August 2016 Closed-End Fund (CEF) Market Update
Senior Investment Analyst Andrew Kerai talks with Portfolio Manager Steve O'Neill about the closed-end fund market for the month of August 2016.
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[BEGIN VIDEO TRANSCRIPT]
ANDREW: Steve, closed-end fund investors have seen discounts narrow during the year. Do you expect that to continue?
STEVE: I think the short answer is yes, but it really depends on the asset class. Muni closed-end funds have had really a great run, and their market prices are certainly high and discounts have narrowed to par. So I think that that asset class is more vulnerable to discount widening, but you still have a lot of, what I think, are cheap opportunities in the taxable bond and equity closed-end fund market. So, when I look at those two groups, equities and taxable fixed income, I think the best predictor of discount narrowing is past performance. I mean, it's as simple as when things are going well for an investor and they're making money, then they're more inclined to put more money to work in that asset class. That demand for - call it corporate credit or U.S. equities - that sort of demand goes into mutual funds and ETFs, and a small part of that goes under the closed-end fund market. When things are going well, you can expect discounts to continue to narrow. Since we can’t predict the future in terms of broader capital market performance, we can really only look at what’s happening today to say, hey, look, after a number of years of sub-par performance in the closed-end fund space, a lot of that due to discount widening, things are going well today. Asset classes are doing well, both stocks and bonds. That discount narrowing combined with renewed demand tends to be cyclical and tends to lead towards further discount narrowing.
ANDREW: Sure. And Steve, with yield products performing very well during the year, both credit and high-yielding equities, do you continue to find yields within the closed-end fund market attractive on a relative basis?
STEVE: Sure. I think it’s relatively attractive, and it’s absolutely attractive as well. Again, looking at taxable fixed income closed-end funds, the yield there is just north of eight percent, which to anybody sounds pretty good. It surprises me that you can see taxable bond funds, really credit-oriented funds, high-yield bond funds or senior bank loan funds at 8-12% discounts with 7-10% yields. In a market where investors are really scouring the planet looking for some extra income, I think it’s surprising that pretty plain vanilla bond funds managed by very large investment managers are trading at 90 cents on the dollar. For us, we think that that’s a good relative opportunity to generate extra income.
ANDREW: Then looking forward through the remainder of the year, do you expect discount volatility to persist or is your expectation for it to remain relatively in line?
STEVE: It’s always, again, dangerous to predict the future, but looking at where taxable bond fund or equity closed-end fund discounts are today, I think there’s obvious value there, so investors are already pricing in some element of uncertainty. Unlike the muni bond market, which is trading at par, I think a surprise in the capital markets could lead to a lot of discount widening in that group, but a 10 percent discount on the high-yield bond fund... there could be interest rate volatility or credit-spread volatility, but it doesn’t necessarily have to cause discount widening. I think looking forward, investors should always be focused on interest rate expectations. If those remain low, that’s a great thing for closed-end funds. If credit spreads remain relatively narrow, right around 500 basis points, I think that creates an ideal environment for investors that are just looking to generate extra income. They’re going to be focusing on spread products in the market, and closed-end funds trading at what I think are historically attractive discounts, I think that’s a good opportunity for those investors. If that set up continues, we could have kind of steady discount narrowing between now and year end. That said, you could always have an unexpected interest rate hike, which would lead to discount volatility, so we always think it’s important to have some dry powder available. The closed-end fund can be unpredictable at times, but now really feels like an environment that, again, the wind is in our sails from a performance standpoint. Investors have had a great year, and the store remains strong. Discounts are wide and yields are relatively high. That sort of demand backdrop could dampen any volatility in the fourth quarter. Again, you always have to be prepared for the unexpected.
ANDREW: Great. Steve, thank you for your time.
STEVE: Thank you, Andrew.
[END VIDEO TRANSCRIPT]
Video recorded 9.13.2016.
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.
Par is a term that refers to a financial instrument that is trading at its face value.
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.
Dry powder refers to marketable securities that are highly liquid and considered cash-like. Dry powder may also refer to cash reserves kept on hand to cover future obligations or purchase assets, if conditions are favorable.
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.
Source: RiverNorth, Morningstar, Inc.