Closed-End Funds Start Second Quarter 2015 in Attractive Terratory (Discounts and Yield)
As the new quarter opened, U.S. and European stocks climbed on April 6, giving the Dow Jones Industrial Average a positive for the year. U.S. stocks were also supported by the possibility that the Federal Reserve may delay raising interest rates because of soft U.S. economic data. Oil prices soared on rising demand in both the U.S. and Asia, helping stocks rise.
According to our April 2, 20155 CEF Universe data, there are currently 620 CEFs and BDCs that trade on US exchanges with a total market capitalization of $297.5 Billion. The pricing of CEFs to their net asset value are currently trading at attractive levels for many sectors. Due to concerns over the impact of rising rates on municipal, taxable bond and various equity sector income focused funds, we see discounts, in our opinion, at levels that build in some of the rising rate risk into the funds’ pricing.
For municipal bond CEFs focused on tax-free bonds, we see a discount level of -6.1% and an indicated yield of 5.8%. Since these funds recovered from a rough 2013, they have traded between a -5% discount and -8% discount vs. a historical discount level closer to -3%. Here we think investors need to be thoughtful on their need for tax-free income and how these funds can meet their needs for investment grade bond exposure.
Taxable bond funds are trading at about a -6.7% discount and an indicated 7.7% yield vs. their recent trading range of -4% to -8% discount levels. We think that overweighting multi-sector bond funds, senior loan / floating loan, convertible bond and emerging market bond CEFs will perform well through most scenarios of a rising rate environment.
Business Development Companies (BDCs) have bounced up from a -10% discount on average in January of this year to an average discount of -4.6%. Earnings season was mostly positive as the fears on how the funds would handle the fourth quarter left many fund rallying after their quarterly update and conference call. This was after a general market over reaction on the downside in October through January. Yields average 9.7% for the debt-focused funds. This sector is positioned to out-perform in 2015 and many funds are overweight variable loans, which should do well after we see rates increase.
Non-US Equity funds have outpaced US focused funds on a market price total-return basis this year as we see better opportunities in some of the global markets. Discounts are still attractive at -9.5% for Non-US funds but slightly wider at -9.8% for US focused funds. Sector funds have underperformed their equity peers so far this year, but show an average -6.7% discount vs. a recent range of -8% to -5% and show a 7.7% indicated yield.
We suggest investors continue to stay diversified across CEF sectors, looking for opportunities to buy funds when they are oversold, and selling funds when the market gets too excited. The benefits of CEF investing: are this repeatable “CEF alpha”, the fixed-capital for the fund managers to maintain conviction through various markets cycle’s, when prudent, adding low cost leverage to potentially increase yield and giving investors daily liquidity at market prices. We continue to see creativity in CEF offerings and know that this 120+ year-old US fund structure will continue to adapt and develop over time.
Disclosure: The views and opinions herein are as of the date of publication and are subject to change at any time based upon market movements or other conditions. None of the information contained herein should be constructed as an offer to buy or sell securities or as recommendations. Performance results shown should, under no circumstances, be construed as an indication of future performance. Data, while obtained from sources we believe to be reliable, cannot be guaranteed. Data, unless otherwise stated comes from the April 2, 2015 issue of our CEF Universe service.