February 2016 Closed-End Fund Market Update
Portfolio Specialist Allen Webb talks to Portfolio Manager Steve O'Neill about the closed-end fund market for the month of February 2016.
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[BEGIN VIDEO TRANSCRIPT]
ALLEN: So Steve, when we got together last month, January was a tough month for most of the capital markets. You had the S&P down a little over four. You had high yield spreads widening. Closed-end funds, I believe were down about two and a half, although some of the subsectors were down even more than that. Rolling into February, more of the same? Or any improvement there?
STEVE: Well, February was another wild ride the for the capital markets in general. Mid-month, the capital markets, equities, fixed income hit their low, and then you had a pretty abrupt rally from about February 11th or 15th, and so closed-end funds did about the same. They were down probably three or four percent for the month, and then they bounced back, which brings a lot of fixed income funds to down two to five percent year-to-date on the taxable side. On the munis, obviously high quality fixed income has done well, and so those have been positive year to date. And equities, it really depends on the asset class. Certainly, international versus domestic, energy versus other sectors, that performance varies.
ALLEN: Steve, you mentioned munis. I believe we talked about this last month. Investors seem to have a penchant for muni closed in funds right now. Is that continuing, and have you seen that move into the other closed in funds sub-asset classes?
STEVE: Sure. I think munis are benefitting from positive performance. A lot of investors will look at a closed-end fund, and they won’t think about the discount or premium. They think about where the price is and where it’s been trading in the past. A lot of investors have had a good experience with munis. 2013 is a distant memory. A lot of investors have made money ever since. More capital is flowing into the space. Performance of the closed-end funds has been strong, and that encourages more investors to buy. There tends to be the type of behavior where investors sell the low, and then they buy asset classes that are doing well. What happens in the closed-end fund space is that discounts which were attractive to a lot of institutional investors over the last few years have narrowed quite substantially, and the buyers tend to be retail at this point. You’re seeing a lot of funds that… the asset class is still attractive to many, and the closed-end fund structure makes sense, but the discount in many cases is nothing to get too excited about. You’re seeing a lot of five, six percent discounts, which historically are attractive, but I’d say it’s a good example of what can happen to closed-end funds once retail investors really embrace it.
ALLEN: Steve, you mentioned discounts. Are we still in the eight percent range, where we’ve been for most of the last three months?
STEVE: Yes. There’s been a lot of movement within the groups. Obviously, as I said, munis have narrowed a bit. I didn’t get a chance to say it, but high yield bond funds have also narrowed as well. I think that when investors look at the space, they become much more interested in the asset class with spreads of 800 relative to spreads of 400, and so that common sense approach- I don’t know if it’s institutional investors that are buying, it’s hard to tell mid-quarter, because we haven’t seen filings yet, but it seems that a lot of smarter money is putting capital to work in the high yield bonds. You’re buying an asset class that’s already cheapened, and you’re able to buy that at what was 10 to 15 percent discounts. In many cases, those discounts have narrowed substantially, so a lot of funds are trading in the 8 to 12 percent range. Munie and high yield have done well. Those discounts have narrowed, but other than that, there’s nothing really too interesting to report. The 8 percent average is probably a little high today, but a lot of funds continue to trade at their widest level since 2009, maybe a couple of hundred basis point narrower than where they’ve traded as a low year to date.
ALLEN: Steve, as we mentioned last month, we thought we would do something a little bit different this month and take some viewer Q and A. We had some investors write some questions in to us over the last month or so, and we’ve selected four questions to ask you as our closed-end fund expert with regards to both closed-end fund market and RiverNorth. Question number one, which I think is an interesting one with where discounts are now: Why don’t more closed in fund sponsors or managers actually buy back their own shares when they’re trading at a discount? It seems like that would be a pretty good use of capital.
STEVE: I would agree, from a shareholder’s perspective, there’s nothing better than buying back the shares of the company at a substantial discount. The accretion far outweighs any potential return, in many cases, that that manager could get by buying cash bonds or equities, but I think many managers have the view that share buybacks don’t influence discounts, and there’s a lot of evidence to suggest that’s the case, but that doesn’t mean it shouldn’t be done anyway. Obviously, from a portfolio management standpoint, why buy more bonds or equities when you can buy the bonds and equities you already like at a discount. I think intuitively, it makes a lot of sense, but from the sponsor perspective, I think the boards would say that it doesn’t offer much support for the discount, and there’s always that conflict where the asset manager is essentially getting paid less because the size of the fund is smaller, so there’s a conflict between the shareholders and the sponsors. Many sponsors are doing the right thing, and I think that shareholders should continue to pressure management to buy back shares at these discount levels. That message, I believe, has been received, but there is more work to be done.
ALLEN: Question two, on a related topic: With discounts as wide as they have been for the last year or two- and we’ve spoken about activism in the closed in fund space a little bit here in some of these videos- in your opinion, why don’t more institutional investors, hedge funds and the like, come in and try to force change and force the discount narrower?
STEVE: There has been a lot of corporate action activism in the space, the most that I have seen in quite a long time, and the reason for that is the discounts have been wide, and they’ve been there for a while. The problem that many institutional messengers have when you’re running an activist type campaign is you need a lot of votes. To get a lot of votes, you need to buy a lot of shares, and it can take a long time to accumulate a sizable block of a closed-end fund, and I’m talking like a 10 to 15 percent position which, in many cases, is necessary to really get the ear of the fund company. It’s a combination of it’s difficult to accumulate sizable positions, and that’s certainly the case when you’re trying to buy those sizable positions at a discount. Really, the more capital you put into the name, the more the discount can narrow, and then the campaign kind of loses its vigor once the discount’s already narrowed.
ALLEN: Steve, I’m assuming that if that did happen, certainly that has an effect on very specific closed-end fund names. It would be very hard for activism in a name or two to drive broad closed-end fund discounts narrower.
STEVE: Right. I think the larger cap names are really out of reach for most hedge funds and activist investors, and so, from a market cap basis, it’s harder to take down those kind of names. A lot of the activism that’s occurred in the last few years has been on funds that have one to two hundred million dollar market caps. Certainly, I think that the existence of activist investors keeps the closed-end fund discount a lot narrower than it otherwise would have been, and it keeps the sponsors honest. They want to certainly keep the fund alive, and they want to do whatever is necessary for shareholders to keep that discount narrow. The activists, I would say, keep them honest in that regard.
ALLEN: Steve, question three, turning to RiverNorth. One of our viewers had been on our website and has noticed on our RiverNorth team page that we now have five software developers, which is about 20% of our employees. So, can you talk a little bit about the software development team and what they’re doing as it relates to helping you and the closed-end fund investment team?
STEVE: Sure. As it specifically relates to investment management, it’s our view that, from a portfolio management level, we like to be in control of all the trading at the firm and the only way to do that is to automate the trading through our proprietary execution management system. The real benefit of that is that Patrick Galley and myself can execute orders that are discount-based orders. Our goal is to put out orders throughout the day that are targeted discounts. We’re not executing necessarily on price. We would buy XYZ closed-end fund at XYZ discount. That enables us to maintain control, put our electronic eye out on the market, and, I think, really efficiently trade the space and take advantage of the opportunities when they present themselves. That’s in contrast to a type of structure where portfolio management gives a team of traders orders, and then they are constantly adjusting limit orders, and that can be efficient to some, but we have found that instead of hiring a half dozen traders working at RiverNorth, we’d rather hire a half dozen programmers, and, I think, get the job done more efficiently.
ALLEN: Last question. Another viewer had also been on our website and noticed in our strategy section a new strategy popped up on the website in late December. The question was, can you talk a little bit about your newest offering, which is the RiverNorth opportunities fund, which is RiverNorth’s first closed-end fund.
STEVE: Sure. RiverNorth is the subadviser to the RiverNorth Opportunities Fund and I’m excited about this because we finally have a product where I don’t need to worry about inflows and outflows, and I can really take advantage of some of the less liquid nooks and crannies of the closed-end fund space. There's a lot of opportunity in closed-end funds in general, and having a captive pool of assets dedicated to that, one that we can also opportunistically leverage, naturally, from a portfolio management standpoint, that’s the most advantageous. For us, it’s a way to potentially take advantage of opportunities that we can’t necessarily focus on for open end funds.
ALLEN: Steve, thanks as always for your time.
STEVE: Thank you.
[END VIDEO TRANSCRIPT]
Video recorded 3.4.2016.
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