Bonds the word on wooden cubes
getty
This is my current assessment of stocks: We are facing some genuine worries as economic warning signs emerge, clashing with the tech-fueled optimism that has propelled stocks to great heights.
The outcome? Increased volatility.
Today, we’ll explore a few quick strategies to safeguard our investments and capitalize on the income opportunities that invariably arise during times like these—including a closed-end fund (CEF) yielding 10.6%.
In essence, we’re focusing on two key strategies.
First, we aim to expand our income options beyond traditional stocks. Specifically, we’ll delve into corporate bond-oriented CEFs, many of which boast double-digit yields and are set to achieve significant price appreciation as the economy contracts.
Second, we will take a step most investors tend to ignore (or simply avoid!): We will cull (or at least reduce) positions that have become excessively overvalued in recent years.
This last point is essential because before we realize it, a rapidly appreciating asset can dominate a larger portion of our portfolio than it ought to, increasing our vulnerability in a market downturn.
Let’s kick things off with those bond CEFs—specifically one that stands out. Following that, we’ll examine (and I admit, it’s a bit of a stretch) a fund that has surged to heights more extreme than any CEF I’ve encountered.
Step 1: Invest in Corporate Bond Dividend CEFs (Starting With This 10.6% Yield)
The Federal Reserve, as we’re all aware, is maintaining higher interest rates for an extended period, longer than anticipated a year ago. This has enabled bond-focused CEFs to acquire more high-yield bonds and secure the substantial payouts they distribute to investors.
Furthermore, as rates fall, these bonds will appreciate in value since they will surpass newly issued, lower-yielding bonds. The maintained low rate of corporate defaults is also enhancing the value of corporate bonds.
These factors have propelled our CEF Insider portfolio’s corporate-debt segment this year. One specific holding that appears especially appealing at present is the Western Asset High Income Opportunity Fund (HIO), which provides a 10.6% dividend yield.
This fund is currently trading at a discount to net asset value (NAV)—which reflects the underlying portfolio value—hovering around 2% as of now. Additionally, its bonds have a weighted average duration of 6.8 years, helping lock in its current income stream for the long haul.
Since we acquired HIO in the February 2024 CEF Insider issue, it has delivered a solid 24% return, and thanks to its sizable (and monthly paid) dividend, a substantial part of that return has come from reinvested payouts.
In essence, HIO, which primarily holds bonds issued by large-cap US firms, has performed precisely as we desired: maintaining a relatively stable price, allowing us to enjoy its generous payout without concern. Moreover, that payout has even increased during our holding period.
The best part is, we can still acquire HIO at a discount, which is quite favorable for us.
Step 2: Divest Overvalued Assets (And Steer Clear of Speculative CEFs Like This One)
Now, let’s shift our focus to the second component of our strategy—reducing exposure in stocks and funds that have surged to unrealistic valuation levels.
As a case in point, let’s transition from the solid (HIO) to the absurd: a CEF known as the Destiny Tech100 Fund (DXYZ).
Before I continue, it’s important to mention that this fund is immediately off our list due to its lack of dividend payout. However, bear with me, as this fund still provides an intriguing and unique perspective, primarily because it exemplifies the vast range of assets available through CEFs.
The first figure that stands out is this fund’s staggering 807% premium to net asset value (NAV), as reported by the CEF Connect fund screener.
This enormous markup is chiefly due to its holdings, which comprise privately-held companies. This might initially appear advantageous, as we cannot directly purchase shares from these firms.
DXYZ Holdings
Destiny Advisors
As depicted above, over a third of the fund is allocated to Elon Musk’s private company, SpaceX. While Musk is often a polarizing figure, he possesses a notably enthusiastic following, which likely contributes to DXYZ’s high premium.
Other investments, such as Axiom Space, Boom Supersonic, and OpenAI, are perhaps best described as speculative. Essentially, investing in this fund means buying into a specific future vision where these companies emerge as frontrunners.
However, even if this vision materializes, it has already been heavily factored into that exorbitant triple-digit premium. This premium also renders the fund’s market price susceptible to significant declines in the event of a broader market downturn.
Given that DXYZ’s holdings are privately held, assessing their historical performance over an extended period is impossible. However, we can examine some publicly traded counterparts to gauge how a market downturn could impact the fund.
Consider Tesla (TSLA), which experienced a substantial decline in 2022, losing nearly two-thirds of its value during that time.
Regarding the other space-related stocks in DXYZ, the drastic drop of Virgin Galactic Holdings (SPCE) since its IPO illustrates the volatility inherent in this sector.
Perhaps this time is different, but with DXYZ’s outrageous markup, we risk overpaying to speculate on the future, especially if real-world economic challenges replace the technocrats’ moonshot optimism in the coming months. Simply put, there’s no reason to assume that level of risk.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Steady 8.6% Dividends.”
Disclosure: none
