Featuring:
Jeff Margolin
Senior Vice President & Closed-End Fund Analyst
First Trust Portfolios
Leading closed-end fund analyst Jeff Margolin with First Trust returns to CEF Insights to review the first half of 2025 and share views on the market ahead. Read or listen to the episode below.
First Trust is a leading provider of advisory services and investment products including closed-end and interval funds. Learn more here.
Transcript
CEFA:
Welcome to CEF Insights, your source for closed-end fund and interval fund information and education, brought to you by the Closed-End Fund Association.
Today we are joined by Jeff Margolin, Senior Vice President and Closed-End Fund Analyst with First Trust Portfolios. First Trust features a family of five closed-end funds, as well as four interval funds. On a quarterly basis, Jeff writes the Closed-End Fund review, which is available on ftportfolios.com.
We are happy to have you with us today, Jeff.
Jeff Margolin:
Thank you very much. I'm very happy to be able to speak with you today.
CEFA:
Jeff, we are just past the midpoint of 2025. Can you discuss the closed-end fund market over the first six months of the year?
Jeff Margolin:
Absolutely. It's been a very solid first six months of the year in terms of performance for many closed-end funds. Now, I think it's important to note that we are following two positive years from a performance standpoint for the average closed-end fund. Indeed, the average fund was up 10.6% in 2023 and then up another 15.3% in 2024. So the past two and a half years have been a very good time for the secondary market of closed-end funds from a performance standpoint. Now, specifically looking at the year to date data through June 30th, the average fund was up a solid 6.1%. Equity funds are up 11.8%. Now, I know that number does sound high relative to say the S&P 500, but it's important to remember that many equity closed-end funds have international exposure and several international equity markets have outperformed the S&P 500 so far year to date.
When we look at taxable fixed income closed-end funds, they're up through June 30th, 5.3%, and municipal closed-end funds are the only broad category that's lower and they are slightly lower by 0.26%. So other than municipal closed-end funds, all of the broad and all of the narrow categories of the closed-end fund marketplace that I track are positive so far year to date through June 30th. And from my perspective, I think the slight weakness that we've seen so far year to date in municipal closed-end funds represents an opportunity for investors. And perhaps we can talk about that more in a bit.
CEFA:
How do you see closed-end fund valuations in the current market?
Jeff Margolin:
In terms of valuations, the trend over the past several quarters has been for average discounts to NAV to narrow, and we ended the second quarter of the year with average discounts to NAV at -4.2%, which was narrower than the -4.5% level that they ended on March 31st. And when I look at average discounts to NAV for the closed-end fund marketplace or average discounts to NAV for a specific category or for an individual fund, I always look at the data relative to the long-term average, say 10 years, to help put the current data in perspective with historical trends. So, with an average discount to NAV of -4.2% as of June 30th, discounts are now narrower than the ten-year average discount to NAV of -5.8%. Now, keep in mind it was only 18 months ago on December 29th, 2023 when average discounts to NAV were nearly -10%, -9.6% to be exact.
And I believe it's encouraging to see average discounts to NAV continue to narrow. Periodically with valuations in the secondary market, average discounts to NAV will widen to high single, low double-digit levels as we saw in 2023, and it can create some short-term frustration for investors, but often it represents an opportunity as eventually investors recognize the value in the closed-end fund marketplace. They recognize that many funds are trading at discounts which are wider than their long-term average. And that is when what I think good old-fashioned price discovery takes hold and investors begin to buy closed-end funds at compelling valuations. And we slowly see average discounts begin to narrow. And I believe we have seen this process play out over the past several quarters. It's also helped that we've had a strong global equity market and solid performance of several key fixed income indices over the past several quarters.
When we look at discounts for equity funds, average discounts to NAV for equity funds also narrowed during the second quarter to -5.6% from the -6.2% level that they ended on March 31st. Average discounts to NAV for equity funds are narrower than a ten-year average discount of -7.2%. Looking at taxable bond, closed-end funds average discounts to NAV for taxable bond closed-end funds widened slightly during the second quarter to minus 0.8% from the minus 0.4% level that they ended on March 31st, but remain narrower than their ten-year average discount of -4.0%.
Among the broad categories, municipal closed-end funds remain the only category where average discounts to NAV are wider than their historical average. Average discounts to NAV for municipal closed-end funds narrowed during the second quarter to -6% from the -6.4% level that they ended on March 31st, but again remain wider than their ten-year average discount to NAV of -5.3%. It remains my view that if the Federal Reserve does indeed lower short-term interest rates at some point later this year, I expect average discounts for municipal closed-end funds to narrow further and potentially trade at discounts which are narrower than the long-term average.
CEFA:
Jeff, what are the key characteristics or metrics that investors should consider when evaluating a closed-end fund?
Jeff Margolin:
Well, right now in the secondary market, there are approximately 400 closed-end funds available in the secondary market right now for investors. So there's clearly plenty of options in all different categories for investors to consider. And I believe there are several key factors an investor should consider when investing in a closed-end fund. First, I think an investor needs to like the fundamentals and valuations of the underlying asset class that the fund is invested in because over time, historically, the share price of a closed-end fund will be highly correlated to the fund's net asset value. And at the end of the day, a closed-end fund is an investment structure. It is not an asset class, but rather a closed-end fund is a way to gain exposure to various asset classes. And therefore, I think it's imperative that an investor favors the asset class that the closed-end fund invests in.
Now after an investor has made the decision that they like the specific asset class that the fund invests in, whether it be Munis, preferred, equities, et cetera. I think it's important to look at the valuation of the closed-end fund, the current premium or discount to NAV that a fund trades at. But importantly, it's crucial from my standpoint to look at the fund's current valuation relative to the historical average of the specific fund to gauge whether the fund is more expensive or cheaper relative to its historical average. I also think it's crucial to look at a fund's distribution and the composition of the distribution. We are seeing a trend of more funds distributing a return of capital in their distributions, and therefore I think it's important to see, and for an investor to see the breakdown of a closed-end fund's distribution, how much is earned net investment income, how much is composed of realized capital gains, how much is composed of return of capital?
So, the composition of a fund is an important factor, as is the historical stability of a fund's distribution, at least from my perspective. I think it's also relevant to look at a fund's share price and NAV performance relative to their peers. When we're talking about closed-end funds, we can't ignore the fact that roughly two-thirds of all closed-end funds employ the use of leverage, and therefore, I believe it's important to look at a fund's leverage structure and the percent the fund is levered. If you're looking at investing in a fixed-income closed-end fund, I think an investor should look at the fund's credit quality breakdown, the duration and average maturity of the bonds in the fund. So, I could go on, but I think the six or seven factors that I just mentioned are a good place to start from my perspective.
CEFA:
What is your outlook for the rest of 2025?
Jeff Margolin:
Well, as the second half of the year commences, I think the biggest factor for the closed-end fund marketplace, particularly for fixed income closed-end funds, will be if the Fed cuts short-term rates. And if so, by how much? As discussed before, roughly two thirds of all closed-end funds employ the use of leverage. And if the Fed cuts rates say hypothetically two times during the back half of 2025, it will be very helpful for levered closed-end funds from the standpoint of likely reducing borrowing costs for levered funds, which increases the spread between their borrowing costs and then the rates that they can earn on the borrowed proceeds. If the Fed does go ahead and cut short-term rates, it should increase many funds earnings rates, which I believe will be viewed favorably by investors and help to create a solid backdrop for many fixed income closed-end funds.
In addition to the Fed potentially reducing short-term rates, another potential positive for the closed-end fund structure for the back half of 2025 relates to the increase in demand and improved overall sentiment. We could see if interest rates decline and yields on competing income-oriented investments such as certificates of deposits, money market funds, US treasuries, et cetera, were to decline. If we see these competing and alternative rates decline later this year, investors may be more likely to consider the closed-end fund structure given the very high and attractive distribution rates that exist in the secondary market for closed-end funds.
CEFA:
Jeff, in the current environment, what sectors do you think provide the best opportunities for income-oriented investors? And likewise for long-term investors?
Jeff Margolin:
I think there are many opportunities right now for closed-end fund investors. I am a big believer in building diversified closed-end fund portfolios by blending funds from different categories that oftentimes have different risk and reward characteristics. Right now, I particularly favor blending municipal closed-end funds, preferred closed-end funds, high yield closed-end funds, and equity income closed-end funds. I am particularly attracted right now to municipal closed-end funds, as I believe the bullish case for investing in municipal closed-end funds is quite strong and centered around three really straightforward bullet points. One, we have attractive valuations from my perspective in municipal closed-end funds. As mentioned earlier, municipal closed-end funds are the only broad category of the closed-end fund marketplace with average discounts to NAV, which are wider than their long-term average. Again, average discounts to NAV as of June 30th of -6% are wider and more expensive than the ten-year average of -5.3% and even wider than the twenty-year average of -3.6%.
So, I believe discounts for municipal closed-end funds could potentially narrow should the Federal Reserve lower short-term rates later this year. Two, the potential for short-term interest rate cuts. If the Federal Reserve reduces short-term interest rates this year, it would likely lead to lower leverage costs and increased earnings rates for leveraged municipal closed-end funds. I believe that would be viewed favorably by investors and increase demand for municipal closed-end funds in the secondary market.
And then finally, when I look at municipal closed-end funds, very compelling distribution rates. As of June 30th, the average municipal closed-end fund had a distribution rate of 6.3%, and I think it's important when we talk about that average distribution rate of 6.3%, to note that many municipal closed-end funds have an overall credit rating of investment grade, which allows investors to potentially earn an attractive distribution rate without having to take significant credit risk, in my opinion. So, in short, while municipal closed-end funds are my favorite category of the closed-end fund marketplace for the next 12 months, I just want to reiterate that I remain a long-term firm advocate for closed-end fund investors, building broadly diversified portfolios across many compelling categories, including but not limited to again, equity income, preferred, high yield, and municipal closed-end funds.
CEFA:
Jeff, thank you so much for taking the time to join us today.
Jeff Margolin:
Thank you for having me. It was my pleasure.
CEFA:
We want to thank you for tuning into another CEF Insights podcast. For more educational content, please visit our website at www.CEFA.com.
Podcast recorded July 2025.
Disclosure
This material is not, and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. All fund-specific information is the latest publicly available information. All other information is current as of the date of this presentation. All opinions and forward-looking statements are subject to change at any time.
First Trust Portfolios disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources; however, First Trust does not warrant its completeness or accuracy. This presentation is not intended to, and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which First Trust is not licensed to conduct business, and/or an offer, solicitation, purchase or sale would be unavailable or unlawful.