8% dividends fly under the radar in the investment world

I have dedicated my career to closed-end funds (CEFs) because, in a way, these high-yield investments saved my life: earning 8% on my portfolio using these funds gave me the confidence I needed to leave academia over a decade ago.

I then began writing about CEFs, largely out of surprise and confusion: Why had these reliable sources of income, currently yielding an average of 8.2%, not become more popular?

After more than a decade of talking to economists, bankers, fund managers and other experts, I believe they should The prospect that they could become more popular, and perhaps even more so after a big shock to the market, made them appealing.

That shock came in 2022 with a crash that caused many ill-informed retail investors to exit the market, never to return and instead hold their assets in cash.

Many of these fearful investors have put their cash into money market funds, which will likely remain there even after the first quarter of 2024, when the S&P 500 will have fully recovered. still As a bystander.

Some of that money is coming from CEFs liquidating. But still, the underlying asset value of the CEFs continues to rise. That’s what’s driving the recovery in CEF earnings, and you can see that in this chart. CEF Insider Index trackers show the performance of CEFs in various sectors, from high-yield bonds and corporate bonds to municipal bonds and stocks.

Still, retail investors are holding back, mainly due to media-fueled fears. In these circumstances, hedge funds and other activists typically step in to try to profit. After all, the average discount to net asset value (NAV, or portfolio value) of CEFs has historically been around 5% but is now lower, at around 7%.

However, CEFs were discounted by more than 9% a year ago, which prompted activists to step in. Now, the situation has entered a new phase. The discount rate has narrowed rapidly, which is PIMCO Dynamic Income Fund (PDI), This is a well-known high yield bond CEF and a good benchmark for us.

As of this writing, PDI is trading at 11%. premium It is expected to trade at a lower premium in 2022, then briefly trade at a discount until mid-2023, before rising to NAV.

I made this point in late 2023 when PDI was trading at par value (unusual for a PIMCO fund that typically trades at a significant premium). As par valuation turned to a double-digit premium, the fund delivered a 17.4% return, a gain typically seen in equity funds, not bond funds like PDI.

When I first started investing in CEFs, these deals were plentiful, but as we move into 2022 and beyond, they are becoming harder to find as many good funds are unusually undervalued. For example, consider the discount/premium movement in another CEF, a tech-focused fund. BlackRock Science & Technology Trust (BST).

You see, in the mid-2010s, BST remained at a deep discount. That was due to concerns about the Federal Reserve, inflation, and recession. But BST’s strong performance saw it achieve a premium valuation in early 2018. At the time, the steady rise in technology had continued for too long for investors to ignore.

Note that another interest rate panic occurred in 2018, which subsequently caused demand to fall. The pandemic then made things worse in 2020, leading BST to reach a new equilibrium point, trading near par value.

This equilibrium still exists because many retail investors still shy away from CEFs, leaving room for even higher premium prices if they were to come back in. And there are indications that this is happening, primarily the fact that, as I mentioned earlier, the average discount rate for CEFs is increasing.

If BST rises further to a 10% premium, investors buying today could potentially realize capital gains of around 13% (as of this writing) on ​​top of the fund’s current 7.9% yield.

Michael Foster is Contrarian OutlookFor more ideas on how to make more money, check out our latest report,Immortal income: Five bargain funds that pay a steady 10% dividend.“

Disclosure: None