Albert Einstein once said, "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." Long-term investors in closed-end funds (CEFs) are keenly aware of this principle. The majority of CEFs have the goal of distributing current income as their primary investment objective and historically the majority of a CEF's total return has come from the distributions it makes. This doesn't mean an individual CEF or category of CEFs cannot earn capital appreciation along with distributions, rather as the data below indicates it simply means over long periods of time the majority of the total return CEFs historically provide comes from the distributions.
This chart displays data points which clearly show the power of CEF distributions adding up over time and making up all of the positive return the First Trust CEF Indexes have earned over the past eight years. Each First Trust Index below shows two returns. The blue bars exclude distributions and only include the price return. The bars shaded in green are total return and include the price return plus the distributions.
The data is very compelling. It clearly illustrates the power of CEF distributions compounding over time and contributing significantly to the total return of these broad based CEF indexes. When putting this chart together I used data which goes back almost eight years and therefore includes the significant price downturn experienced in 2008. If I had used data which only goes back five years it would still show the majority of the return earned in these indexes coming from the distributions, however it would show some of the return coming from capital appreciation as well. For example, the First Trust Closed-end Fund Composite Price Index (UPCEF) had a cumulative return of 41.67% from 12/31/2008-12/31/2013. The First Trust Closed-end Fund Composite Total Return Price Index (UPCEFT) generated a cumulative total return of 110.04% during the same five year period (12/31/2008-12/31/2013).
Whether looking at this total return data over five years or eight years the point remains the same. The distributions CEFs make on a regular basis can have a significant impact on the total returns investors have historically earned in CEFs. If an investor owns one CEF or a portfolio of dozens of funds, I believe it is critical to always consider the distributions when calculating the return as in all likelihood the distributions will make up a substantial part of the total return.
The chart is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results. The First Trust Composite Closed-End Fund Index is a composite index of the municipal, taxable fixed income and equity indexes and is intended to provide a capitalization weighted representation of the entire U.S. closed-end fund universe. The First Trust Municipal Closed-End Fund Index is a capitalization weighted index designed to provide a broad representation of the U.S. municipal closed-end fund universe. The First Trust Taxable Fixed Income Closed-End Fund Index is a capitalization weighted index designed to provide a broad representation of the taxable fixed income closed-end fund universe. The First Trust Equity Closed-End Fund Index is a capitalization weighted index designed to provide a broad representation of the equity based closed-end fund universe. An index cannot be purchased directly by investors.
Closed-end funds are subject to various risks, including management's ability to meet the fund's investment objective, and to manage the fund's portfolio when the underlying securities are redeemed or sold, during periods of market turmoil and as investors' perceptions regarding the funds or their underlying investments change. Unlike open-end funds, which trade at prices based on a current determination of the fund's net asset value, closed-end funds frequently trade at a discount to their net asset value in the secondary market. Certain closed-end funds may employ the use of leverage which increases the volatility of such funds.
All opinions expressed constitute judgments as of the date of release, and are subject to change without notice. There can be no assurance forecasts will be achieved. The information is taken from sources that we believe to be reliable but we do not guarantee its accuracy or completeness.
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