As investors in dividends – and in particular in closed-end funds (CEFs) – we to know to stay the course when market corrections hit: we don’t want to sell and cut off our precious payouts!
It’s the opposite of fanboys and gals dabbling in crypto, tech nonprofit stocks, NFT, and god knows what else. When recessions come, they are free to bail out—although they always do it much too late. Then they are forced to sit back and watch what is left of their money get eaten away by inflation!
Staying the course, we do not do We have to worry about these risks: with the high yields of our CEFs, we can rest easy during tough times, taking our payments happily until things calm down.
In fact, we can do more than sit still, we can turn to a reliable indicator that tells us when the next recession is coming (hint: it says is not one on the horizon now). When our “recession signal” kicks in, we can pick up CEFs that increase our earnings and dampen our volatility. We will discuss two of them below.
But first, let’s talk about that recession signal you’ve probably heard of: the yield curve.
This chart shows the difference between the 10-year US Treasury yield and the 2-year US Treasury yield. As I write this, the former is 1.816% and the latter is 1.196%. So the “spread” between the two is 0.62, a positive number.
Makes sense. After all, when you buy a 10-year treasury, your money is tied up for a decade, so you should be compensated for that lack of cash. As you can see from the table, this is how things normally go.
But six times in the past 45 years, that number has gone negative, meaning investors have had less incentive to hold a longer-term bond. That does not make any sense! When this happens it is called an inverted yield curve. And whenever this pattern occurs, a recession ensues, often within six to 18 months.
So if we want to predict the next recession, we just need to look at the Treasury yield curve and once it turns around, we know a recession is coming.
How to beat the next recession (with “drama-free” dividends of 7% and above)
This is where our High Yield Closed Ended Funds (CEFs) give us a big advantage as we always demand a discount when we buy. Indeed, a CEF with a high discount to the net asset value (NAV or value of the fund’s portfolio) can act as a “shock absorber” for our portfolio, because it is difficult for a heavily discounted fund to be cheaper!
We have seen it in action with the two health CEFs in our CEF Insider wallet, the Tekla Life Sciences (HQL) and Tekla Healthcare Investors (HQH) funds, both of which were trading at roughly 11% discounts at the start of March 2020. As you can see, this duo didn’t fall as far as the S&P 500 when the crash hit, and they rebounded faster (and higher) than the market as their discounts dwindled to around 7% by the end of the year.
Additionally, both funds historically yield 7% to 9% north. And since the above yield includes dividends, much of it was in cash.
Municipal Bond CEFs Cruise Through Corrections
We don’t need to rely solely on our rebates here: we can give ourselves another layer of protection by adding funds that actively reduce their own volatility (and also increase our income). Take CEFs that hold municipal bonds, which are far less volatile than stocks and offer high tax-free dividends for most investors. These two assets make them excellent options in difficult times.
To see what I mean, consider the BlackRock Municipal Income Trust (BLE) and the BlackRock MuniYield (MQY) Quality Fund, that I highlighted in my Monday column on Contrarian Outlook. Both have survived the last two recessions (they haven’t been there to see more) and have made money along the way.
And we shouldn’t overlook the value of this tax-free income benefit. Right now, BLE pays 5.3%, which is pretty healthy on its own, but it could be the taxable equivalent of an 8.8% payout for you if you’re in the highest tax bracket. higher. Similarly, the 5.1% return on MQY could be the same as an 8.1% payout on a high income taxable stock or fund.
Covered call funds give you “soft” exposure to equities
Another option is a covered call CEF, which sells call options (contracts that give buyers the ability to buy the fund’s assets at a fixed price in the future in exchange for cash now).
This is a smart way to generate income, because either the stock is sold at the fixed price, called the “strike price”, or it is not. Either way, the fund keeps the payment the buyer makes for that right, called the premium, and hands it over to shareholders as part of their dividend. This strategy works especially well in volatile times like today.
A popular covered call CEF is the Nuveen S&P 500 Dynamic Overwrite Fund (SPXX). As its name suggests, it owns the stocks of the S&P 500, so its portfolio is very similar to that of a popular index fund, such as the SPDR S&P 500 ETF Trust (SPY), with Apple (AAPL), as the main asset, followed by Microsoft (MSFT), Alphabet (GOOGL), Amazon.com (AMZN) and You’re here (TSLA).
But unlike SPY, which returns a tiny 1.3%, SPXX gives you a serious dividend payout of 5.8%, thanks to its smart dividend strategy.
Michael Foster is the Principal Research Analyst for Opposite perspectives. For more revenue ideas, click here for our latest report »Indestructible income: 5 advantageous funds with safe dividends of 7.5%.”