Tag Archives: closed-end-funds

Closed-End Funds: Still A Bargain

In a world in which very little is cheap and most mainstream stocks and bonds offer little in the way of expected returns, closed-end funds have been a fantastic source of value. I’ve been writing about closed-end funds for the better part of a year (see Closed-End Bond Funds Near Their Deepest Discounts Since 2008 ) and I’ve been very pleased with their performance in an otherwise choppy, directionless market. Yet I’ve noticed that some of the fantastic bargains I saw a year ago are starting to dry up. Or at least they’re not quite as juicy as they were. The 15% discounts to net asset value are now closer to about 10%. Though it may simply be a case of me getting spoiled. By any historical standard, closed-end funds are still exceptionally well priced. Patrick Galley, manager of the Rivernorth DoubleLine Strategic Income Fund, gave his thoughts to Barron’s this past week. (See 4 Closed-End Funds Yielding Up to 9% ): Q: Closed-end fund discounts have come in a lot since the beginning of the year. Aren’t they getting less attractive in general? A: Actually, closed-end fund discounts are still pretty attractive overall. In January and February they got so wide it was reminiscent of 2008. Fear was high and investors were dumping assets. Discounts got to the 98th percentile of the widest levels they’ve reached going back to 1996. They narrowed in March and April. Now they are at the 76th percentile of the widest levels. The averages are very much skewed by the muni-bond sector. Munis have had a good run and everyone wants them. Investors are chasing those past returns. They aren’t even looking at discounts and premiums. Meanwhile, taxable fixed-income spreads are still wide. As the examples I gave you show, a lot of them are still double-digit discount opportunities. 76th percentile is nothing to complain about. Sure, it was a lot more fun buying them at 2008-caliber discounts. But that’s really not normal, and every buying opportunity can’t be that good. So for the time being, I’ll plan on maintaining a solid allocation to closed-end funds in my Dividend Growth portfolio. The portfolio is up 13.5% year to date , and closed-end funds have certainly played their part in achieving those returns. This article first appeared on Sizemore Insights as Closed-End Funds: Still a Bargain Disclaimer : This site is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results.

One Investment… Three Ways To Profit

$150 billion is a lot of money. And due to some planned changes the makers of S&P and MSCI indexes are making, that’s the amount of money that is likely to flow into shares of real estate investment trusts (REITs) over the next few months. You see, up until now, REITs have been considered “financials” for the purposes of sector weighting. Well, that’s just crazy. A landlord that owns a portfolio of rental properties really has little in common with a bank or an insurance company. Yet, that’s where REITs have historically been lumped. But now that the index creators are fixing their mistake, there are going to be a lot of mutual fund managers and other institutional investors who will be pretty dramatically out of balance. According to recent research by Jefferies, that $150 billion is how much would need to be reallocated to REITs so that mutual fund managers can meet their benchmark weightings. I expect that the real number will be a decent bit lower than that. A lot of managers will be content to be underweight REITs relative to their benchmark. But even if it ends up being half that amount, that’s a big enough inflow to seriously buoy REIT prices. The entire sector is only worth about $800 billion. I’m telling you this now because we’ve been mentioning REITs in Boom & Bust of late, and so far, the results have been solid. But what I want to mention today is potentially even better. If you believe in the REIT story and expect REIT prices to go higher, and someone told you that you could buy a portfolio of REITs for 90 cents on the dollar, wouldn’t you jump at the opportunity? Well, that’s exactly the situation today in the world of closed-end funds. And in Peak Income , the new newsletter I write with Rodney Johnson, I recently recommended a closed-end REIT fund trading for about 90% of net asset value. Out of fairness to the readers who pay for that information, I can’t share the specific stock with you. But I can definitely tell you how I chose this fund and what you should look for when evaluating closed-end funds on your own. With most mutual funds, you can really only make money one way: the stocks in the portfolio must rise in value. Sure, dividends might chip in a couple extra percent. But for the most part, you only make money if the stocks the manager buys go up. That’s not the case with closed-end funds. In fact, you can make good money in three ways with this particular investment vehicle: #1 – Current dividend is generally a large component of returns. Unlike traditional mutual funds, closed-end funds are specifically designed with an income focus in mind, so they tend to have some of the highest current yields of anything traded on the stock market. This is partially due to leverage. Closed-end funds are able to borrow cheaply and use the proceeds to buy higher-yielding investments. This has the effect of juicing yields for you. #2 – Returns delivered via portfolio appreciation. Just as with any mutual fund, you make money when the stocks your fund owns rise in value. #3 – You have the potential for shrinkage of the discount or an increase in the premium to net asset value. That sounds complicated, so I’ll explain. Because closed-end bond funds have a fixed number of shares that trade on the stock market like a stock, the share price can deviate from its fundamentals just like any stock can. Sometimes, you can effectively buy a good portfolio of stocks, bonds or other assets for 80 or 90 cents on the dollar … or even less from time to time. But often, that same dollar’s worth of portfolio assets might be trading for $1.10 or higher on the market. Well, I’m not a big fan of paying a dollar and 10 cents for just a dollar’s worth of assets… no matter how much I might like those assets. But I do rather like getting that same dollar’s worth at a temporary discount. And when that discount closes, your returns outpace those of the underlying portfolio. The ideal closed-end fund investment should have solid potential from all three factors. It will pay a high current dividend, will have a portfolio poised to rise in value, and will be trading at a deep discount to net asset value. Be sure to look for those three things when you research closed-end funds. This article first appeared on Sizemore Insights as One Investment… Three Ways to Profit . Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post

Time To Extract Value From CEF Investment Recommendation

Payoff Pitch Update – Time to Extract Value from CEF Investment Recommendation On July 20, 2015 we wrote a strategic article entitled “Finding Value in the Ninth Inning of the Great Bond Rally” which made the case for an investment in closed end mutual funds (CEF’s) backed by municipal bonds. This article reviews the original investment thesis, updates the reader on the performance and attributes of the securities we recommended and concludes with new advice on the position. In the original article, we analyzed 50 muni-backed CEF’s in order to select a manageable sub-set of securities offering the most potential. The analysis supporting the recommendation relied upon many self-imposed factors and risk constraints, many of which we will not rehash in this article and some of which we did not detail in the prior article. There are three factors, however, which are worth reviewing as we evaluate and potentially change our investment recommendation. They are as follows: Discount to Net Asset Value (NAV) – Closed end funds frequently trade at a premium or discount to their net asset value (current market value of the securities held by the fund). One of the driving factors behind our investment decision was the fact that many muni-backed CEF’s were trading at historically large discounts to their NAVs. We believed at that time, barring severe credit dislocations in the municipal bond sector that CEF investors would benefit from the normalizing discounts. Interest Rate Forecast – We have written numerous times that we expect the U.S. economy will continue to be plagued with weak economic growth and increasing deflationary pressures. Such an environment typically bodes well for fixed income assets, specifically those that are investment grade. This theory which would result in even lower interest rates was another factor supporting our recommendation. Municipal Yield Spread to Treasuries – Like all bonds, municipals trade at a yield spread, or differential, to U.S. Treasury bonds. Statistically, the relationship between municipal bond yields and Treasury bond yields exhibits a strong correlation. The spread can help astute investors create more dependable risk/reward forecasts. When the original paper was written, we calculated that municipal bonds were trading at a premium versus U.S. Treasury bonds. While the risk existed that the yield spread would normalize, we thought the advantages of the discount to NAV and our overriding interest rate forecast would more than offset the potential yield spread risk. Performance and Investment Attributes Since recommending the trade, the selected CEF’s have performed very well. The first table below highlights the performance of the CEF’s and the second set of tables, on the following page, compares the original attributes table to an updated version. Click to enlarge Data Courtesy: Bloomberg — A negative number in the premium/discount to NAV column represents a discount Within the tables are a few points worth detailing. First, the CEF’s, on average, have a total return of +10.39% or nearly +20% annualized. The graph below compares the cumulative total return of the CEF’s to that of the S&P 500 (-8.64%), IEF a 7-10 year U.S. Treasury ETF (+2.82%), and MUB a municipal bond ETF (+3.51%). The returns include both price appreciation and dividends. Cumulative Total Return CEF’s vs Popular Investment Alternatives Data Courtesy: Bloomberg Second, the discount to NAV, for all of the securities, improved. The CEF’s, on average, witnessed a 3% decrease in the discount. Think of this as appreciation in the value of the fund above and beyond changes to the value of the fund’s holdings. While all of the securities still trade at attractive discounts, they are currently trading back in line with their 3 year average. Third, the CEF’s also benefited from a drop in yields during this holding period. The lower CEF yields were a function of the aforementioned decrease in the discount to NAV, as well as a general move lower in municipal and Treasury yields. During the period, the average yield on the selected CEF’s fell by .43% while comparable Treasury yields fell by .22% and the Bond Buyer GO 20 Municipal Bond Index fell by .32%. The bonds underlying the funds, likely saw yields on average decrease more than Treasury bonds during this period. In bond market parlance one would say the municipal -Treasury yield spread tightened or became richer, to the benefit of municipal bond holders. Investment Review As previously mentioned at the time we wrote the article we were comfortable with the risk that municipal bond yields might underperform Treasury bond yields. Our thought being that any widening of municipal/Treasury spreads would likely be more than offset by our expectation for lower yields in general and the normalization of discounts to NAVs. Given the improvement in the discounts to NAV and lower yields, we need to re-address the risk that municipal yields underperform Treasury yields. Said differently, it is worthwhile here to assess the risk that the municipal-Treasury yield spread could widen or cheapen. The scatter plot below compares municipal-Treasury spreads as a percentage of Treasury yields through different interest rate environments since 2000. While there are many ways to evaluate the spread, the method shown is attractive as it accounts for spreads with consideration for the absolute level of rates. The effectiveness of this model is supported by an R-squared of .93, which denotes a very tight relationship between the factors. Data points that lie below the regression trend line are instances where the spread is considered tight or rich, with the difference between municipal yields and Treasury yields being lower than average. The opposite holds true for data points above the line. Municipal/Treasury Spreads as a % of Treasury Yields – January 2000 – Current Data Courtesy: St. Louis Federal Reserve (NASDAQ: FRED ) – Ten Year Treasury CMT vs Bond Buyer G.O. 20 Index The current spread is represented by the red dot, and the spread from July 2015 is yellow. By comparing the two highlighted data points, one notices the spread tightened further over the last 6 months. Statistically this can be quantified by measuring the distance between each dot and the trend line. During this period the spread moved from 1.40 standard deviations to 2.25 standard deviations below the trend line. The current spread, is now the tightest (furthest from the trend) that it has been since at least the year 2000. Current recommendation Given that the factors driving our original recommendation (discount to NAV and lower yields) are not as compelling today as they were in July, coupled with a probable widening of the municipal-Treasury spread, we are not as comfortable with the risk-reward scenarios as we were. To further appreciate the tight spread, consider that if the spread were to instantly revert back to trend, the prices on the bonds underlying the CEF’s, on average, would decline by about 3%. Given that the CEF’s employ leverage the likely price drop of the CEF’s would be greater than the drop in the bond prices underlying the CEF’s. Due to our concern over the potential for spread widening and weakened prospects for further discount normalization we are recommending that investors sell LEO (Dreyfus Strategic Municipal Fund) as the discount to NAV is nearing zero. We also recommend investors sell half of their shares in the other holdings. Take well-earned profits and remain vigilant on the remaining holdings, perhaps consider employing a stop loss order to sell shares. The remaining CEF’s still offer a sound value proposition.