EVT: This Well-Positioned Fund Can Protect Against Inflation (NYSE:EVT)

The Eaton Vance Tax-Advantaged Dividend Income Fund (NYSE:EVT) is a closed-end fund that income-focused investors can purchase as a method of earning a high level of income without sacrificing their equity exposure. This is something that could be particularly important right now given the pervasive inflation that is likely to persist going forward. As I stated in a recent article:

One of the nice things about this fund is that it invests in equity securities, so it provides a certain amount of protection against inflation, which may be a bigger problem going forward than it has been in the past. After all, the projections for large fiscal deficits are well known, and it is difficult to see any way for these deficits to be funded by any method apart from the creation of new currency. Historically, equities, real estate, and gold have been the best ways to preserve the purchasing power of your money against inflation.

The news headlines continue to declare that inflation has been beaten, but the latest data does not completely support that viewpoint. The core consumer price index increased by 0.2% month-over-month in July, an acceleration from the 0.1% month-over-month figure in June:

A 0.2% month-over-month increase works out to 2.4% annually, which is still above the Federal Reserve’s target level. Meanwhile, the same report had rent inflation running at a 5.1% rate and services inflation at 4.9% year-over-year. Admittedly, all of these figures indicate that inflation has slowed down from the levels that existed back in 2022. However, if this is the best that the central bank has been able to accomplish after two-and-a-half years of a “tight monetary policy” (that is not even tight at all, which I have shown in various previous articles) then it seems that a wise investor should prepare for inflation to be a permanent state of affairs. The fact that the Eaton Vance Tax-Advantaged Dividend Income Fund invests in equities should help with this preparation.

Investors in this fund do not need to sacrifice income for inflation protection in the case of this fund. As of the time of writing, the Eaton Vance Tax-Advantaged Dividend Income Fund boasts an 8.23% distribution yield, which is quite attractive compared to most things in the market. As is frequently the case with Eaton Vance funds, though, it is only average when compared to its peers:

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As expected, the Eaton Vance Tax-Advantaged Dividend Income Fund does not have the most attractive yield among its peers. It does manage to do better than a few other funds in this category, however. In addition, this fund increased its distribution back in April, so that is a bonus for anyone who is seeking a certain amount of inflation protection.

As regular readers might remember, we previously discussed the Eaton Vance Tax-Advantaged Dividend Income Fund back in January of this year. At the time, I suggested that the fund was a buy due to its reasonable valuation and high yield, but I warned that it could underperform the broader market. That has generally proven to be a correct prediction. The fund’s share price has appreciated by 7.58% since the date that my previous article was published:

We can see that the fund underperformed against both the Allspring Utilities and High Income Fund and the Calamos Strategic Total Return in terms of share price appreciation. It is unsurprising that the Calamos Strategic Total Return Fund beat it, since that fund tends to engage in momentum trading and has no specific focus on maximizing its yield like the Eaton Vance Tax-Advantaged Dividend Income Fund does. The fact that the Allspring Utilities and High Income Fund outperformed is rather surprising, though, as that fund has a substantial bond exposure that we would have expected to drag it down a bit.

The S&P 500 Index (SP500) was up 12.78% over the period, so this fund underperformed that as well.

However, as we can see in the table above, both of the outperforming funds have lower yields than the Eaton Vance Tax-Advantaged Dividend Income Fund. That helps to balance things out somewhat, since it provides a greater boost to the fund’s total return. As I have stated in previous articles:

A simple look at a closed-end fund’s share price performance does not necessarily provide an accurate picture of how investors in the fund did during a given period. This is because these funds tend to pay out all of their net investment profits to the shareholders, rather than relying on the capital appreciation of their share price to provide a return. This is the reason why the yields of these funds tend to be much higher than the yield of index funds or most other market assets.

When we include the distributions paid out by the Eaton Vance Tax-Advantaged Dividend Income Fund and its peers into the chart above, we get this alternate performance chart:

This actually will likely reduce the appeal of this fund somewhat according to some investors, as this time it is in the bottom half of the performance comparison. The RiverNorth Opportunities Fund, by virtue of its substantially higher yield, managed to deliver a higher total performance in addition to both of the funds that outperformed it when we were only looking at the share price. When we consider that closed-end funds usually get a price jump when they raise their distributions, this is doubly disappointing.

However, past performance is no guarantee of future results. Today’s underperformer could be tomorrow’s outperformer. As such, we should take a look at the fund’s portfolio today to try to make an educated projection of where it will be tomorrow.

About The Fund

According to the fund’s website, the Eaton Vance Tax-Advantaged Dividend Income Fund has the primary objective of providing its investors with a high level of after-tax total return. This objective makes a lot of sense for an equity fund, given that equities are, by their nature, total return instruments. However, the fact that this one is classified as a hybrid fund suggests that its portfolio does not solely consist of equities. The fund’s semi-annual report provides the following asset allocation as of April 30, 2024:

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The entirety of the exchange-traded funds holding consists of the Global X U.S. Preferred ETF (PFFD) so that should be considered as part of the preferred stock holding. Even so, that gives us a 99.2% weighting to common stocks and a 2.7% weighting to preferred stocks. That certainly looks much more like a pure common equity fund than a hybrid fund. For comparison, the Calamos Total Return Fund has the following asset allocation today, according to its website:

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This is a lot closer to what we would expect the asset allocation of a hybrid fund to look like, as it represents a mix of both common equities and fixed-income securities. As of right now, the Eaton Vance Tax-Advantaged Dividend Income Fund consists almost exclusively of common stock. It does have a little exposure to preferred, but as its non-common stock exposure is less than 5%, it is unlikely to have much of an impact on the fund at all. This is perhaps especially true given that the fund has no bonds in its portfolio at all.

The prospectus for the Eaton Vance Tax-Advantaged Dividend Income Fund describes its investment strategy thus:

Under normal market conditions, the Fund invests at least 80% of its total managed assets in dividend-paying common and preferred stocks that Eaton Vance believes at the time of investment are eligible to pay dividends that qualify for federal income taxation at rates applicable to long-term capital gains. For the purposes of the 80% test, total assets is defined as net assets plus any borrowings for investment purposes. In selecting securities, the Adviser will seek common and preferred stocks of issuers that are, in the opinion of the Adviser, undervalued or inexpensive relative to the overall market. The Adviser retains broad discretion to allocate the Fund’s investments between common and preferred stocks in a manner that it believes will best effectuate the Fund’s objective. The Fund may invest in common and preferred stocks of both domestic and foreign issuers.

This certainly explains why this is classified as a hybrid fund. As the description clearly states, the Eaton Vance Tax-Advantaged Dividend Income Fund can invest anywhere from 0% to 100% of its assets in either common or preferred stocks. It will not invest in bonds like many other hybrid funds, but it does have the potential to provide exposure to both common equities and fixed-income securities (in the form of preferred stock). However, as of right now, the fund’s management appears to believe that common stocks are likely to have better total returns than preferred stocks going forward. I agree with this conclusion, as preferred stocks are priced for about 200-basis-points of cuts to the federal funds rate over the next twelve months:

It does not seem very likely that the Federal Reserve will reduce rates much below the 325 to 350 range unless a major recession sets in within the next several months. As already mentioned, inflation is likely to be a major problem in perpetuity, so even 200 basis points of cuts might be optimistic. It is therefore difficult to see much upside for preferred stocks, but common equities are a different matter due to the simple fact that inflation boosts the bottom lines of most corporations. Thus, the fund’s heavy weighting to common equities is probably the correct choice right now.

The description of the fund’s strategy from the prospectus states that the Eaton Vance Tax-Advantaged Dividend Income Fund focuses its portfolio investments on common stocks that pay a dividend. The fund’s largest positions confirm that this is the case, which we can see here:

Many of these companies do pay a dividend, and indeed most of them have yields that are above the 1.23% trailing twelve-month yield of the SPDR S&P 500 ETF Trust (SPY). Here are the yields of the fund’s largest holdings:

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We can see that BJ’s Wholesale Club Holdings is the only company among the fund’s largest positions that does not pay a dividend. There are only three companies among the fund’s largest positions, including BJ’s, that have a lower yield than the broader S&P 500 Index. As such, this fund actually seems to be following its mandate to invest its assets primarily in dividend-paying stocks. This is different from many of Eaton Vance’s other closed-end funds that claim to invest in dividend stocks but actually do not (or did not, until the mega-cap technology companies started paying a meager dividend earlier this year).

As I stated in my last article on this fund:

The first thing that we notice is that none of the “Magnificent 7” technology stocks are listed among the fund’s largest positions. These are the seven companies whose stocks have been responsible for a substantial percentage of the total returns of the S&P 500 Index over the past year and as such these companies now account for an outsized portion of many investors’ portfolios. This is obviously not particularly good from a diversification perspective so the fact that this fund includes different companies is very nice to see.

This fund’s diversification does not extend merely excluding the “Magnificent 7,” however. In fact, several of the companies shown above are ones that are not often seen among the largest positions in any closed-end fund’s portfolio. This is something that we can appreciate, as it appears as though this fund will provide its investors with exposure to companies that they might not otherwise have in their portfolios. This could, in some cases, result in the fund providing investors with exposure to an opportunity that they otherwise would have missed out on. That is a good thing, regardless of the individual’s goals.

There have been numerous changes to the fund’s largest positions list since the last time that we discussed it. In particular, Constellation Brands (STZ), ConocoPhillips (COP), American International Group (AIG), Linde plc (LIN), and Huntington Ingalls Industries (HII) have all been removed from their former positions among the fund’s largest holdings. In their place, we have NextEra Energy, Thermo Fisher Scientific, Hasbro, Mid-America Apartment Communities, and BJ’s Wholesale Club. It is rare to see a fund change its largest holdings to this extent over a six-month period, which suggests that this fund has a very high turnover. However, the semi-annual report states that it was only a 24% annualized rate during the first half of the fiscal year. This is not particularly high for an equity fund, and in fact, it is lower than some of Eaton Vance’s other dividend-focused closed-end funds. Thus, some of the changes that we see here might be due to one of the fund’s holdings delivering better relative performance that elevates or reduces its weighting. Another would be the possibility of few changes apart from the five just reported. In either case, this fund does not appear to be trading as aggressively as we might assume from half of its largest positions list getting altered.

Leverage

As is the case with most closed-end funds, the Eaton Vance Tax-Advantaged Dividend Income Fund employs leverage as a method of increasing the effective yield and total return that it obtains from the assets in its portfolio. I explained how this works in my last article on this fund:

In short, the fund borrows money and then uses that borrowed money to purchase dividend-paying common stocks and other assets that produce income. As long as the purchased securities are able to deliver a higher total return than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio.

This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, it will normally be the case that the strategy works properly. With that said though, the interest rate on borrowed money today is going to be higher than the yield of just about anything except for certain energy partnerships so the strategy is not nearly as effective as it was two years ago.

Unfortunately, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not employing too much leverage since that would expose us to too much risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for this reason.

As of the time of writing, the Eaton Vance Tax-Advantaged Dividend Income Fund has leveraged assets comprising 19.06% of its portfolio. This is a slight decrease from the 19.82% leverage ratio that the fund had the last time that we discussed it, which makes sense. After all, the fund’s share price increased over the period in question and that usually means that its net asset value increased, which reduces the proportion of the portfolio represented by the fund’s leverage.

This is indeed the case, as the fund’s net asset value increased by 7.87% since the date that my previous article was published:

As I have explained in numerous previous articles, this typically results in a fund’s leverage ratio declining, all else being equal. Indeed, unless the fund borrows more money as its net asset value increases, its leverage is guaranteed to decline. This appears to be what we are seeing here.

The current leverage ratio of the Eaton Vance Tax-Advantaged Dividend Income Fund is well below the one-third of assets levels that we would ordinarily consider to be acceptable for an equity fund. However, it is still a good idea to compare it to its peers to ensure that its leverage is acceptable for its strategy. Here is a comparison chart:

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(All figures from CEF Data.)

The leverage ratio of the Eaton Vance Tax-Advantaged Dividend Income Fund is below the median of this peer group. This is a good sign as it suggests that the fund is not employing an excessive amount of leverage. Potential investors should not need to worry too much about its leverage.

Distribution Analysis

The primary objective of the Eaton Vance Tax-Advantaged Dividend Income Fund is to provide its investors with a high level of after-tax total return. As is the case with most closed-end funds, it primarily provides its total return in the form of direct payments made to its shareholders. The fund makes a regular monthly distribution of $0.1646 per share ($1.9752 per share annually), which gives it an 8.23% yield at the current share price.

While it has not been perfect, this fund has generally been pretty reliable with its distribution over the years:

From the previous article:

As we can clearly see, the general trend has been for the fund to raise its distribution over time. At least, that has been the general trend since the financial crisis and the ensuing Great Recession. We do see a cut following the 2022 bear market, but that still left the distribution at higher levels than prior to the pandemic.

The fund raised its distribution again in April 2024, and as of right now, the fund has the highest distribution that it has ever had. Earlier in this article, I suggested that this fund could be a suitable option for investors who need to protect themselves against inflation. One way to do that is to grow income, and this fund has a pretty good track record in this respect.

Naturally, though, we want to consult the fund’s financial reports to see how well it can sustain this newly raised distribution. For this purpose, we will consult the semi-annual report for the six-month period that ended on April 30, 2024. A link to this document was provided earlier in this article. It is much newer than the report that we had available the last time that we discussed this fund, so it should work well for the provision of an update.

For the six-month period that ended on April 30, 2024, the Eaton Vance Tax-Advantaged Dividend Income Fund received $21,497,667 in net dividends and $11,641,728 in net interest income. This gives the fund a total investment income of $33,139,395 for the six-month period. The fund paid its expenses out of this amount, which left it with $9,570,259 available for shareholders. This was not sufficient to cover the $67,729,572 that the fund paid out in distributions during the period.

The fund was able to make up the difference through capital gains. For the six-month period that ended on April 30, 2024, the Eaton Vance Tax-Advantaged Dividend Income Fund reported net realized gains of $70,051,580 along with $278,738,717 net unrealized gains. Overall, this fund’s net assets increased by $290,630,984 after accounting for all inflows and outflows in the period. This was easily enough to cover the distribution, with a great deal of money left over.

The fund was able to fully cover its distribution just with net investment income and net realized gains. The massive amount of unrealized gains represents future money that the fund could tap to cover distributions, assuming that the market does not harshly decline in the near future. As such a market decline seems rather unlikely, we probably do not have to worry about the fund’s distribution. It appears to be having no difficulty covering it.

Valuation

Shares of the Eaton Vance Tax-Advantaged Dividend Income Fund are currently trading at an 8.54% discount to net asset value. This is reasonably in line with the 8.20% discount that the shares have had on average over the past month.

Conclusion

In conclusion, the Eaton Vance Tax-Advantaged Dividend Income Fund is technically a hybrid closed-end fund that is currently positioned like a pure equity fund. This makes a certain amount of sense given the limited upside of fixed-income securities right now. After all, the interest rate declines that are likely to occur are more than priced into them already. The fact that this fund is primarily invested in common equities is also a good thing for investors who need inflation protection, which most income investors probably do.

Eaton Vance Tax-Advantaged Dividend Income Fund is one of the few funds that has a history of growing its distribution over time, and it appears to be fully covering the current payout. The fact that this fund also trades at a discount to NAV, adds to its appeal right now.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.