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5 Big-Yield Funds to Watch

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You can go out and hunt for yields, or you can find a good manager who knows how to "make" yields using options. After setting some rigorous criteria, this handful made the cut.

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The average yield of all covered-call stock CEFs is 9.85%, which is more than three percentage points greater than the average yield of the entire stock CEF universe. Sounds impressive, but keep in mind that covered-call CEFs are able to pay out more in cash because selling call opÂ-tions caps the upside appreciation of the underlying stock.

For example, if a CEF holds a stock trading at $48 and a call option with a $50 strike price is sold against it for $1.50, the maximum profit the CEF can earn from that stock position is $51.50-a 7.3% rate of return [($51.50/$48) -1]. In contrast, a CEF without covered calls benefits from stock appreciation without restriction.

Still, many conservative investors may gladly forfeit speculative upside stock potential that may never materialize in return for receiving additional income up front. In determining which of the 31 covered-call CEFs is most attractive, the yield should not be the determining factor.

Yield chasing never works because high yields can signify high risk of a dividend cut and/or a cash pay-out based on destructive return of capital rather than based on investment profits (e.g., income or capital gains). "Total return" is the name of the game, which is defined as the combination of cash yield and capital appreciation. Receiving a 10% cash yield but losing 10% in NAV equals a zero total return and is a worthless return of capital.

Also important is a fund manager good at picking stocks and who outperforms a passive index benchmark. Consequently, I screened the covered-call CEF universe for those that met the following criteria:

  1. Positive one-year return on NAV
  2. Annual cash yield lower than one-year return on NAV
  3. Market price at a discount to NAV
  4. Annual expense ratio below 1.2%
  5. Positive 3-year "Alpha" (a measure of risk-adjusted outperformance) against its benchmark index greater than 2% annualized

Out of the 31 candidates, only five covered-call CEFs made the cut, and all five came from just two fund families located in my favorite cities, Chicago-based Nuveen and Boston-based Eaton Vance. The five covered-call CEF star performers are listed below in descending order of yield:

  • Eaton Vance Tax-Managed Buy- Write Opportunities (NYSE:ETV), 10.5%
  • Nuveen Equity Premium AdvanÂ-tage (NYSE:JLA), 9.3%
  • Eaton Vance Tax-Managed Buy-Write Income (NYSE:ETB), 9.1%
  • Nuveen Equity Premium OpporÂ-tunity (NYSE:JSN), 9%
  • Nuveen Equity Premium Income (NYSE:JPZ), 8.7%
Editor's Note: This article was written by Jim Fink of Personal Finance.

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No positions in stocks mentioned.
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