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Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on June 1, 2022.

Eaton Vance Tax Managed Buy-Sell Income Fund (NYSE: ETB) held up reasonably well on a YTD basis. One of the problems with this is that the fund’s share price has held up better than its net asset value per share. This has resulted in a further increase in the fund’s premium since the last covered the fund.

I think ETB offers an attractive opportunity for investors as a long-term holding, but when trading at a better valuation. It has been quite volatile in terms of premium, so an investor may not have to wait too long.

For investors already holding the fund, it doesn’t look like they need to offload immediately. In fact, it could go against what an investor wants to hold the ETB for in the first place. It is the tax management strategy that is employed to reduce the tax liability of the investor.

This is one of those Eaton Vance funds that deliberately produce distributions classified as return of capital. I know some investors immediately see a return of capital and delist a fund. However, for this fund, it is intended. This is a topic we discuss a lot when updating the coverage of these index-writing Eaton Vance funds.

The simple version is that they generate realized losses on their options strategy or on the underlying portfolio. If the indices rise, their options strategy is incurring losses, but the underlying portfolio is likely to appreciate. When indices fall, their options strategy may provide realized gains, but these may be offset by selling underlying positions for a loss.

What ends up happening is that the fund tries to avoid having too many realized gains. When return of capital constitutes all or part of the distribution characterization, it defers an investor’s tax liability. This is done because the return of capital reduces an investor’s cost base. Therefore, no tax will be paid in the year it is received. At least under current tax law. This would only happen when an investor sells for a realized gain or when the cost basis drops to $0.

For the 2021 tax year, over 92% of the distribution was identified as ROC. This is exactly what some investors are looking for. I know this may offend other investors who think ROC “just gives you your money back”.

2021 Eaton Vance Tax Classifications

2021 Eaton Vance Tax Classifications (Eaton Vance (author’s highlights))

Here is another way of looking at things. Since the launch of the fund, they have paid out a total of $22.86 in distributions through 2021. This does not count any of the distributions from 2022 so far. At this point, if you originally bought it for $20, you’ve been paid in full. Yet the fund continues to pay the same monthly distribution of $0.1080 or its quarterly equivalent since 2010.

The basics

  • Z-score over 1 year: 1.47
  • Premium: 7.57%
  • Distribution yield: 7.63%
  • Expense ratio: 1.10%
  • Leverage: N/A
  • Assets under management: $413 million
  • Structure: Perpetual

ETB’s investment objective is “to provide current income and gains, with a secondary objective of capital appreciation”. This is fairly standard for most CEFs and also does not distinguish it from other EV option underwriting funds.

To achieve this goal, they will focus on “a diversified portfolio of common stocks and write call options on one or more US indices on a substantial portion of the value of its common stock portfolio to seek to generate income. current from the option premium.”

There are several Eaton Vance funds that all look quite similar and even have the same name. The only way ETB is a little different is that they focus on the S&P 500 specifically. It can be compared to something like Eaton Vance Tax-managed Buy-Write Opportunities Fund (ETV). It is the sister fund that focuses on the S&P 500 and the Nasdaq. This means that it leans a bit more towards technology compared to ETB. However, both funds target up to 100% portfolio crush.

For closed funds, these expense ratios are rather low. They don’t change all that much either, depending on the size. ETV is nearly 3.5 times the size of ETB and charges an expense ratio of 1.08% versus 1.10%. Overall, Eaton Vance funds operate with relatively lower expense ratios.

Performance – Drop In NAV pushes Premium

Overall, ETB held up relatively well relative to the total stock price return. As we can see from the chart, it briefly joined the S&P 500 in a bear market, but then exited just as quickly.

Chart

Y-Charts

What we can also see here is that the total NAV return was significantly worse. This is precisely what has driven the fund’s premium up since our last visit to the fund.

The current valuation places it well above the average of the last decade. At the same time, I could see the argument being made that stocks are down across the board. So the fund is relatively expensive, but the price itself is still cheaper than it was before.

Chart

Y-Charts

For these reasons, I still wouldn’t call it a sale. As noted above, there is another consideration for an investor to consider. Since collecting return of capital distributions in those years, an investor’s cost base could be quite low. If held in a taxable portfolio, it could mean a significant tax burden due to gains made by investors. In my opinion, this should push even further into premium territory before it makes sense to sell for some investors.

Others who aren’t as concerned about their tax burden could potentially sell from time to time when the fund returns to near parity with its net asset value per share. Historically, this would mean a much better price for investors who own or buy the fund. Additionally, given the market’s movements this year, an investor may have already made enough losses to offset these potential gains.

Distribution – backed by earnings, something to watch

As equity funds, they will rely primarily on capital gains to fund their distributions. Unless, of course, they want to reduce their realized gains to stay under tax management.

ETB has been a fairly stable fund. They cut once in their history, and that was shortly after 2008/09. They then switched from a quarterly distribution to a monthly distribution but kept the same equivalent payment.

ETB distribution history

ETB distribution history (CEFConnect)

This is where we can see a little more about how the fund works. From their latest annual report, we can see that only a small portion of revenue comes from net investment income.

ETB Annual Report

ETB Annual Report (Eaton Vance)

They also haven’t made enough gains in the last year to fully cover their distribution. This is where the unrealized appreciation of the portfolio came in to still result in a positive overall return for the fund for the year.

From there, we can take a look at a more detailed breakdown of this report. The image below shows that they generated over $29.6 million in realized gains from their underlying portfolio. However, offsetting those gains came from realized losses of $22.22 million on their written options. This resulted in a net gain of approximately $7.4 million.

ETB Annual Report

ETB Annual Report (Eaton Vance)

This visually shows an exact example of what I was describing at the beginning of this article.

For 2022, options should no longer generate losses – or at least they should be relatively limited to years when the market is up. This helps ETB offset some of those drops we’ve seen. Below is the performance against the S&P 500 SPDR (SPY) ETF to highlight how they avoided losses as deep as the “market”.

Chart

Y-Charts

ETB Wallet

Interestingly, ETB’s portfolio only holds 181 positions. They don’t hold as many as the S&P 500 itself. So it’s more concentrated, but over the years they’ve chosen to hold some of the ones that have done very well.

ETB Top 10

ETB Top 10 (Eaton Vance)

These mainly include MAMAA names. These are Microsoft (MSFT), Amazon (AMZN), Meta (FB), Alphabet (GOOG)(GOOGL) and Apple (AAPL). In this case, they don’t hold the FB position as the top position, but they had been in our previous update. In this article, we were looking at the top ten at the end of November. Now the above is as of the end of April 2022.

Chart

Y-Charts

Expanding the full list of names, we can see that FB still accounts for 1.57% of the portfolio and occupies the eleventh largest position. It just so happened to fall just short of the top ten. From the chart above, we can see that this was a function of a rapid decline in the stock against these other mega-cap tech names.

By the way, FB will change their ticker to META on June 9th. Originally they were looking to change their ticker to MVRS. However, since then an ETF that used the META ticker has discontinued it.

Tesla (TSLA) is another position in the portfolio that has been shrinking rapidly lately. They are not alone, as technology and growth stocks have been particularly hard hit. A combination of overvaluation and disgrace are the most important factors. It’s also a very controversial title overall. On a YTD basis, TSLA is down 30%.

Chart

Y-Charts

I know this is a position one might be surprised to find in ETB’s portfolio. Although this is an actively managed fund, it will still mirror the S&P 500 in general. The reason for this comes down to their overall tax management strategy. They can’t have too many positions that will deviate from the performance of the S&P 500.

If they do, they could risk not being hedged properly with their index writing strategy. Since TSLA tends to be quite volatile or make massive moves, it is a position that can move the S&P 500. Therefore, a great position to include in ETB’s portfolio.

Conclusion

I hope this ETB update has been helpful to some investors. I can see the reasons why some investors would want to continue holding and for others why selling right now makes a lot of sense. If you’re worried about your tax obligations and don’t have offsetting capital losses, it could result in a tax bite at the end of the year. If you are not so concerned about the tax situation, reducing or selling the position could also make a lot of sense at this time. Then review when that fund is trading more in line with its historical premium.