gembree (99.98)

The Life You Save May Be Your Own (yes, you, BRENT)

September 02, 2009 – Comments (2)

BRENTEFS123  commented yesterday:

"I guess I'm a sucker for owning CFP, but a monthly check of 15K will due until something better comes along, but I do agree with your suspicion of the stock (or fund). I found a lot of puzzling data while researching this high dividend flier. Now if I can just hold on......"

Brent, this is an intervention.  You are intrigued by the visceral thrill of high payouts, even knowing that this fund is suspicious and you are headed for a crash.  But with the help of a power greater than yourself* you can beat this addiction.  My goal, and the goal of any commenters to this post, is to help you sell CFP today.  We love you, and you can do better.  Closed-end funds can be tricky, but you're a smart guy and you can understand them.  There is nothing puzzling about this one except why anyone would buy it.

CFP is a closed-end fund - a mutual fund whose shares are traded on an exchange.  It's like an ETF, but because there's no arbitrage to keep the price close to its actual value, it can swing all over the place; it can be a discount to net asset value, or a premium.  Right now, CFP is trading at about a 50% premium.  That means that while it costs $9.50 to buy a share, the fund's assets are only $6.35.

CFP has a huge distribution, 26% a year.  Some of this is funded by investment gains, but most of it is just divvying out the existing pie to shareholders.  This isn't evil in and of itself, but combined with the huge premium CFP trades at, it's a recipe for disaster.

CFP pays out $0.205 a month, $2.46 a year.  Some mixture of these three things has to happen, mathematically:

1) CFP earns really great investment returns.

Cornerstone Progressive Return Fund could make $2.46 on $6.35, or 39% a year.  That's really good.  Especially considering that the fund charges a 1.25% expense ratio, and other Cornerstone funds have been in the 3-6% range long term.  CFP actually does have an interesting-sounding strategy of investing in other closed-end funds, but there's no reason you can't do this yourself and get the same returns.

2) The premium on CFP continues to increase.

Let's say CFP earns $0.30 in investment returns (6% minus fees) and pays out $2.46.  It has $6.35 + $0.30 - $2.46 = $4.19 in assets left.  So for it to stay at the same price, the premium has to increase to 127%.  This is unlikely to happen, and if it does, it portends doom.  Here are the two times I am aware of when closed-end funds exceeded a 100% premium:

- Just before the Crash of '29, in many, many funds (the median premium was 47 percent!)

- Cornerstone Total Return Fund, last year, just before the dividend was cut.

3) CFP crashes.

Cornerstone Total Return Fund (CRF), after a long period of dwindling assets, cut its distribution for 2009 by over 50%.  CRF crashed from a high of $30 to a low of $6, and even its current rebound to $12 is dangerously unsustainable, because it still trades at the same high premiums CFP and CLM do.  Eventually CFP will have to officially cut its distribution and the fund will crash.  This will happen soon.  In fact, it happened about this time last year.  Don't be there when it does.  Please.

* Benjamin Graham

P.S. Then again, maybe you are chuckling because you know you've got an ace up your sleeve?  There are some reasons that could make owning this fund not crazy, although not a value investing proposition.  The most important is the negative short interest rebate.  The three Cornerstone Funds have strong demand among short-sellers because of their unsustainable payouts, so the holding brokers of the stock are able to charge a "negative rebate" in order for the privilege of borrowing it - I have seen them quoted at 25% a year.  If you have access to a broker that will let you receive this fee, then it becomes a game of chicken - will you earn back enough in lending fees to offset the crash, when it happens?  Still a dangerous game, but more like all-in Texas hold 'em than Russian roulette.  Maybe you have a broker that passes these through to you as part of your monthly check, Brent?  Let me know if you do, I'm definitely curious who would.