EOI: Strong Historical Performance But High Fees And Small Discount To NAV

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The Eaton Vance Enhanced Equity Income Fund focuses on providing current income and capital appreciation.EOI has underperformed the S&P 500 on an absolute basis but has outperformed on a risk-adjusted...

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The fund's secondary objective is capital appreciation. EOI invests in large and midcap securities and writes call options on individual securities to generate additional income from the option premium. While the fund has underperformed the S&P 500 on an absolute basis, it has significantly outperformed on a risk adjusted basis. EOI has a high distribution but much of this distribution is funded via capital gains distributions, which results in tax inefficiency. EOI is characterized by a high expense ratio and currently offers a small discount to NAV. For these reasons, I rate EOI a Hold but would consider upgrading the fund if the discount to NAV widens. CEF Overview EOI was launched in October 2004 and currently has net assets of ~$691 million. The fund charges a management fee of 1% and has other expenses of 0.11%. Thus, the fund's total expense ratio is 1.1%. The fund is actively managed, is not currently levered. Thus, the extent of EOI's writing of call options is based on the fund's manager's view regarding the trade-off between option premiums and reduced participation in future stock price appreciation. EOI pays a monthly distribution and is currently characterized by a NAV distribution rate of 7.47% and a market distribution rate of 7.73%. Strong Historical Risk Adjusted Performance Since inception, EOI has delivered a total return of 342%. This is less than the 528% total return delivered by the S&P 500 over the same time. However, absolute relative performance does not tell the whole picture as EOI covered call strategy reduces risk for the fund to some degree. On a risk adjusted basis, EOI has fared much better. Since inception, EOI has delivered an average 3 year sharpe ratio of 0.94. Comparably, the S&P 500 has delivered an average 3 year sharpe ratio of 0.79 over the same period. Another relevant comparison is the Global X S&P 500 Covered Call ETF (XYLD) which launched in June 2013. Since then, XYLD delivered a total return of 108% while EOI has delivered a total return of 234%. EOI has also experienced a much better average 3 year sharpe ratio than XYLD over the same period of time. These results suggests that EOI's active approach to covered call writing in terms of scaling and security selection has historically added value for investors. However, it must be noted that research suggests that historical outperformance by actively managed funds is not necessarily predicative of future outperformance. Data by YCharts Data by YChartsData by YChartsData by YCharts High Expense Ratio Is A Negative EOI charges a total expense ratio of 1.1%. Comparably, the average equity mutual fund fee is ~0.44% while the average equity ETF expense ratio is ~0.16%. Low fee passive products in the covered call category include XYLD as well as the Global X Nasdaq 100 Covered Call ETF (QYLD) which both charge a total expense ratio of 0.60%. A low fee active product in the space is the JPMorgan Equity Premium Income ETF (JEPI) which charges a total expense ratio of 0.35%. Thus, EOI is clearly a high fee product. I view this as a clear negative, given the fact that the majority of actively managed funds have failed to outperform over long-periods of time. Small Discount To NAV As shown by the chart below, EOI is currently trading at a 3.4% discount to NAV. Comparably, the fund has traded an average historical discount to NAV of 4.5%. Currently, CEF funds more broadly are trading at a ~11.7% discount to NAV, which compares to a median discount to NAV of 7.5% over the past 10 years. Equity option strategy CEFs are trading at a median discount to NAV of ~10.4%. Based on these comparisons, I do not find EOI's discount to NAV as highly attractive. Generally speaking, CEFs are currently trading at a wider discount to NAV than their historical averages. Comparably, EOI is trading at a tighter discount to NAV, which I do not believe is warranted. I would view a discount to NAV of ~7% as more attractive, as this would bring EOI's trading level relative to its historical average discount to NAV as more inline with the broader CEF universe. Data by YCharts EOI Holdings Overview As of December 31, 2023, EOI's top holdings were fairly similar to the S&P 500. EOI is fairly concentrated, with the top 10 holdings making up ~43% of the total fund. Comparably, the top 10 holdings of the S&P 500 account for ~31.2% of the fund. EOI has moderate overweights to MSFT, AAPL, AMZN, NVDA, and META. While the fund has not yet released its Q4 2023 factsheet, the Q3 2023 factsheet disclosed that EOI had sold options on 44% of the stock portfolio and the average call strike was 7.2% out of the money. I view EOI's focus on technology stocks as a positive, given the fact these stocks tend to be highly volatile in nature and thus offer significant option premium from call selling.   Eaton Vance Covered Call Selling Has Become More Crowded Over the past few years, a number of covered call focused ETFs have seen massive inflows. The chart below includes some of the largest ones but there are many more. The reason this matters is that a proliferation of covered call selling funds has the potential to make selling covered calls less attractive going forward as a higher supply of call options to sell leads to a reduced risk premium. For this reason, I am somewhat cautious regarding covered call strategies, as I want to see how the recent surge in covered call selling ETFs impacts the returns of covered call strategies more broadly. Data by YCharts Tax Inefficient Vehicle EOI follows a managed distribution plan, which means distributions may include capital gains and a return of capital in addition to net investment income. As shown by the table below, the amount of the fund's annual distribution which is funded by net investment income is very low (typically less than $0.10 per share in the context of a $1.31 annual distribution) while the distributions related to realized gains has been much higher. Capital gains distributions can be unfavorable for investors as it forces them to pay capital gains tax on these elevated distributions each year. Long-term holders face a potential tax drag (assuming the shares are held outside of a tax advantaged account) in terms of compounding their investment compared to passive products. Additionally, EOI's managed distribution policy also gives shareholders less control of the timing of tax realization. This is arguably most important for investors who plan to hold EOI until death and would otherwise benefit from a step-up in basis, which would lead to no tax on the capital gains. Furthermore, some investors might be in a high tax bracket today but will be in a lower tax bracket in the future and thus would prefer to realize capital gains at a later time.   EOI Annual Report Conclusion EOI is a CEF with a solid history of delivering strong risk adjusted returns. The fund charges a fairly high expense ratio, which I believe represents a key headwind going forward. EOI currently trades at a modest discount to NAV, which is less than the fund's historical average discount to NAV. Covered call focused strategies have seen massive inflows over the past few years, which may result in a lower risk premium related to selling call options going forward. EOI's managed distribution policy results in a potential tax inefficiency for investors who hold shares outside of a tax advantaged account.  For these reasons, I rate EOI a Hold. I would consider upgrading the fund if the discount to NAV widens to more than 7%. I would also consider upgrading the stock if the expense ratio were to be substantially lowered from current levels.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2408224982"}