I typically don’t cover closed-end funds in the Safety Net column. That’s because, to arrive at a dividend safety rating, I plug a company’s data into the SafetyNet Pro model to analyze variables like cash flow and payout ratio. But closed-end funds’ data differ from typical companies’ data.

A closed-end fund is similar to a mutual fund except that it has a limited number of shares and trades like a stock. Closed-end funds don’t generate cash flow. Any income they make from their investments typically fluctuates from year to year. The fund is not run like a business, so it’s difficult to analyze it in the same way you would analyze a company.

Nevertheless, when a reader suggested I look at Cornerstone Strategic Value Fund’s (NYSE: CLM) dividend safety, I was intrigued.

It pays a 20% yield.

That’s not a typo… 20%.

The fund invests in growth and value stocks. Its largest holdings are Apple (Nasdaq: AAPL), Amazon (Nasdaq: AMZN) and Alphabet (Nasdaq: GOOGL).

Apple pays a 1.4% yield. Amazon and Alphabet don’t pay a dividend. Neither does the fund’s sixth-largest holding, Facebook (Nasdaq: FB).

So how, in the name of all that is holy, can this fund pay a 20% dividend yield?

Return of capital.

If it does not generate enough income or capital gains to pay the dividend, it returns capital to shareholders, which decreases the net asset value (NAV). In other words, it returns shareholders’ money to them in the form of a dividend.

A Dividend Policy Doomed to Fail

The fund’s policy is to pay out 21% of its NAV in the form of dividends. But remember, if the fund’s returns don’t equal the dividend, the NAV falls. So if it continues to pay the same percentage of a declining NAV, the dividend has to decline with it.

And 21% is a pretty high hurdle to clear in terms of returns. If a fund manager returned 21% year after year, they would be legendary. So far this year, the S&P 500 has returned less than 6%. So even if the market gets going in the final months of the year, the fund will need some incredible outperformance to come close to 21%.

It’s a pretty safe bet that the fund’s investments will not return 21% this year (or most years).

It’s hard to imagine a scenario where Cornerstone Strategic Value Fund’s dividend doesn’t stop falling. Investors shouldn’t get too comfortable with its 20% yield.

Dividend Safety Rating: F

If you have a stock whose dividend safety you’d like me to analyze, leave the ticker in the comments section.

Good investing,