Saba's Payout Puzzle: Income or Return of Capital?

NEW YORK, NY – November 28, 2025 – At first glance, the latest announcement from the Saba Capital Income & Opportunities Fund II (NYSE: SABA) appears routine. The closed-end fund (CEF) declared its monthly distribution of $0.058 per share, a figure that provides an attractive annualized yield. But buried within the legally mandated Section 19(a) notice is a detail that fundamentally changes the narrative: for the fiscal year to date, nearly 60% of the fund's distributions have been classified as a “return of capital.”

While the most recent monthly payment is sourced entirely from net investment income, the cumulative picture tells a different story. Of the $0.696 per share distributed so far this fiscal year, a staggering $0.416—or 59.78%—is simply the fund returning a portion of its shareholders' own invested money. This isn't profit or yield in the traditional sense; it's a financial maneuver with significant implications for an investor's tax basis and the long-term health of their principal. For those drawn to the allure of high-yield CEFs, this notice serves as a critical lesson in looking beyond the headline number.

Deconstructing the Distribution

For many investors, a distribution is a distribution. However, the source matters immensely. A Section 19(a) notice, required by the Investment Company Act of 1940, forces funds to provide an estimate of where the money is coming from. The three primary sources are net investment income (from dividends and interest), realized capital gains (from selling assets at a profit), and return of capital (ROC).

When a fund's distribution includes a significant ROC component, it means the fund is paying out more than it has earned in income and realized gains. Instead of being taxed as income, a ROC distribution reduces an investor's cost basis in the fund. For example, if an investor bought a share for $10 and receives a $1 ROC distribution, their new cost basis for tax purposes becomes $9. This defers the tax liability; a larger capital gain will be realized when the share is eventually sold. If the cost basis is reduced to zero, any further ROC is taxed as a capital gain in the year it is received.

This can be a double-edged sword. While it provides a tax-deferred cash flow, a high and persistent reliance on ROC can signal that a fund's underlying portfolio is not generating enough organic income to support its payout. In a worst-case scenario, this can lead to an erosion of the fund's Net Asset Value (NAV), meaning the fund is liquidating itself over time to maintain a steady distribution. The key question for investors is whether the ROC is “destructive” or simply a feature of a fund’s total return strategy, where unrealized gains in the NAV are sufficient to cover the payout even if it's classified as ROC for tax purposes.

New Management, New Math

The current distribution strategy is unfolding under new leadership. On January 1, 2024, Saba Capital Management, L.P., the activist hedge fund led by Boaz Weinstein, took over as the investment adviser from Franklin Templeton. Saba Capital is renowned in the CEF space not just for managing funds, but for its activist campaigns targeting underperforming CEFs that trade at a significant discount to their NAV.

This context is crucial. The Saba Capital Income & Opportunities Fund II has persistently traded at a discount, recently hovering around 10% below its NAV of $9.78 per share. One of the primary objectives of a managed distribution plan, like the one SABA employs, is to provide a consistent payout that can attract investors and help narrow this discount. By maintaining a fixed $0.058 monthly distribution, Saba may be attempting to build shareholder confidence and close the gap between the market price and the intrinsic value of the fund's assets.

From an activist's perspective, using ROC to fund distributions could be a strategic tool. It provides a steady, high-yielding cash flow to shareholders while the management team repositions the portfolio. However, the sustainability of this strategy hinges entirely on the fund's ability to generate a total return—the combination of NAV appreciation and distributions—that outpaces the payout rate. The fund's cumulative total return of 13.16% for the current fiscal period suggests it has, so far, earned its distribution. Yet, the heavy reliance on ROC in the year-to-date figures underscores the pressure on Saba's management to deliver strong NAV performance to avoid eroding investor principal over the long term.

A Case Study in CEF Investing

The situation at SABA serves as a powerful case study for anyone investing in the complex world of closed-end funds. These vehicles offer access to unique strategies and often provide higher yields than their open-end mutual fund counterparts, but they come with their own set of rules and risks.

The dynamic between NAV and market price, the existence of discounts and premiums, and the mechanics of managed distributions are all critical concepts. SABA’s Section 19(a) notice is a stark reminder that an attractive distribution rate is only the beginning of the story. An investor must dig deeper to understand its composition.

Comparing SABA to its peers reveals that managed distribution plans and the use of ROC are common tactics, not anomalies. However, the degree to which a fund relies on ROC is a key differentiator. Prudent investors in this space regularly monitor not only a fund's yield but also its NAV performance, its distribution coverage from net investment income, and the source of its payouts as detailed in these periodic notices. The ultimate health of a CEF is reflected in its ability to grow or at least maintain its NAV over time, net of its distributions. Without that, a high yield can become a siren song, luring investors with cash payments that are ultimately just their own money being handed back to them.