CEFS: High-Yielding Fully Diversified Income-Focused Fund Of Funds

~ by Snehasish Chaudhuri, MBA (Finance).

Exchange Listed Funds Trust – Saba Closed-End Funds ETF (BATS:CEFS) is an exchange traded fund (“ETF”) that itself invests in various other funds which invest in public equity, fixed income, and commodity markets across the globe. Thus, CEFS can be termed as a fund of funds (“FOF”).

Being a fund of funds, it has a very high expense ratio of 2.9 percent. The fund has a record of generating strong yield, mostly within a range of 8 to 12 percent. Such a high yield enabled CEFS to generate positive total return over the past 3 years. This year, the return however is negative, but that’s much better than the S&P’s return. It is currently trading at a premium over its net asset value (“NAV”) of $17.54, and has an asset under management (“AUM”) of $90 million. I’ll try to evaluate this FOF with the help of my “Seven factor model for evaluating dividend focused funds.”

Saba Closed-End Funds ETF Is A Diversified Small-Sized Fund Of Funds

Saba Closed-End Funds ETF was launched and is managed by Exchange Traded Concepts, LLC. The fund is co-managed by Saba Capital Management, L.P. This FOF invests in funds that invest mostly in three types of asset classes – equities, fixed income securities, and commodities. For its equity portion, it invests in funds which invest in dividend paying stocks of companies operating across diversified sectors. For its fixed income portion, it invests in low rated funds with varying maturities. A significant portion of its fixed income investments is below investment grade. For its commodity portion, it invests in funds that invest in energy, utility, natural resources, and other commodity markets.

CESF has invested equally in fixed income securities and equities. 70 percent of its investments are made in 3 sectors – energy, technology and utilities. This FOF is quite bullish on the energy sector, and invested not only in equities or bonds in this sector, but also have significant investments in master limited partnerships (“MLPs”). This FOF has taken a short position on 5 Year Treasury Note Future Dec 22, which is almost 35 percent. As a result, the company has a long position of 135 percent of its AUM. The biggest risk of this fund lies in the fact that almost 59 percent of its bond portfolio is below investment grade, i.e., rated below BBB. One can argue that this ratio is not that high, but when coupled with such a high proportion of short portfolio, and an AUM of less than $90 million, the fund becomes a bit risky.

Composition And Performance Of Saba Closed-End Funds ETF’s Portfolio

Saba Closed-End Funds ETF benchmarks its performance against the S&P 500 Index. It has invested almost 90 percent of its AUM only in 9 funds. This percentage may seem exceptionally high, but we need to remember that CEFS has a long portfolio of 135 percent. Effectively, the investment in top 9 funds will be around two-third of total investments. These are some of the most renowned funds, such as the BlackRock ESG Capital Allocation Trust (ECAT), Templeton Global Income Fund (GIM), ClearBridge Energy MLP Opportunity Fund Inc. (EMO), Delaware Investments National Municipal Income Fund (VFL), ClearBridge Energy MLP Total Return Fund, Inc. (CTR), Morgan Stanley Emerging Markets Domestic Debt Fund (EDD), Neuberger Berman Next Generation Connectivity Fund Inc (NBXG), Nuveen Multi-Asset Income Fund (NMAI), and Nuveen Core Plus Impact Fund (NPCT).

Among its top 25 investments, only four funds have been able to generate positive returns during the past one year. These funds are EMO, CTR, Center Coast Brookfield MLP & Energy Infrastructure Fund (CEN), and Cushing MLP & Infrastructure Total Return Fund (SRV). So, energy and infrastructure funds, especially their investments in MLPs, have mostly been able to generate positive returns during the past one year. It’s difficult for stock market investors to directly invest in MLPs, as those are not listed, and investments in unlisted entities require huge funds. ETFs or mutual funds are the best ways to enjoy the growth benefits of those MLPs. Investments in MLPs so far has proved to be good for Saba Closed-End Funds ETF, at a time when the overall macroeconomic situation is not quite optimistic.

There are some basic reasons behind investors betting high on energy and infrastructure funds. Energy suppliers & infrastructure entities are expected to be in demand for several decades to come. While covering an energy MLP fund named Global X MLP & Energy Infrastructure ETF (MLPX), I found that:

“[T]he move towards clean and green energy has made building new infrastructure even more difficult…..As construction of new interstate pipelines becomes increasingly difficult due to regulation and politics, the value of existing energy supply networks grows.”

I also feel that investments in infrastructure and energy funds are less sensitive to macroeconomic factors such as inflation, interest rates, unemployment, etc. These funds also generate strong growth over the short and medium term, have a reasonable expense ratio, and generate strong and steady yield around 5 to 7 percent.

Saba Closed-End Funds ETF Generates Strong And Sustainable Yield

What works in favor of Saba Closed-End Funds ETF is its balanced portfolio and consistent and strong yield. Most funds that CEFS holds are diversified funds with exposure to numerous equity stocks, fixed income securities, commodities, etc. Diversification reduces portfolio risk and volatility, and provides significant benefits for CEFS and its shareholders.

The fund has been paying steady monthly dividends from the very beginning. CEFS generated an annual average yield of 9.5 percent during the past 5 years, and 12.55 percent during trailing twelve months (“TTM”). Such yield seems sustainable, as under the current macroeconomic situation, CEFS’s investments in MLPs and high-yield bonds are expected to generate strong growth. The fund is also diversified enough to absorb the impacts of over-performance or underperformance by any particular stocks or funds.

My Seven Factor Model For Evaluating Dividend-Focused Funds

While analyzing a dividend-focused fund, I use seven criteria – stock price performance, AUM, annual average yield, level of portfolio diversification, average credit rating, current discount to NAV and most importantly the future sustainability of its yield – in order to understand its investability. Saba Closed-End Funds ETF is trading around $18, at a very low premium to its NAV, and its price performance is nothing substantial. CEFS generated an average total return of only 6.4 percent over the past 5 years. However, this return is not unacceptable given the market conditions over these periods. It generated positive returns during the Covid-19 pandemic, too.

Investments in below investment grade fixed income securities, coupled with 35 percent of short portfolio makes this fund a bit risky. Moreover, it has a very low AUM, and quite high expense ratio, which limits its capacity to invest in a large pool of funds with higher market value. Despite these drawbacks, CEFS can be considered as an option by income seeking investors, due to its balanced and diversified portfolio and strong and sustainable yield. Moreover, the fund has been paying steady monthly dividends for the past 67 months since its inception, which is quite attractive for income seeking investors.