Understanding Return of Capital in Closed-End Funds

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1 Closed-End Funds Understanding Return of Capital in Closed-End Funds Investors are increasingly seeking sources of cash flow that are: HIGH to help fund their desired lifestyles, DIVERSIFIED to withstand different market environments, STABLE to reasonably budget their income against their expenses, and TAX EFFICIENT to keep more of what they earn TO TRY TO ADDRESS THESE DESIRED OUTCOMES, many investors turn to closed-end funds to complement other income investments. Closed-end funds that use equity or alternative asset strategies may be particularly well-suited to help diversify and augment traditional income-oriented portfolios, although success is never guaranteed. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE

2 Many equity and alternative asset strategy closed-end funds use a managed distribution program to include capital gains and appreciation in each regular distribution. At Nuveen, the goal of our managed distribution programs is to offer attractive and tax-efficient regular cash flow to our shareholders from a variety of investment strategies, by converting the expected long-term total return potential of their fund s investment portfolio into regular quarterly or monthly distributions. Managed distribution sources may include net investment income, realized gains, and /or a return of capital (ROC) in each regular distribution. Return of capital may be one of the most misunderstood closed-end fund concepts; this discussion seeks to clarify some of the confusion. 1. The fund s capital: not just your original investment Income Realized Capital Gains Capital Appreciation Shareholders Initial Investment return A fund s capital its net asset value (NAV) starts with shareholders initial investment in common shares. The value changes as the fund s investment portfolio appreciates, depreciates, or generates and distributes income from dividends and interest. The fund s total return on net asset value is comprised of its income and any gains, both realized and unrealized, after expenses.* Regulations require a fund to distribute most of its investment income and realized gains each year. If the fund distributes only its net investment income and realized gains, and has unrealized appreciation as well, the fund s net asset value its capital at the end of the year will be higher. Fund capital For most fixed income strategies, net investment income makes up the majority of the fund s total return, and the fund s NAV is not typically affected much by unrealized appreciation over time. * Net investment income: dividends and interest received from securities held by the fund, less any applicable expenses. Realized gain: the amount resulting from selling a security at a profit (at a price higher than the original purchase price). gain: the difference between a security s current valuation and its purchase price. If the security is sold at its current valuation, the gain then becomes a realized gain. Note that funds may also have realized and unrealized losses.

3 Understanding Return of Capital 2. Return of capital is a choice What if the fund s expected return consists mainly of appreciation, not income, as is true for many equity and alternative asset strategies? Income Realized Capital Gains Must be distributed each year The fund s first choice: whether to pay a distribution amount that is greater than the required minimum of just net investment income and realized gains. To trade more competitively in the market, or to meet a stated goal of converting as much of the fund s total return into regular cash flow as possible, the fund may wish to pay a higher regular distribution amount than regulations require. If it has unrealized appreciation, the fund has a second choice: whether to realize some or all of its appreciation, selling portfolio securities to raise cash to increase its distribution amount. Selling appreciated securities creates at least two consequences: Fund has a choice to distribute Capital Appreciation Shareholders Initial Investment Realized gains will be taxed in the current tax year at either long-term or short-term rates. The fund gives up future appreciation potential for the securities sold. To avoid either of those situations, instead a fund can pay the additional distribution amount from its capital. The fund s capital consists of two sources: (i) shareholders initial investment, plus (ii) the value of the unrealized appreciation, over its lifetime, if any. For tax purposes, both sources are labeled return of capital. What happens when a distribution includes ROC? If the return of capital amount exceeds the fund s unrealized appreciation, some or all of the ROC will represent part of the shareholders initial investment capital. If a fund continues to pay out part of this initial capital, its assets and earning power will diminish over time. The fund still needs cash to pay the additional distribution amount. This cash can come from a variety of sources, including selling a depreciated security. Return of capital typically is not taxed in the current year. Instead, it reduces a shareholder s cost basis in the fund. When the shareholder sells his or her fund shares, any gains will consider the selling price relative to the reduced cost basis. This means that ROC usually defers some of the shareholder s tax liability. So, a fund s choice to return capital can be an attractive tax-management decision, or it can diminish future earnings power, or sometimes it can be both.

4 3. How can you evaluate return of capital? When a fund returns capital, investors want to discern which situation exists: a good tax choice, diminished original invested principal, or some of both. The key is to compare a fund s distribution rate on NAV with its total return on NAV over various time periods. Most managed distribution programs seek to match distributions to return over the long term, seeking to preserve shareholders original investments. Income If a fund s total return on NAV exceeds its distribution rate on NAV, any return of capital is likely to be a decision that defers some tax liability into the future. Realized Capital Gains Return If Return > Distributions then Return of capital is a beneficial choice, deferring some tax liability. Capital Appreciation An example may help: The 19(a) notice information for Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX) showed that an estimated 43% of its distributions represented return of capital (as of November 30, 2014). Fund Per Share Distribution Income (NII) Estimated Percentage of the Distribution Realized Gains QQQX % 50.9% 43.1% ROC Fund Inception Date Per Share Distribution Quarterly Monthly Equivalent Monthly NII However, the fund s one-year total return on NAV in that time period was 20.38%, far greater than its annualized distribution rate on NAV at the time of 6.80%. During this time period, the fund s return of capital distribution represented a choice to reduce current year taxes and retain future earning potential for some of its portfolio holdings. YTD Net Realized Gain/Loss Inception Gain/Loss Current Distribution Rate on NAV Return on NAV 1-Year 5-Year YTD YTD Distribution Rate on NAV QQQX 1/30/ % 20.38% 17.29% 17.11% 6.61% These examples are intended to illustrate how return of capital can affect cash flow and are not intended to project the performance of any specific fund.

5 Understanding Return of Capital In summary Closed-end fund investors should keep the following in mind: Fund strategies that expect much of their total return from appreciation, versus dividends and interest, often use a managed distribution program. Managed distributions may include one or more sources: net investment income, realized gains, or return of capital. A fund s capital includes shareholders initial investment capital PLUS any unrealized portfolio appreciation. Return of capital distributions may represent either or both of these sources. When a distribution includes either realized gains or ROC, regulations require the fund to provide a written 19(a) notice including the estimated distribution sources and relevant NAV performance information. To evaluate ROC, compare the fund s distribution rate on NAV to its total return on NAV for various time periods. If the fund s return is less than its distribution rate, some or all of the ROC is destructive negatively affecting future earnings power. This may not be sustainable over time. If the fund s return exceeds its distribution rate, returning capital distribution likely represents a beneficial tax choice. Nuveen s approach to managed distributions seeks to match total distributions to total returns over longer time periods, though there is no guarantee this will occur in any specific time period. IMPORTANT RISK CONSIDERATIONS Investing in closed-end funds involves risk; principal loss is possible. There is no guarantee a Fund s investment objectives will be achieved. Closed-end fund shares may frequently trade at a discount or premium to their net asset value. It is important to consider the objectives, risks, charges and expenses of any fund before investing. Past performance is not a guarantee of future results. CEF distribution sources historically have included net investment income, realized gains, and return of capital. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor s objectives and circumstances and in consultation with his or her advisors. Nuveen is not a tax advisor; investors are encouraged to consult their own tax advisors for guidance that is specific to their own tax situation. The example of QQQX (Nuveen Nasdaq 100 Dynamic Overwrite Fund) shown in this presentation is as of November Investments in QQQX shares are subject to risks: Common stock returns often have experienced significant volatility. The Fund may not participate in any appreciation of its equity portfolio as fully as it would if the Fund did not sell call options. In addition, the Fund will continue to bear the risk of declines in the value of the equity portfolio. Because index options are settled in cash, sellers of index call options, such as the Fund, cannot provide in advance for their potential settlement obligations by acquiring and holding the underlying securities. For these and other risks, including tax risk, please see the Fund s web page at nuveen.com/qqqx. Nuveen Securities, LLC, a subsidiary of Nuveen, LLC. nuveen.com/cef

6 Understanding Return of Capital Why Nuveen for Closed-End Funds? A trusted closed-end fund provider for more than thirty years, Nuveen offers advisors and investors dedicated client service with a legacy of integrity and innovation. Market leadership A pioneer in long-term income and cash flow solutions Focused expertise Active management from Nuveen and its investment affiliates To learn more about Nuveen s closed-end funds: Deep commitment Pursuing long term, lasting value for advisors and investors Financial Advisors: Visit nuveen.com/cefresources Contact your Nuveen Advisor Consultant Team at or our Nuveen CEF specialist at CEFSpecialist@nuveen.com Investors: Visit nuveen.com/cef Contact your Financial Advisor Nuveen Securities, LLC, member FINRA and SIPC. E SI - R OI -1117D I N V-Y-11/18 Nuveen 333 West Wacker Drive Chicago, IL nuveen.com/cef