CEF Market Update: 2.14.2017
Senior Portfolio Specialist Allen Webb talks with Portfolio Manager Steve O'Neill about the closed-end fund market for the last month.
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[BEGIN VIDEO TRANSCRIPT]
ALLEN: Steve, capital markets started the year with a very strong month in January. The S&P was up about two percent. Generic bonds were up about 25 basis points. Credit was up about a percent and a half, and it's really hard to find anything that was actually down in the month. Fair to assume that closed-end funds also had a good month?
STEVE: That's true. Closed-end funds were up 3.3%. Certainly, it was a good month for your average fund. A big part of that was discount narrowing. The average discount narrowed 150 basis points. So now we're at an average discount of 4.8%, which is pretty close to the long-term historical average of 4.5%. Part of the reason why discounts narrowed so significantly in January is what investors generally called the January effect, which sounds a little bit hokey, but the reality is that investors harvest tax losses in the fourth quarter and that excess supply that hits the market in November and December tends to cause discounts to widen, and then, as that selling pressure subsides as the calendar year turns, discounts narrow. It was a good seasonal contribution to the return, and then just generally, as you said, capital markets were strong. Interest in fixed income was certainly strong, whether it's investment grade or high-yield bonds. Really, every investment vehicle is picking up flows, and so some of that interest is hitting the closed-end fund market, and that's causing discounts to narrow. So it was really just an overall positive month, both from an NAV and market price perspective.
ALLEN: Steve, you mentioned the average discount is about 4.8%. That takes us to where we were kind of at the end of August of last year, before we saw some meaningful widening in September, October and November. From an opportunity perspective, are we getting expensive again, in your opinion, or are you still finding ways to put together attractive portfolios?
STEVE: I think you have to be more selective. If you're looking at equities, you're probably still safe, because your average equity fund, it would be hard to own equity fund narrower than 10 percent discounts, so there, discounts are wide. On the fixed-income side, I think you really need to be selective. To pick on bank loans, your average bank loan fund is trading really close to par, and I know that you're picking up some leverage. That can be advantageous, but there's just too much tail risk in that trade, so if you want to own bank loans, I would say, you're better off owning an open-end fund or a mutual fund. There's a handful of names in the space that still look attractive in the bank loan sector, but that would be the type of answer where I'd say you have to be really selective there. If you're just talking about corporate credit, high-yield bond funds, the majority of those, in my view, are still cheap. You're still able to buy funds with a market cap in excess of 500 million trading at eight, nine percent discounts and that really is an anomaly relative to strong interest in closed-end funds. Usually investors buy closed-end funds for yield and high-yield bond funds have some of the highest yields in the space. Historically, they've traded at premiums, but now they're trading at, you know, 5 to 10 percent discount. I think that's a part of the market where you still need to be selective, but it's almost part of a beta trade there, too. I see an average discount of four and a half and, when I think about constructing the portfolios, we're nowhere near four and a half, because you can be selective and build a portfolio closer to 10. I think there's a lot of funds in that six to 10 percent discount range that still look attractive. Again, it's asset class specific. In the fixed-income market, munis continue to be relatively cheap. I think taxable fixed-income, absent bank loan funds, could still narrow quite a bit if investor interest in the asset class remains strong.
ALLEN: How about volatility? We've talked in a couple videos previously that, with a new administration in office, one that likes to make headlines, whether that be political or capital markets related, that it certainly stands to reason that volatility across many asset classes, including closed-end funds, might pick up a little bit. Have you seen that happen or have we kind of settled in from some of the early volatility around the actual election?
STEVE: We've certainly settled in. After the election, I'd say we had the best trading environment since 2013. November or December were just tremendous. I'd say the number of ideas and the volume and, really, the capital that we were able to deploy was exciting, and I think that level of volatility is something that I'd like to see continue. That could continue if there's interest rate volatility this year, but that has certainly died down in the month of January, really coming into February. I think we're more still looking at a trending market, where investors are happy with their portfolio. Everybody's made money. Discounts have narrowed, and I would argue they could narrow quite a bit more. I would expect that, instead of the choppiness of plus or minus one percent every couple of days in closed-end funds, you're going to just see continued demand for the asset class, and I expect that to cause discounts to narrow up until a point where you hit that next bout of volatility, but in the short term, which is really as far as I feel comfortable forecasting, I expect volatility to remain relatively low and discounts to continue to narrow.
ALLEN: Thanks, Steve. Look forward to seeing you next month.
STEVE: All right. Thanks, Allen.
[END VIDEO TRANSCRIPT]
Video recorded 2.14.2017.
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.
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 Bloomberg Barclays U.S. High Yield Corporate Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. The indices cannot be invested in directly and do not reflect fees and expenses.
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.
Market Capitalization (Market Cap) is the total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share.
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.
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
Muni is short for municipal bonds.
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Source: RiverNorth, Morningstar, Inc.