We are in a bear market. That means that the market is going to be in a medium-term downtrend, and that rallies will be short-lived.
It also makes a lot of investors very nervous. I am particularly concerned that many investors are overweighted in large-cap dividend stocks. I think these stocks are significantly overvalued, as conservative investors were forced out of bonds which were paying next to nothing. They moved into large-cap dividend stocks because they saw them as safe.
They aren’t safe if they are overvalued, and I believe they are, by as much as 30%.
Closed-End Funds Carry Less Risk
Instead, I suggest investors sell those stocks and give these safer closed-end funds a look. There is still risk, of course, but I think these closed-end funds have strategies that are less risky than large-cap dividend stocks.
The first type I would consider are closed-end funds that invest in utilities. The great thing about utilities is you know that they are going to make money because people must use energy, and rates are set by regulation. Thus, a certain amount of cash flow is going to be guaranteed, and very likely enough to pay dividends.
One of the safest plays is called a “buy-write” fund. This is where the managers buy underlying stocks, then sell covered call options against those stocks. That means they sell the right for someone else to buy the stock from them at or above a given price on or before a given day. In exchange, they get paid a premium. If the stock doesn’t rise above that price, they hold the stock and can sell it again. Likewise, if the stock gets sold, they can buy it back.
Choices in Closed-End Funds
The Eaton Vance Tax-Managed Buy-Write Income Fund (NYSE: ETB) is a good choice. While it is down for the year, it also puts out a monthly distribution that yields close to 8.5%
The Blackrock Utilities and Infrastructure Trust (NYSE: BUI) is a closed-end fund that invests in a wide variety of utilities – electricity, energy, natural gas, water and telecom – and uses a buy-write strategy to enhance returns. Some 72% of the utilities are in the U.S., with the rest scattered throughout western Europe. It has 74 total holdings and a modest expense ratio of 1.1%. It is actually up 2% during this troubled year.
It makes monthly distributions that amount to about a 10% yield annually.
The lowest-risk choice of the lot today is the Nuveen Select Maturities Municipal Fund (NYSE:NIM). The fund invests in municipal securities across varying maturities, while aiming for an average of intermediate duration. About 80% of assets are rated investment grade (Baa/BBB or better by S&P, Moody’s, or Fitch). Municipal bonds have advantages, in that they very rarely default. That’s because they are usually backed by some kind of revenue-generating activity that the bonds themselves actually fund. They are also tax-exempt on a federal level.
Total fees come to 0.57%. The fund is up 1.49% so far this year. Even in 2014, when equities did very well, it was up 14%.
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