Posted by: Aaron Pressman on March 1, 2007
The closed-end fund market has been busy the past few months rolling out some monster new products to feed the need for higher yield. Eaton Vance last November sold $2.6 billion of shares in its Tax-Managed Diversified Equity Income Fund (Symbol: ETY), the biggest initial public offering of its kind at the time, according to Marketwatch. Then in January, Alpine’s Total Dynamic Dividend Fund (AOD) raised $4 billion. Last week, Eaton Vance was back with a sequel, the $5.5 billion Tax-Managed Global Diversified Equity Income Fund (EXG), similar to its November predecessor but buying stocks — wait for it — globally.
These income-oriented funds provide some cushion when the market tumbles as it did this week. ETY was down only 0.6% on Tuesday while AOD dropped 1.5%. EXG isn’t invested yet so it was unchanged.
The funds aren’t exactly identical. Eaton Vance is using the covered call strategy that was so popular two years ago, which involves selling call options on a portion of the portfolio, generating more income immediately but giving away some of the upside if the market rallies. Alpine is not. But all three funds are using a strategy known as dividend harvesting or dividend capture that’s been a staple of hedge funds for years.
Instead of simply buying a bunch of high-dividend stocks and collecting pay-outs quarterly, the funds buy dividend stocks only for the minimum two-month holding period to qualify for the lowest dividend tax rate. Once the funds qualify and get the dividend, they sell that stock and buy another stock with dividends yet to be paid. That means they get six dividend payments per stock a year on average instead of just four. On the flip side, they have to pay more for all that trading so transaction costs eat into the returns a bit.
Closed-end fund expert Thomas Herzfeld says the strategy is completely viable though he worries that too much money may flood in if more copy-cat funds launch this year. Remember to exercise caution buying closed-end funds when they first come to maket as the underwriting fees come out of the fund’s assets. Most closed-end funds trade down as much as 5% to 7% in their early days as the underwriting fees go out the door.
There are also regular mutual funds that use dividend capture strategies to boost their yields, including Alpine’s own Dynamic Dividend Fund (ADVDX), which yields almost 14% and has beaten the S&P 500 by almost 6 percentage points a year for the past three, according to Morningstar.