CEF Market Update: 12.14.2016
Senior Portfolio Specialist Allen Webb talks with Portfolio Manager Steve O'Neill about the closed-end fund market for the previous month.
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[BEGIN VIDEO TRANSCRIPT]
ALLEN: Steve, November was a very interesting month in the capital markets. On the one hand, you had equities up about three and a half percent, which is quite a good month for equities. On the other side, you had fixed income as measured by the Barclays Agg down about two and a half percent, which is one of the worst months anybody can remember in the last five or ten years. With that going on, what happened in the closed-end fund market in November?
STEVE: It was a bad month for closed-end funds. Your average closed-end fund was down about 2 percent. The reason for that is that most closed-end funds are bond funds. When you look at bond funds, in general, the taxable bond funds were down about one and a half percent, and your muni bond funds were down 500 basis points, which quite a large monthly loss. When you think about that and think about munis as an asset class in general, munis had their worst monthly return since 2008, and closed-end bond funds that own munis obviously had their worst month in quite a long time as well. So, when you think about the great returns in the equity market for the month of November, that is not at all what happened for closed-end funds. Your average closed-end fund, as I said, was down about 200 basis points. I guess the silver lining would be that discounts didn't really widen out. Your average discount is still around six and a half percent.
ALLEN: To our viewers, maybe we should explain. That means that net asset values were also down and sort of in line with prices, which is the reason the discounts didn't blow out with that price decline, correct?
STEVE: Exactly, and I think it's also interesting, when you have such a historic loss for bonds during one single month, you would just assume that discounts would widen. But it goes back to what we've been saying for a while. The market has been pricing in a rising industry environment since 2013. So it doesn’t necessarily mean the discounts will widen if interest rates go up.
ALLEN: Steve, talk about discounts for a minute from an opportunity standpoint. You sort of said, for the last few months, that the opportunity was good. It maybe wasn't historically great, but it was good. Are we still in that camp as we enter the end of the year here?
STEVE: Yes, I think the closed-end fund market offers something to everyone. If you're very bullish on the economy and the equity markets, you can still buy equity closed-end funds at 15 to 18 percent discounts. If you think that credit spreads are going to continue to narrow and benefit from a strong economy, you still have high-yield bond funds and multi-sector bond funds at 10 to 12 percent discounts. Then, if you're going to bet that interest rates are going to back down and you think this has gone too far too fast, you have a lot of good opportunities in that space because the high duration part of the closed-end fund market is what's been hit the worst. So you've got muni closed-end funds and preferred stock closed-end funds that have had, in many cases, 10 point discount lows in six months. So those all create pretty interesting trading opportunities. I think the ones that are most timely would be the latter — the muni closed-end funds and the preferred stock funds — because you're seeing a lot of year-end tax loss, selling volumes a lot higher for those funds, which is indicative of people booking losses and moving on. I think, once that selling pressure subsides at the end of the year, those would be the funds that I would guess would have the biggest bounce back from a discount perspective.
ALLEN: That's a great point, Steve. Thanks for joining us as always.
STEVE: Thank you.
ALLEN: A quick note to our viewers, this is likely our last video for 2016. We greatly appreciate all of you who have clicked on the video on our website or clicked on the email when we mail it out to you. If you have any questions or any topics you'd like us to address in videos in 2017, please email those to info@rivernorth.com. Again, we greatly appreciate the support and we hope everyone has a happy holiday.
[END VIDEO TRANSCRIPT]
Video recorded 12.14.2016.
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.
Investing involves risk. Principal loss is possible.
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.
Definitions
The 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. The indices cannot be invested in directly and do not reflect fees and expenses.
Muni is short for municipal bonds. Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment's cost, its current market value or its face value.
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.
Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment's cost, its current market value or its face value.
A credit spread is the difference in yield between two bonds of similar maturity but different credit quality. Widening credit spreads indicate growing concern about the ability of corporate (and other private) borrowers to service their debt. Narrowing credit spreads indicate improving private creditworthiness.
Duration is a measure of the sensitivity of the price of a fixed income investment to a change in interest rates.
CEF Index Definitions
The High Yield CEF index total return and discount statistics are based upon the Morningstar Unweighted 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 Unweighted 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 Unweighted 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 Unweighted 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 Unweighted 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 Unweighted 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 fixedincome 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.
Source: RiverNorth, Morningstar, Inc.
