CEF Market Update: 4.19.2017
Sr. Portfolio Specialist Allen Webb and Portfolio Manager Steve O'Neill provide a closed-end fund market update for the last quarter.
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[BEGIN VIDEO TRANSCRIPT]
ALLEN: Steve, we're starting to sound like a broken record. Closed-end funds continue to do well as we sit here in the middle of April. By the Mark's was positive across the board for most closed-end fund asset classes. Things have really taken off in the first two weeks of April as, at least all closed-end funds are up another 1% or so, which puts us up, I think, a little over 6 for the year. So, is it business as usual from the first quarter perspective? Capital markets do well, which trickles down to investors feeling good and closed-end funds continue to see positive returns and discount narrowing?
STEVE: It's common sense. Discounts narrow when there is an investor demand for an asset class. Both equities and fixed income have done well year to date, which is somewhat of an anomaly, but discounts have followed suit. So, you've got equity funds up 9% year to date. You've got bond funds up about 5% year to date. That's through the 15th of April. Discounts have been a part of that return. On average, discounts have narrowed about 200 basis points. So, I think, as we said back in January, it's not a stretch to say that, if returns continued to be positive, discounts will narrow. Certainly, your average discount is close to 4%. One could ask if there's a lot of runway left in that trade, but from my seat, I see a lot of funds trading at 7 to 10% discounts still, whose NAV returns now have been equivalent to more popular funds trading at narrower discounts. So, I think, if you have the view that fixed income, whether it's high yield, bank loans or even equities, if you have the view that risk assets will continue to perform well, it would be my expectation that those discounts will follow.
ALLEN: Let's turn to equities for a second. Frequently, we spend a lot of time on these videos talking about fixed income and taxable fixed income closed-end funds. We mention equities from time to time, usually on the context of "equities are lagging from a discount perspective", but when you look at equities this year, coming off a very strong 2016, from a return standpoint, discounts are about 350 basis points narrower this year. I think total returns lead the pack across asset classes. Has there been a wholesale sentiment change as it relates to equity closed-end funds, or is this simply that they lagged for so long that now there's been some rotation into equities finally?
STEVE: I think there are a couple reasons. The covered call group has been very popular. You've got billion dollar buy-write strategies trading around par. I think that's fairly significant when you think about the asymmetry that's really present in that trade. A lot of those funds are trading at 10 to 12% discounts at some point in the last few years. I think investors are really focused on equity income strategies, and those buy-writes deliver that. So, those funds are trading close to par, which brings your overall equity discount a lot narrower. Then, I'd say, outside of buy-writes, there continues to be a demand for bond proxies. So, you've got utilities and MLP funds trading well.
Third, I would say that the presence of shareholder activists in the closed-end fund space has kept discounts wider on average [NOTE: Steve intended to say "narrower on average"]. There are very few funds that continued to trade at 15% discounts because fund companies and sponsors are saying, "One fund after another is settling with an activist. So, maybe we should be proactive." I think the combination of those factors... investor demand for covered calls, investor demand for buy-write strategies and then activists picking up everything those other investors don't want, has caused equity discounts to narrow.
ALLEN: Steve, last question. Clearly, closed-end funds have done well from a return standpoint and from a discount standpoint. When you look at the technicals of the market, is that indicative of increased volumes, more retail investor participation, all the other technical factors you look at, or is it sort of business as usual from that standpoint?
STEVE: Narrow discounts indicate more retail ownership. Firms like RiverNorth are looking to monetize gains from discounts that we've purchased much wider than were they are today. So, we are generally sellers into this type of market and retail investors that are more focused on price returns and distribution rates are ultimately the buyers. There's a reason why closed-end funds ultimately trade at premiums and that's really the clear absence of institutional ownership. At that point, it means that there's nobody left paying attention to the closed-end fund valuation.
ALLEN: Is that price momentum?
STEVE: That's a lot price momentum and investors just buying more of something that works well. I think, from a technical standpoint, the market volume is about the same as it's been for the last year, but clearly, you’re selling it to a retail market if you selling equity covered call funds at par. When I think about the opportunity set, despite the fact that the average discount is narrow, we still find a lot of opportunities in that 7 to 10% range. There are a lot of out-of-favor funds. Whether that's because they have a low distribution rate or a sponsor that's not necessarily mainstream, that creates some opportunities for us, but you really need to be a lot more selective. I feel that way pretty strongly on the equity side.
On the fixed-income side, I find it somewhat surprising that high-yield bond funds continue to be so cheap. If you told me that average discounts were 4 ½, I would have just blindly guessed that high-yield would be trading pretty close to par in that environment. But you're still able to buy a lot of high-yield funds at 8 to 10% discounts. So, I think that part of the market remains pretty cheap. That's probably a long-winded answer to your question about market technicals.
From my seat, the average discount is pretty narrow. This is not necessarily a time that we just want to own closed-end fund beta. Our portfolios are becoming more concentrated. We're really focusing on funds that have distribution stability, relatively wide discounts and whenever possible, the potential for corporate action. When you have those sort of safety... safety is probably not the right word... when you have those sort of factors in the closed-end fund valuation, it tends to cause less discount volatility, which will certainly be more present for other funds.
If you've got funds trading at 4 ½% discount, that's a retail market. I think any sort of hiccup along the way will cause more volatility because firms like RiverNorth don't necessarily step in on the first 2% drop after your closed-end fund is up 40% last year. I think you've got some air pockets ahead. Right now, from just a risk management perspective, if you like the asset class, I would say, from a technical perspective, you could expect more discount narrowing because the market rewards closed-end funds that are doing well.
ALLEN: Steve, thanks, as always, for your comments. I look forward to chatting with you next month.
STEVE: My pleasure, thanks.
[END VIDEO TRANSCRIPT]
Video recorded 4.19.2017.
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.
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.
Par is a term that refers to a financial instrument that is trading at its face value.
Muni is short for municipal bonds.
Par is a term that refers to a financial instrument that is trading at its face value.
A covered option contract is secured by cash (covered put) or shares underlying the option (covered call). A call option is an agreement that gives the investor the right, but not the obligation, to buy a stock, bond, commodity, or other investment at a specified price within a specified time period.
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.
Shareholder activism is 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.
Beta reflects the sensitivity of a fund’s return to fluctuations in the market index. A beta of 0.5 reflects half of the market’s volatility as represented by the Fund’s primary benchmark, while a beta of 2.0 reflects twice the volatility.
CFA® is a registered trademark owned by the CFA Institute.
Source: RiverNorth, Morningstar, Inc.