it easier to keep track of their investments – if it is just one investment, then it stands to reason that research time would be cut down quite significantly. Of course, these positions can be held within a portfolio which is already diversified as well. It presumably wouldn’t cause too much disruption by changing the allocation significantly either.
Additionally, using a closed-end fund approach, we typically get active management within the funds. That means fund managers are hopefully picking the best investments, with the most opportunity. For exchange-traded funds; they typically go with a rules-based approach for inclusion and rebalance periodically.
Some funds of funds invest in other CEFs or ETFs – some use an approach of investing in both CEFs and ETFs too. Today, I wanted to highlight several funds of fund investments that might pique an investor’s interest. It is an all-inclusive list, but I believe some of the most popular will be highlighted.
It should also be noted that, while the benefit of a fund of fund approach is instant diversification; one downside is typically the higher fees. With this approach, you will get fees on fees as well. For the CEFs, this is partially mitigated by also receiving a discount on the discount effect. Then, for ETFs, this is also partially mitigated by having lower fees due to less active management. After all, a rebalancing once a year is easy for a computer to pull off.
Closed-End Fund ‘Fund of Funds’
Cohen & Steers Closed-End Opportunity Fund (FOF) is one of the more popular approaches. It is managed by one of, what I would consider, top CEF managers. Let’s excluded their operation of Cohen & Steers MLP Income and Energy Opportunity Fund (MIE). Outside factors played a significant role in the outcome of that fund.
FOF has an objective of “total return consisting of high current income and potential capital appreciation.” The approach is to invest in “common stock of closed-end management investment companies that invest significantly in equity or income-producing securities.” Basically, FOF has the flexibility to invest in any type of CEF they deem appropriate. While it isn’t expressed in that brief description of their investment style – they do also include ETFs in their list. That isn’t necessarily a bad thing as it allows them even greater freedom to invest.
The fund has around $310.5 million in total managed assets – they do not utilize leverage, but some of their underlying investments do. The expense ratio for the fund is 0.96%. Most investors will concentrate on that 9.55% distribution rate, though. It is quite attractive, and the fund’s wider discount of 7.29% also doesn’t hurt.
For an income investment, they have done a pretty good job being consistent. The one big drawback would be in 2009 when they switched to a quarterly dividend from a monthly. They have since switched back to monthly, but the damage is probably done in some investors’ eyes.
(Source – CEFConnect)
Another rather popular CEF in this space is RiverNorth Opportunities Fund (RIV). In this case, they offer investors a bit of a more aggressive approach with a high managed distribution plan. They target 12.5%, and this is reset annually. RIV investors will also be given the chance to vote on conversion in 2021.
Similar to FOF; RIV is “a closed-end fund designed to opportunistically invest in closed-end funds and exchange-traded funds…” Investing in both CEFs and ETFs, as we discussed above, can give greater flexibility to the investment managers for potential opportunities.
While the managed plan is nice for consistency, it is likely that the fund would continually have to cut overtime. Additionally, this higher rate is presumably in an attempt to raise the funds premium/discount to pull off rights offerings that they do quite regularly. The latest one just finishing up in early November. Though, none of this will be a concern should it be voted to convert.
The fund currently pays 15.19%. The NAV distribution rate is 14.57%. Due to being towards the end of the year, we would be anticipating a cut to come soon. The discount is somewhat attractive at 4.11% – this being related to the rights offering that was just conducted. RIV also uses a small amount of leverage that can make it a bit more volatile.
(Source – CEFConnect)
Exchange-Traded Fund ‘Fund of Funds’
I wanted to include First Trust CEF Income Opportunity ETF (FCEF) as it is an actively managed ETF that some CEF investors will recognize for their other CEF and ETFs. They invest “at least 80% of its net assets in a portfolio of closed-end investment companies…” In this case, the portfolio is split between 64.71% in equity CEFs and 34.05% in fixed-income CEFs. It doesn’t contain any ETF exposure.
The fund also doesn’t utilize leverage directly, but does report the underlying holdings have weighted average leverage of 20.11% – the underlying funds also average a discount of 11.20%.
Due to holding CEFs, the fund does pay an enticing 5% dividend. Over the last several months, this has declined some as the underlying portfolio took cuts over this volatile year. The smaller size of the fund could cause issues for some investors. At less than $35 million in assets – daily volume averages around 12.5k per day.
A lower amount of assets can also increase expense ratios as there is less capital to spread the expenses across. They charge a management fee of 0.85% – they report that the acquired fund fees and expenses are 2.36%. This puts the total annual expense at 3.21%.
(Source – Fund Website)
Saba Closed-End Funds ETF (CEFS) is another smaller fund, around $53.22 million in total managed assets. They are interesting because they are also actively managed, which isn’t surprising as they are an activist group. Activists usually find funds at deep discounts and force boards to increase distributions or conduct tender offers. Operating through this fund can get investors ahead of their actions. Additionally, the operation of this fund allows them greater control of the potential target.
Their objective overall is to “generate high income by investing in closed-end funds trading at a discount to net asset value and hedging the portfolio’s exposure to rising interest rates.” At least, for now, we haven’t had to worry about exposure to rising interest rates. It hasn’t been too much of a concern.
They are one of the highest in terms of their management fee. This comes to 1.10%. Then, this is also combined with the acquired fund fees and other expenses of 3.38%. This comes to a whopping 4.48% annual fee, and it definitely has played a role in its tempered returns.
The fund is another one that income investors might be drawn to with their monthly distribution. Though, the potential for appreciation through the deals they make for themselves could also play a positive role. At the current price and dividend, this works out to a tempting 8.96%.
(Source – Fund Website)
Amplify High Income ETF (YYY) is an ETF that takes a different approach. This is the more passive nature that we’ve come to know from ETFs. They will invest in “a portfolio of 30 CEFs based on a rules-based index.” The index is the ISE High Income Index, and it “selects CEFs ranked highest overall by ISE in the following factors: Yield, Discount to Net Asset Value, and Liquidity.”
Investing in 30 CEFs still provides plenty of diversification, even if the others discussed invest in more. 30 CEFs are still enough to have exposure to a plethora of both equities and fixed-income investments. Thanks to the passive nature, this CEF has one of the lower expense ratios. The management fee comes to 0.50%, and the acquired fund fees and expenses come to 1.67%. Equaling a total expense ratio of 2.17%. It also is significantly larger than the other ETF candidates at over $231.5 million in assets.
The fund also pays one of the highest yields at 10.92%. This is paid out monthly to investors at the most recent payout of $0.13.
(Source – Seeking Alpha)
Invesco CEF Income Composite ETF (PCEF) isn’t a big name in the CEF space. However, they are well known in the ETF universe. This is another passive ETF that is based “on the S-Network Composite Closed-End Fund Index.” It will “normally invest at least 90% of its total assets in securities of funds included in the index.”
This index holds CEFs that invest in both fixed-income and equities. Though, the equity investments utilize an option writing strategy. This is also more active in terms of rebalancing as it is conducted quarterly – rather than annually. The index is composed of 125 CEFs.
There are quite a few rules to be included in this index:
- Must be Registered in The United States
- Minimum Market Cap of $100 million
- Fund Must Be Listed on an Exchange
- At least 95% of Index Weight Must Be Allocated to Funds that have 3-month ADTV >$500,000
- Total Expense Ratio Below Threshold (Threshold varies based on current US Federal Funds Effective Rate)
- Funds Trading at Premiums > 20% Eliminated
Ultimately, not a bad set of rules to live by. This has also resulted in lower fees, but not lower than YYY above. The management fee is the same 0.5% – but acquired fund fees and expenses come to 2.05%. This works out to a total expense ratio of 2.55%. That is a minimal difference from YYY above – it also might be worth it for some investors for the greater amount of holdings.
This is also the largest fund on this list at $736.6 million in assets. That liquidity might be welcomed by larger investors. The 30-day average daily volume comes to 133,408 – a healthy amount for most retail investors.
One downside for income investors might be the varying monthly dividend that it pays. The 7.73% distribution rate is certainly attractive, but it various each month that it pays.
(Source – Seeking Alpha)
Taking a look at the performance YTD, we can see how the various approaches above have played out. FOF and RIV will both trade quite a bit differently from their share price – so do note the differences there. ETFs can also trade at premiums and discounts, but it isn’t usually as extreme. For example, FOF looks like it was the worst-performing fund. However, the actual total NAV return that the managers can impact is down 7.12%. For RIV, they are quite similar at this time, though this can change, and sometimes, drastically.
Interesting to note that YYY has performed the worst on an NAV basis. They also coincidentally have the lowest expense ratio – which is worth noting in itself that one shouldn’t look at the expense ratio alone! It is more about investing in which fund you have conviction. If you want a more active approach FOF, RIV, FCEF, and CEFS can be a good option. CEFS is probably the most active in terms of the fund being from an activist investor.
All of these funds can also be appropriate for an income investor. All of them pay higher than usual distribution yields and pay monthly. A monthly dividend is certainly enticing for investors relying on a regular income. All except PCEF also pay quite consistent dividends. Meaning that they will pay the same amount for a variable period of time. PCEF appears to change its distribution monthly as income comes in. That isn’t necessarily a bad thing either but is worth noting when considering one of these funds.
A fund of fund approach can give investors instant diversification through simply holding one investment. As we highlighted today, there are different ways to approach this. They can either be a more active or passive role – in both CEF or ETF wrappers.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: This article was originally published to members of the CEF/ETF Income Laboratory on November 6th, 2020.