Don’t Be Seduced By The 17% Yield On This Closet S&P 500 Fund
An Unsustainably High Distribution Yield
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.
The financial markets just wrapped up their best month of 2023 and the momentum for equities is strong, if not necessarily warranted. Closed-end equity funds certainly enjoyed November as those unrealized capital gains can now potentially be used to fund distributions or shore up existing shortfalls. For the Cornerstone Total Return Fund (CRF), that might be especially welcome news.
It’s one of those funds that has an unsustainably high distribution yield and relies on heavy doses of capital gains to try to stay above water on the coverage ratio. A lot of investors get roped in by a fund’s high yield only to be disappointed on a total return basis. CRF isn’t necessarily one of those funds, but it is one whose construction raises some pretty serious questions about how valuable it really is.
Fund Background
CRF’s investment objective is capital appreciation with current income as a secondary objective. That’s counter to a lot of funds whose primary objective is high income with capital appreciation only being a secondary consideration. That could make CRF less effective for income seekers, but, as we’ll see in a moment, investors are clearly attracted to that yield.
In determining which securities to buy for the fund’s portfolio, its adviser uses a balanced approach, including “value” and “growth” investing by seeking out companies at reasonable prices, without regard to sector or industry, which demonstrate favorable long-term growth characteristics. CRF also utilizes a modest degree of leverage to improve yield and total return potential.
We can start with the fund’s strategy, which seems pretty good at a high level. I generally like funds that use a multi-pronged approach because it can effectively use one strategy as a cross-check on the other. It’s sort of like a dividend ETF that looks at both company quality and dividend history as selection criteria. You get the best of both worlds. CRF’s focus on both value and growth accomplishes a similar goal. The strategy can help avoid value traps and stocks with excessive valuations at the same time. This is effectively an old school “growth at a reasonable price” strategy and those tend to generate pretty decent returns over time. The 9% use of leverage will only add limited exposure, but given today’s high interest rates and cost, that might not be a bad thing.
When you get into the portfolio construction, you can start to see some of the inherent weaknesses. CRF’s sector allocation doesn’t look substantially different from that of the S&P 500. This immediately raises concerns that you’re buying a closet index fund in a high cost CEF wrapper. Since the fund focuses on large-caps, its 1.15% net expense ratio is more than 100 basis points higher than the Vanguard S&P 500 ETF (VOO). If the portfolio overlap proves to be high, you’d be better off buying the index fund and calling it a day.
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