Alternative Income Securities
Closed-End Funds fall outside the ETF sphere of activity and, as well, outside the institutional investment community. This makes for fertile ground. Most investors are familiar with the open-end mutual fund structure, which is ‘open’ to purchases of new units at any time, and always happens at the precise net asset value as of that day’s close. Whenever an investor purchases units, the broker or financial advisor (if any), receives a distribution fee. In contrast, a closed-end fund sells its shares to the public once, when the broker receives a distribution fee, after which the shares trade on the stock exchange, no different than for a share of IBM. The broker has no further incentive to suggest a pre-existing closed-end fund. In addition, because the closed-end fund shares trade freely throughout the day, they can trade well above or well below their actual net asset value.
The best time to seek discounted closed-end funds is following the occurrence of declining prices in a given sector, such as municipal bonds or even MLPs. It is the fund shareholders who create the discount when they react to the declining NAV of the fund, often forcing the fund share price yet lower. Every several years it is possible to purchase a well-diversified, well-managed closed-end fund at a discount of 10% or more. At such an entry point, one secures a higher yield than the underlying portfolio and, simply via reversion to the mean, the expectation of that discount ultimately closing – which very likely means an additional source of capital appreciation to augment the above-market income.
Non-Traditional or Non-Index REITs are generally those that are too illiquid in terms of share trading to be practicable as constituents in the major real estate ETFs. By way of demonstration, the Vanguard REIT ETF alone has over $50 billion in AUM. Many of the REITs that are excluded from the indexes are not small, per se, but may simply have substantial inside ownership, such that fewer shares are available for trading. One will find that simply being excluded from the indexation flow of funds – being on the wrong side of the ETF divide, so to speak – is sufficient to make the average yield of the ‘unpopular’ REIT almost twice as high as the ‘popular’ REITs. Paradoxically, one does not take greater risk in order to receive this yield premium, one actually takes less valuation risk.
Dividend Equities are very strongly distinguished, here, from what have lately been mischaracterized as high-dividend stocks. In the indexation world, a large, liquid security with a dividend much above that of the 10-year Treasury (i.e., 1.8%) is labelled as a dividend stock. There will be a sameness to them, because they are subject to the same marketing and demand dynamics. A utility ETF will yield 3%, a REIT ETF will yield 3%, and a diversified fund such as the iShares Core High Dividend ETF (HDV) will yield 3.5%.
However, as with non-Index REITs, the mere fact of being excluded from the indexation and institutional flow of funds means that certain companies of deservedly high reputations for long-term growth and excellent management might have actual high dividend yields. These would be companies that by policy distribute a large portion of their earnings, but have insufficient trading liquidity for institutional purposes. One of the best examples, and long owned in certain strategies, is Icahn Enterprises. This is the primary investment vehicle of Carl Icahn. As he owns about 90% of the company, it is clear that there cannot be what might be termed industrial scale trading in these shares. Icahn Enterprises is a highly diversified portfolio of investments, managed by a highly talented investor. Dividend yield: 10%.
- Other Income Securities Example: Coupon Income
- Other Income Securities Example: Discounted Bond Price
- Other Income Securities Example: Convertible Securities
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