April 2016 Closed-End Fund (CEF) Market Update
Senior Portfolio Specialist Allen Webb talks with Portfolio Manager Steve O'Neill about the closed-end fund market for the month of April 2016.
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[BEGIN VIDEO TRANSCRIPT]
ALLEN: Steve, thanks for joining us for the month of April closed-end fund market review. It seemed like the capital markets were relatively benign versus the first three months of the year. The S&P was up about a quarter of a percent, Barclay's Agg was up about the same. Credit was relatively tame. How did that translate into the closed-end fund market and returns?
STEVE: Closed-end funds had a great month. They significantly outperformed the S&P 500, many of the asset classes were up +200 basis points bringing really strong year-to-date returns. Taxable bond funds are now up about 7.5 percent total return. Munis, we talked about last month, continued their run, they’re up about 8 percent year-to-date, and equity funds are up about 200 basis points this year.
ALLEN: Steve, let’s talk about discounts for a minute. I believe the all closed-end fund average discount was about 5.25 at the end of April. We touched on this last month... does that imply that the attractiveness of closed-end funds from a discount perspective is now less attractive because we’ve come in so much at 5.25, or are you still finding opportunities as you look through some of the sub asset classes?
STEVE: I think the bifurcation of the market speaks to the opportunity. When investors like an asset class, they bid up the closed-end funds to very narrow discounts. You look at the muni closed-end funds today, which make up a large part of the closed-end fund market, they’re trading at an 80 basis point average discount. There are many billion-dollar funds that are trading at premiums to their net asset value. Investors are extremely comfortable with the leverage risk, apparently are very comfortable with the long durations of these portfolios, and they’re willing to pay a premium to get it. From an institutional perspective, that doesn’t make a lot of sense to us, but that doesn’t mean that the pendulum doesn’t swing both ways. We say often that closed-end funds become fearful at the lows and they become greedy at the highs. What it speaks to is the opportunity in the out-of-favor asset classes today. You’ve got munis that are at an 80 basis point discount, but you’ve got high-yield bond funds and bank loans that are trading – you know, you can easily build a portfolio of those names with an average discount of 9 to 11 percent. When investors like an asset class, they bid it up. We view that if you want to take taxable fixed income exposure, the market is still giving you a very good opportunity to build a full portfolio of wide discounts. Despite the fact that the average discount for bond funds is narrow, it’s really just a bifurcation of the market where tax-exempt income is rich and regular taxable income is cheap. When you think about equity closed-end funds, investors have been putting money to work in active managers for a while. You can, again, despite the fact that the average discount is narrow, it’s quite easy to build a portfolio with very wide-discount equity funds.
ALLEN: The message would be, don’t let the all closed-end fund average discourage people from some of the attractiveness of other parts of equity, as you mentioned, and the credit portion of the closed-end fund market.
STEVE: Yeah. As we said last month, closed-end funds have a lot of momentum. As a manager, we become more bullish on the closed-end funds base as a whole when parts of the market are trading well. It shows that investors are coming back to the market, and it proves the concept that discounts can narrow. We’ve been at wide discounts for many years on taxable fixed income funds, and it’s right for people to question whether discounts will ever narrow, but I think the same question could’ve been asked about muni closed-end funds in 2013 and 2014. People said, “Why would I ever buy these funds? They have a structural disadvantage by having leverage and long durations.” Lo and behold, we’re looking at premiums just a few years later. When there’s parts of the market that are strong, it gives us more confidence at the top-down perspective that discounts can narrow in other parts.
ALLEN: Steve, last question. You have talked a couple times in the past months about corporate actions and activism activity in the closed-end fund market has been on the rise. Can you give us an update on whether you’re still seeing that, and has anything specific happened to funds in the closed-end market?
STEVE: I think this month was certainly an important milestone in the closed-end fund market. You saw the AllianceBernstein Income Fund, a $3 billion closed-end fund, convert into an open-end fund. That fund was trading at an average discount of 10.5 percent last summer. What happened was institutional investors pressured the management company to take a discount-narrowing measure. Ultimately, the fund company decided to convert the closed-end fund into an open-end mutual fund. When you see such a large fund convert into an open-end fund and essentially give shareholders a 10.5 percent excess return in just a year’s time, that encourages more people to buy into corporate action opportunities. Really, when we think about where discounts have been for a while, retail investors have abandoned the market, really, for the last few years in the taxable fixed income space. Who is buying those closed-end funds? Those tend to be institutional investors that are going to exercise their vote in order to narrow discounts as a whole. Management companies certainly can see the writing on the wall, so they’re taking proactive measures to get ahead of these types of dissident activities. You’re seeing a lot of fund mergers, you’re seeing a lot of buybacks, and really an attempt by management companies to keep discounts narrow to keep the activists at bay. It’s, I’d say, more so than any other time in the last five years, you’re seeing a lot of institutional interest in the space. You’re seeing investors that have typically been passive taking a more active role. That’s ultimately resulting in, I think, an average discount that’s going to be narrower because everybody has an incentive to get the funds to trade better.
ALLEN: Steve, thanks for your comments this month.
STEVE: Thank you.
[END VIDEO TRANSCRIPT]
Video recorded 5.4.2016.
Produced by RiverNorth Capital Management, LLC ("RiverNorth" "we" or "us").
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Definitions
The price at which a closed-end fund trades often varies from its NAV. Some funds have market prices below their net asset values - referred to as a discount. Conversely, some funds have market prices above their net asset values - referred to as a premium.
Muni is short for municipal bonds.
Basis Points (BPS): A common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument.
Duration is a measure of the sensitivity of the price of a fixed income investment to a change in interest rates. Duration is expressed as a number of years.
Shareholder activism: A way in which shareholders can influence a corporation's behavior by exercising their rights as owners. Although shareholders don't run a company, there are ways for them to influence the board of directors and management. These can range from dialogue with management to voice their concerns about a particular issue to formal proposals that are voted on by all shareholders at a company's annual meetings.
S&P 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy based on the changing aggregate market value of these 500 stocks. This unmanaged index does not reflect fees and expenses.
The Barclays Capital U.S. Aggregate Bond Index is an unmanaged index of investment-grade fixed-rate debt issues with maturities of at least one year.
The High Yield CEF index total return and discount statistics are based upon the Morningstar Un-weighted High Yield CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a high yield investment strategy. High yield closed-end funds are defined as funds that seek high current income through investing in non-investment grade debt instruments.
The Preferred CEF index total return and discount statistics are based upon the Morningstar Un-weighted Preferred CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a preferred investment strategy. Preferred closed-end funds are defined as funds that invest primarily in preferred and/or convertible preferred stocks.
The Municipal Bond CEF index total return and discount statistics are based upon the Morningstar Un-weighted Municipal Bond CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a municipal bond investment strategy. Municipal bond closed-end funds are defined as funds that invest in a diversified portfolio of investment-grade municipal bonds in a variety of sectors and States.
The Global Income CEF index total return and discount statistics are based upon the Morningstar Un-weighted Global Income CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a global income investment strategy. Global income closed-end funds are defined as funds that invest primarily in a mixture of U.S. and foreign government and corporate debt, with an emphasis on developed countries.
The Investment Grade CEF index total return and discount statistics are based upon the Morningstar Un-weighted Investment Grade CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a investment grade investment strategy. Investment grade closed-end funds are defined as funds that invest primarily in investment grade debt instruments.
The Emerging Income CEF index total return and discount statistics are based upon the Morningstar Un-weighted Emerging Income CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing an emerging income investment strategy. Emerging income closed-end funds are defined as funds that invest primarily in emerging market government and corporate debt securities.
The Multi-Sector Bond CEF index total return and discount statistics are based upon the Morningstar Un-weighted Multi-Sector Bond CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a multi-sector bond investment strategy. Multi-sector bond closed-end funds are defined as funds that invest across several fixed income asset classes, with typically less than 50% in any one of these asset classes.
The Bank Loan CEF index total return and discount statistics are based upon the Morningstar Un-weighted Bank Loan CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a bank loan investment strategy. Bank loan closed-end funds are defined as funds that invest primarily in collateralized senior bank loans issued by corporations. Most of these securities are typically rated below investment grade.
The Convertible CEF index total return and discount statistics are based upon the Morningstar Un-weighted Convertible CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a convertible investment strategy. Convertible closed-end funds are defined as funds that invest primarily in Convertibles bonds / Convertible preferred stock.
The Mortgage Bond CEF index total return and discount statistics are based upon the Morningstar Un-weighted Mortgage Bond CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a mortgage bond investment strategy. Mortgage bond closed-end funds are defined as funds that invest primarily in a variety of mortgage-backed securities and mortgage derivatives.
The Government and Agency CEF index total return and discount statistics are based upon the Morningstar Un-weighted Government and Agency CEF Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a government and agency investment strategy. Government and Agency closed-end funds are defined as funds that invest primarily in U.S. Treasuries and Agency debt.
The Emerging Market Equity index total return and discount statistics are based upon the Morningstar Un-weighted Emerging Market Equity Index, which is the average of all closed-end funds categorized by Morningstar as utilizing an emerging market equity investment strategy. Emerging Market Equity closed-end funds are defined as funds that invest primarily in emerging market government and corporate debt securities.
The Covered Call index total return and discount statistics are based upon the Morningstar Un-weighted Covered Call Index, which is the average of all closed-end funds categorized by Morningstar as utilizing a covered call investment strategy. Covered call closed-end funds are defined as funds investing in equities and generate additional income by writing calls on at least 50% of their portfolio.
The Global Equity index total return and discount statistics are based upon the Morningstar Un-weighted Global Equity index, which is the average of all closed-end funds categorized by Morningstar as utilizing a global equity investment strategy. Global equity closed-end funds are defined as funds that invest primarily in equity securities in U.S. and foreign countries, with an emphasis on developed countries. Most of these funds seek long-term capital appreciation rather than high income.
The Domestic Equity index total return and discount statistics are based upon the Morningstar Un-weighted Domestic Equity index, which is the average of all closed-end funds categorized by Morningstar as utilizing a domestic equity investment strategy. Domestic equity closed-end funds are defined as funds investing their assets primarily in U.S. equity securities; generally, these funds are seeking long-term capital appreciation rather than income.
The Hybrid index total return and discount statistics are based upon the Morningstar Un-weighted Hybrid index, which is the average of all closed-end funds categorized by Morningstar as utilizing a hybrid investment strategy. Hybrid closed-end funds are funds investing in both equity and fixed-income securities in U.S. and foreign countries, with an emphasis on developed countries. Funds are categorized into this peer group if they have a policy of investing no more than 70% of their assets in either equities or fixed income.
The indexes cannot be invested in directly and do not reflect fees and expenses.
Source: RiverNorth, Morningstar, Inc.
