Minor Bubble Forming in High Dividend CEF’s

There appears to be a minor bubble forming in some closed end funds that specialize in creating abnormally high dividend payouts without using managed distributions.

Here are three closed end funds in this category (Data as of: October 26, 2009):

Ticker:AGD     Alpine Global Dynamic Dividend Fund   pays monthly 

  • Assets= 174.3 MM
  • Annual Distribution (Market) Rate= 17.05%    Income Only Yield= 15.30%
  • Expense ratio= 1.40%              Premium over NAV= +37.36%
  • Portfolio Turnover rate= 301%

Ticker: AOD    Alpine Total Dynamic Dividend   pays monthly

  • Assets= 1,501 MM
  • Annual Distribution (Market) Rate= 19.40       Income Only Yield= 17.06%
  • Expense ratio= 1.35%              Premium over NAV= +29.61%
  • Portfolio Turnover rate= 423%

Ticker: FAV     First Trust Active Dividend Income   pays quarterly      

  • Assets= 76.8MM
  • Annual Distribution (Market) Rate= 13.71%                 Income Only Yield= 11.34%
  • Expense ratio= 1.31%              Premium over NAV= +16.50%
  • Portfolio Turnover rate= 1722% (WOW!- they aren’t kidding when they say “active” )

These abnormally high dividends are created by using strategies that appear to be somewhat gimmicky:

–         High Yield Dividend Capture Strategy: Normally a long-term investor holds a dividend paying stock and captures four dividend payments a year. But funds that use a dividend capture strategy try to capture more dividends by rotating between two securities through the year. They typically only hold a security for a little more than 60 days so that the dividends qualify for favorable tax treatment.

–         “Special” Dividend Opportunities: These funds look for companies that are paying out extraordinarily high “special” dividends which are often one time events. Again the holding periods are as short as possible to capture the tax-advantaged dividend.

Of course these strategies explain the high portfolio turnover rates. The high turnover exposes the funds to increased trading costs such as:

  1. Brokerage commissions  (not included in expense ratio)
  2. Bid-asked spreads: Varies depending on stock traded.
  3. Market impact costs: This can be a problem especially for larger funds such as AOD when a stock moves “away” from a fund as they try to accumulate a large position.    

The brokerage commission expenses are not included in the expense ratio, and are usually not listed in the shareholder reports mailed to shareholders. But you can normally access the information in the NSAR-A and NSAR-B SEC Edgar filings on a semi-annual basis. Unfortunately, the NSAR-A and NSAR-B reports are in XFDL format which is quite cryptic. The semi-annual brokerage expense is listed on line 21 of the report. But for international stocks, brokerage commissions are often built into the price and may not be included in the line 21 value. The international stock fee is usually about 15 to 30 basis points of the transaction amount.

The bid-asked spread and market impact costs are not available in any reports and must be estimated by the investor.

Some of you may be tempted to sell short the three funds listed here. But their shares are hard to borrow and even if your broker could borrow the shares, you would most likely have to pay a high interest rate to borrow the shares which would not be worthwhile.

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One response to “Minor Bubble Forming in High Dividend CEF’s

  1. Pingback: PIMCO Global StocksPLUS & Income Fund « Quant Investor’s Blog

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