Out On The Street

Parsing A Market Correction

Revisiting the varieties and attractiveness of Closed End Funds

by Steve Selengut

Mr. Selengut is a private investor and a contributing editor to Advisor Magazine. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at [email protected]

Please take the time to read this. It will give you a different perspective than most of you have heard before… one that will help you claw your way through this and any other downturn you might experience. It applies to all “quality” securities while dealing primarily with Closed End Funds containing all forms of individual securities. The blasphemy starts in paragraph five.

CEFs, even the equity variety, are most attractive because of their excellent diversification, active professional management and high (after expenses) yields compared with all other securities… and like ETFs, they are every bit as liquid as individual common stocks. Also, like both ETFs and Mutual Funds, they allow you to own all the best, biggest, and brightest companies at significantly lower prices and, normally illiquid securities (bonds, mortgages, etc.) in liquid form.

Historically, they maintain their high income levels while mirroring broad market, market value, movements. So, yes, market corrections are an ideal time to make the switch from a low income/high risk/poor diversification/buy ‘n hold portfolio to a more tradeable, naturally diversified, higher income, and lower financial risk approach to investing.

But because of their (CEFs) higher income production, one has to view their performance differently from other equity like investments. To do this, one has to go back to the fundamental nature of higher income investments (like dividend achievers, even). We buy them because they can afford to pay their owners properly, and because we want to spend or reinvest the income that they produce… if profits become available, it’s just the béarnaise on a great piece of beef (or marinara on the eggplant parmesan).

To do this, we are buying both our growth (equity) and income purposes securities in equity like packages, knowing that this will add to the volatility of portfolios whose content (when looked at as individual securities) are the least volatile, the least risky, and the last to have their payouts cut, deferred, or eliminated.

The Blasphemy:

  • We need to adjust our focus from Wall Street’s, and the media’s, obsession with Market Value to a new, perhaps counterintuitive, focus on what I’ve referred to for forty years as “Working Capital”. Simply put, a portfolio’s WC is the total “cost basis” of all the securities and cash it contains. Unless I sell something at a loss (or withdraw cash) my WC is growing with every penny of income or profit that I receive. You should use WC for all asset allocation decisions.
  • Up or down movements in market value have absolutely no impact (that’s zero impact) on either working capital or income production.

So long as you religiously select only high quality securities, diversify very conservatively (2% to 3% max of the total portfolio) in any one, insist upon income from every security you own, and take reasonable profits as soon as they become available… market value fluctuation is just not something you need to be overly concerned about… at least not at the panic level I hear all over the place during corrections.

  • Regardless of correction size or duration, eventually, the vast majority of higher quality companies (and debt based securities) emerge from corrections like a Black Lab coming out of water… they shake it off and get back to normal activities

So stay within these manageable guidelines, have confidence in the research that led to your selection decisions, diversify like crazy, insist on income from everything you own, be patient with whatever economic circumstances unfold around you, take reasonable profits (as little as 3% to 5% is reasonable for CEFs when there are unlimited buys available) without ever looking back.

Admit it, you’ve always looked back, particularly at those unrealized profits that have now disappeared. But remember: there has never been a rally/correction that has not succumbed to the next correction/rally.