The world of investing in closed-end funds can be difficult to navigate. CEFs must be carefully selected based not only on their management, expenses, and assets, but also on their market price versus their net asset value (NAV). Investors putting money to work in a fund trading at a premium to its NAV are essentially paying an additional fee, sometimes as high as 20%. The key is to find opportunities in funds that offer good management, good assets, and trade at or below NAV.
Investors may have found an opportunity such as this in two Eaton Vance equity funds. Both the Eaton Vance Enhanced Equity Income Fund (EOI) and the Eaton Vance Enhanced Equity Income Fund II (EOS) trade well below NAV. Let me be clear: There are reasons that these two funds trade below NAV. Eaton Vance had to reduce the distributions from these funds late last year as management determined the current yield was unsustainable. Both funds took a hit from the news.
Those issues may well be behind the funds now. Both funds' NAV has increased over the last year. NAV for EOI is up 7.5% and EOS is up nearly 10.5%. Yet the market prices have lagged, creating a larger gap between NAV and market price. EOI is currently trading at a 10.75% discount to NAV and EOS is trading at a 8.25% discount to NAV.
These two funds are unique. Both focus on income first and capital appreciation second. Despite holding a portfolio of stocks that resemble an index fund, the funds generate high distributions. They do this by generating income from selling covered calls against their long positions. If you are not familiar with covered calls you may want to read this explanation from Invstopedia. Selling, or writing, covered calls is a low risk strategy to generate additional income. The biggest risk incurred is that the underlying stock is "called away" at a lower price than what you could now sell it for.
Below are the top ten holdings for these two funds. As you can see, they offer a diversified basket of well known companies.
Top Ten Holdings
| EOI | ||
| Name | Symbol | Percent of Assets |
| Apple, Inc. | AAPL | 4.00% |
| ExxonMobil Corp | XOM | 3.50% |
| JP Morgan Chase & Co | JPM | 2.70% |
| Microsoft Corp | MSFT | 2.60% |
| General Electric Co | GE | 2.50% |
| Oracle Corp | ORCL | 2.30% |
| Hess Corp | HES | 2.30% |
| Google, Inc. | GOOG | 2.30% |
| Danaher Corp | DHR | 2.20% |
| Wells Fargo Co | WFC | 2.10% |
| Top 10 Percent of Assets | 26.48% |
Top Ten Holdings
| EOS | ||
| Name | Symbol | % of Assets |
| Apple, Inc. | AAPL | 6.00% |
| Google, Inc. | GOOG | 4.10% |
| ExxonMobil Corp | XOM | 4.10% |
| International Business Machines | IBM | 3.90% |
| Microsoft Corp | MSFT | 2.90% |
| Goldcorp, Inc. | GG | 2.30% |
| Danaher Corp | DHR | 2.20% |
| Oracle Corp | ORCL | 2.10% |
| Monstanto Co | MON | 1.90% |
| Freeport-McMoRan | FCX | 1.90% |
| Top 10 Percent of Assets | 31.31% |
These two funds invest in a wide range of large cap stocks. EOS has slightly more exposure to technology. Both funds offer some exposure to commodities. EOI provides more exposure to financials, which may account for some of its recent underperformance compared to EOS. I personally prefer the assets of EOS. With more exposure to technology and lack of financial exposure, I feel that it may provide more opportunity for capital appreciation.
Excluding income distributions, both funds have been laggards over the past year. While I would never expect these funds to outperform the indexes in market gains, I do expect that they will improve in overall performance.
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Market price performance has also lagged the S&P 500 index since the financial crisis. Below is a five year chart.
As I stated, I would not expect these funds to outperform the indexes in market gains. So where do the Eaton Vance funds really perform? Remember, these funds focus on income first. EOI pays a $0.09 distribution every month. This is the reduced amount from a prior $0.12 monthly distribution. This gives EOI a yield of almost 9%. EOS also pays a $0.09 monthly distribution, for a similar yield.
Before you get too excited, these distributions have mostly been return of capital in the past. This means that the actual yield is much lower. I expect that in the future the rate of capital return will decrease with these two funds, which will increase their actual yield. In addition, return of capital reduces the NAV, which is already very high compared to these funds' market prices. EOI and EOS have an expense ratio of 1.12% and 1.13%, respectively. This is about in line with actively managed ETFs.
EOI and EOS have not performed well in the past. Eaton Vance realizes this and has taken steps to improve performance. Contributing to the underperformance is the fact that selling covered calls can be a difficult strategy in a quickly rising market as underlying stocks tend to get called away. While the reduction in distributions hurt the funds, it was a necessary step in fixing them. The NAV of the funds has increased significantly over the past twelve months. This will eventually be recognized in their market price. For income investors, this may be an opportunity to invest in two funds whose outlook should improve.
Disclosure: A partnership with which I am involved may initiate a long position in either or both EOI and EOS.
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