A Big Distribution Increase Cements The Case For This Covered Call Fund
One Worth Considering
Every week, we’ll profile a high yield investment fund that typically offers an annualized distribution of 6-10% or more. With the S&P 500 yielding less than 2%, many investors find it difficult to achieve the portfolio income necessary to meet their needs and goals. This report is designed to help address those concerns.
This week’s inflation report once again enhanced the case for why the Fed is going to have a lot of difficulty justifying rate cuts later this year. The market’s decidedly negative reaction shows that investors may not be entirely prepared for another 2022-like sell-off in equities should inflation remain persistently high. While investors have been targeting cyclicals as a way of playing the reflation trade, the latest inflation data shows that more defensive strategies may have an opportunity to outperform soon. Covered calls may be one of those opportunities if the option income premiums earned can outweigh the forgone share price upside.
One fund that recently made the case for consideration is the Eaton Vance Enhanced Equity Income Fund II (EOS). It just made a big increase to its monthly distribution, which should make investors feel better about its prospects given the shaky backdrop for equities. Like many funds, however, it took advantage of last year’s rally in the magnificent 7 stocks to enhance its returns, something which might not be sustainable going forward. Its combination of high yield, large-cap tilt and improved income generation prospects could be what investors need to get through the current rough patch.
Fund Background
EOS’s primary investment objective is to provide current income, with a secondary objective of capital appreciation. It invests in a portfolio of primarily large- and mid-cap securities that the investment adviser believes have above-average growth and financial strength and writes call options on individual securities to generate current earnings from the option premium.
Overall, this is a fairly conservative covered call strategy, focusing on large company stocks as the foundation and writing options on individual holdings over about half of the portfolio. The 50% overlay allows for the capture of high yields without sacrificing all share price upside, which is a nice middle ground for growth & income. The expense ratio is reasonable within this category. The other number that stands out is the 4% out-of-the-money figure for the portfolio. The goal for covered call strategies is for the option not to get exercised, so this cushion is right in the sweet spot where it minimizes the risk of the stock getting called away, but still allows the fund to maximize option income potential.
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