September 2015 Closed-End Fund Market Update

Portfolio Specialist Allen Webb talks to Portfolio Manager Steve O'Neill about the closed-end fund market for the month of September 2015.

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[BEGIN TRANSCRIPT]

Allen: Steve, the last two months we've gotten together, the total return story in the closed-end fund market has been pretty negative. Was September more of the same?

Steve: It was. The closed-end fund market was down two-and-a-half percent in the month of September. That matched the performance of the S&P 500, and high yield bonds generally. Those were the risk assets that underperformed. Higher quality fixed income was up about 70 basis points.

Allen: So Steve, from a historical standpoint, you know, we're down a pretty significant amount, year to date. Does this remind you of any period in the last few years?

Steve: Yeah, it certainly reminds me of 2008-2009 in terms of the size of the losses. Just looking at equity closed-end funds, over half of equity closed-end funds are down more than 20 percent year to date... I'm sorry, off their highs. Looking at the fixed income market, which will put a different scale on that, but over half the fixed income funds are down more than 10 percent off their highs total return. And that's a very sizable loss for a fixed income security, and so, although we did see a lot of fixed income volatility in 2013, the fact that the credit markets are underperforming so significantly off their recent highs reminds me more of 2008-2009. Certainly the magnitude of the NAV losses were much higher then, but the way the closed-end funds are pricing in fears reminds me a lot of 2008-2009. And, as we've told our viewers, the discounts are reflecting that today.

Allen: Steve, before we move onto discounts, you know 2013 was more about the fixed income side of the story. I get the feeling this year very few asset classes have been spared from the drawdown?

Steve: Definitely. The S&P 500 has been one of the leading equity markets and the Barclays Aggregate has done well from a fixed income side on a relative basis, but, you know, looking at the asset classes within the closed-end fund market, most fixed income funds have a corporate credit component, spreads have widened out materially, year to date. On the equity side, there's a lot of diversification outside of the S&P 500. You've got MLP funds that constitute about 20 percent of the equity closed-end fund market. Their NAVs are off forty percent from the June levels, and so you're seeing pretty sizable NAV losses, and the performance of equity closed-end funds is certainly much work than the S&P 500.

Allen: Steve, you referenced discounts a minute ago. When we first, excuse me, when we last got together, discounts were approaching 10 percent from an all closed-end fund basis. Are we still kind of in that neighborhood after the end of September?

Steve: Yeah, the ten percent number is still good. It started the month at ten and ended right around there as well. We actually don't focus a lot on the average discount because we're looking at bottom up opportunities, and we like to say that one in five closed-end funds today is trading at a 15 percent discount or greater.

Allen: Interesting. Steve, anything else on your mind outside of just total returns and discounts in the closed-end fund market?

Steve: I think the last time that people were as concerned about closed-end funds was 2008-2009 and managing capital then, we had a lot of questions about the leverage of the underlying funds. That's coming up again. Leverage is playing a role as net asset values are down, the leverage magnifies that loss and a lot of investors are looking forward as well and saying, "Is there going to be potential for forced liquidations to meet leverage tests?" And that certainly is possible, and is actually occurring in the MLP market today, but for the most part, I think it's just important to step back and say what kind of leverage profiles do most of these funds have? And, you know, looking at the taxable bond market, 90 percent of those funds have some component of leverage. Uh, munis... ninety-five percent of the muni funds are levered, and about half of the equity funds are levered. There's less leverage on the equity funds because the asset class is more volatile, but looking at the average ratios, you're looking at about thirty percent leverage on most taxable funds. Slightly higher on the munis, and again, on the equity side, it varies. Funds with utility exposure might have higher exposure or leverage ratios than something that's general equity exposure. And so those leverage ratios in and of themselves are not extraordinarily high, but closed-end funds must meet asset coverage ratio tests, and therefore, forced deleveraging can occur when the markets move quickly, but we think that, you know, when you think about that, we encourage closed-end fund investors to call their fund sponsors. That's certainly one of the most important issues that those sponsors are focusing on today, and I think it's important for a diligent investor to understand the leverage risks. Understand how they're gaining that leverage, whether it's through preferreds or bank debts or repo, and understand the unique risks that that might introduce to the return profile of the fund.

Allen: Steve, we talk a lot about returns and discounts in these monthly videos, but I'm assuming it's safe to say that the type of leverage and amount of leverage is something that your team looks at very closely as you look at closed-end funds that you own across the various strategies.

Steve: Definitely. Our background was lending to closed-end funds at one point, and so we have a very strong understanding of how closed-end funds are levered, and certainly have a view of what types of leverage are more advantageous than others when capital market volatility increases. And so, we believe that was a competitive advantage that we had back in the financial crisis of 2008-2009, and we certainly are spending, you know, we're always spending a lot of time analyzing the leverage profiles of the fund, but today it's one of the key components of an opportunity that we look at.

Allen: Steve, thanks as always for your time.

Steve: Thank you.

[END TRANSCRIPT]

Video recorded 10.8.2015.

Produced by RiverNorth Capital Management, LLC ("RiverNorth" "we" or "us").

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This information is provided for informational purposes only and should not be considered tax, legal, or investment advice. References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Opinions referenced are as of the day recorded and are subject to change due to changes in the market, economic conditions, or changes in the legal and/or regulatory environment and may not necessarily come to pass.

Past performance is not a guarantee of future results. Diversification does not ensure a profit or guarantee against loss.

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Definitions

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 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 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 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 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 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 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.

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. 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. This unmanaged index does not reflect fees and expenses. The S&P 500 and Barclays Capital U.S. Aggregate Bond Indices are indices only and cannot be invested in directly.

High yield bond spreads are the percentage difference in current yields of various classes of high-yield bonds (often junk bonds) compared against investment-grade corporate bonds, Treasury bonds or another benchmark bond measure. Spreads are often expressed as a difference in percentage points or basis points (1/100th of 1%, or 0.01%).

MLP - A master limited partnership (MLP) is a publicly traded limited partnership. Shares of ownership are referred to as units. MLPs generally operate in the natural resource, financial services, and real estate industries.

Source: Morningstar, Inc.