PCEF ETF: Capital and Income Reduction (NYSEARCA: PCEF)

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This series of ETF reviews aims to assess products based on historical price and current portfolio value and quality. As holdings and metrics change over time, I may update reviews, usually no more than once a year.

PCEF Quick Facts

The Invesco CEF Income Composite ETF (NYSEARCA:PCEF) is a fund of funds. It tracks the S-Network Composite Closed-End Fund Index. The payout ratio (7.29% at present) is very attractive. However, the cost of ownership is high: adding ETF management fees (0.50%) and holding fees (1.47%), the total expense ratio is 1.97%.

PCEF has 125 farms screened on several factors. In particular, the management fee must be less than 1.25% and the premium must be less than 20%. Weightings are based on net asset value and adjusted to favor funds with a discount and penalize those with a premium. Weightings are capped at 8%, currently they are all below 5%. The top 10 holdings, listed below, represent 26% of asset value.

Teleprinter

name

Mass%

PDI

PIMCO Aggressive Income Fund

4.474

EXG

Eaton Vance Diversified Global Tax Managed Equity Income Fund

3.306

BDJ

BlackRock Enhanced Equity Dividend Trust

2.617

JPS

Nuveen Preferred Securities and Income Fund

2.498

NFJ

Virtus Dividend, Interest and Premium Strategy Fund

2.36

DSL

DoubleLine Income Solutions Fund

2.318

PDO

PIMCO Dynamic Income Opportunities Fund

2.295

BXMX

Nuveen S&P 500 Buy-Write Income Fund

2.159

ETY

Eaton Vance Diversified Tax Managed Equity Income Fund

2.006

VEV

Eaton Vance Limited Time Income Fund

1.965

SSource: Invesco

Performance

PCEF has underperformed the S&P 500 (SPY) in total return by a wide margin since its inception (February 2010) with larger declines. It’s not the most appropriate benchmark, but total returns matter. Money is money, whether it comes from dividends or capital gains.

Full return

Annual return

Sample

Sharpe report

Volatility

PCEF

119.25%

6.70%

-41.41%

0.61

11.05%

TO SPY

409.81%

14.40%

-32.05%

1.01

14.10%

Data calculated with Portfolio123

This table raises a red flag: the annualized return reinvesting all distributions, without paying tax on them, is a little below the current distribution rate, and below the historical average (about 7.8%) . PCEF pays a high yield and slowly dissolves the principal. The share price has lost 14.6% since inception:

PCEF share price history

PCEF share price history (TradingView on Seeking Alpha)

A perishable revenue stream

To get the full picture, we also need to consider a slowly declining face value income stream: the monthly distribution per share was around $0.18 in 2010; it is around $0.13 in 2022 (source: Invesco). That’s a 28% drop. On top of that, inflation hurts both the invested capital and the purchasing power of the income stream. It’s not pretty, and it can get worse. In a rising rate environment, closed-end funds would have rising leverage costs and likely falling stock prices (like most high yield financial instruments). This can accelerate the loss of capital and income streams in nominal value for PCEF shareholders, and even more so in inflation-adjusted value.

Comparing PCEF with a Easy reference

I wrote in a previous paragraph that SPY is not the best benchmark. Now I will show a good one. The following table compares the PCEF since inception with a subset of the closed-end fund universe holding the same number of funds as the PCEF: the 125 CEFs with higher returns among those with average liquidity greater than $100,000 per day and a positive discount to the net asset value (net asset value). The subset is rebalanced quarterly in equal weights.

Full return

Annual return

Sample

Sharpe report

Volatility

PCEF

119.25%

6.70%

-41.41%

0.61

11.05%

Reference subset

181.91%

8.94%

-47.23%

0.64

14.36%

Past performance is not a guarantee of future returns. Data source: Portfolio123

This benchmark, much simpler than the PCEF strategy, beats it by a significant margin, with one caveat: ETF returns are real, the benchmark is hypothetical.

Digitization of the PCEF wallet

I looked at two metrics in PCEF holdings:

  • Reset to NAV (negative is bad).
  • Relative discount = Discount on NAV minus its 12 month average (negative is bad).

The fund has 125 holdings, 25 of which score low on both measures.

The portfolio’s aggregate discount is lower than the capital-weighted discount of the full CEF universe (3.5% versus 6.0%).

The aggregated relative haircut is also lower than the capital-weighted relative haircut of the full CEF universe (2.7% vs. 3.1%).

These measures indicate a portfolio value below the average in the CEF universe.

A solution to obtain high yields without rotting

Capital and income degradation is a structural problem in many closed-end funds, as in most high-yield instruments. However, it is not inexorable if one knows how to trade CEFs instead of using them as buy-and-hold instruments. I designed a 5-factor ranking system statistically linked to futures returns across the entire CEF universe, and began publishing the top 8 ranked liquid CEFs in Quantitative Risk & Value (QRV) after the March 2020 market crash. The list is updated weekly. Its average dividend yield varies around 7-8%. This is not a model portfolio: trading the list every week is too expensive in terms of spreads and slippage. Its purpose is to find funds with a good entry point. In the table and graph below, I give the hypothetical example of starting a portfolio on 03/25/2020 with my initial list of “top 8 ranked CEFs” and updating it every 3 months since then, skipping intermediate updates. Returns are calculated with initially equally weighted holdings with no rebalancing until the next 3 month update. Dividends are reinvested at the beginning of each 3 month period.

since 03/25/2020

Full return

Annual return

Sample

Sharpe report

Volatility

The 8 best quarterly CEFs

140.16%

53.83%

-9.84%

2.68

15.70%

PCEF

60.42%

26.16%

-14.62%

1.51

12.53%

TO SPY

87.71%

36.28%

-14.23%

2.01

Best CEF vs SPY list

List of Top 8 CEF vs SPY (Graphic: author: data: Portfolio123)

Past performance is not a guarantee of future performance. Data calculated with Portfolio123. Dates and listings can be checked in the QRV post history (trial is free).

I don’t expect the “Best 8” list to beat SPY like it has for the past 2 years, but a spin strategy focused on discounts in CEFs has a much better chance of protecting both capital and income stream against erosion and inflation than any other high yield passive investment like PCEF.

Take away

PCEF selects closed-end funds using a sophisticated rules-based strategy. However, past performance, distribution history and valuation measured in overall discount are disappointing. The PCEF can be a useful instrument for tactical allocation, swing trading, or catching certain market anomalies, but it doesn’t look like a good buy-and-hold investment for people in need of sustainable income. and preservation of capital.

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