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2017 CEF Market Review

CEFA spoke with Eric Boughton, Portfolio Manager and Chief Analyst — Matisse Capital, during a recent webinar to reflect on the closed-end fund market’s performance in 2017. Boughton has 20 years of investment experience, and he's advised and manages Matisse Capital's discounted closed-end fund strategy across all the firm's accounts. These opinions are those of the speaker and are not necessarily supported by the Closed-End Fund Association.

Key Points:

  • In Matisse Capital’s view, prevalent discounts are the most important factor when evaluating closed-end funds.
  • Closed-end funds are not uniform.
  • There are always opportunities in closed-end funds.
Eric Boughton
Eric Boughton
Portfolio Manager
& Chief Analyst
Matisse Capital

Let’s start with the closed-end fund market review in 2017. The first thing we're going to discuss is what discounts were prevalent at the end of 2016, and you'll see soon why we start and end with this. It's the most important factor when evaluating closed-end funds, in our opinion.

So what was the discount climate for closed-end funds coming into 2017? The first thing we'd like to note was that the closed-end fund universe was at a 6.4 percent average discount at the beginning of 2017, which is very attractive when compared to the longer-term average of 4.7 percent over the last 12 years, and 3.5 – 4 percent over the last 20 years prior to that.

The most extremely discounted sectors in the closed-end fund marketplace were equity closed-end funds, not bond closed-end funds at that time. U.S. equity funds were about 10 percent discounted, and international equity closed-end funds were about 11 percent discounted. I'd like to point out this is back to 12/31/16.

International equity funds were the most discounted that they'd been since the 2008 event. Also, equity funds were lower than their long-term average, and the overall universe was cheaper than its own average.

We manage a portfolio of highly discounted closed-end funds within our mutual fund, MDCEX. Our portfolio coming into 2017 was 16 percent discounted, as compared to our own long-term average discount of about 13 percent. So what opportunities specifically did we see coming into 2017? Of course, international equity closed-end funds. Our own portfolio within Matisse was 30 percent foreign stocks on a look-through basis coming into 2017. We clearly saw a lot of opportunities there.

We also saw individual opportunities in certain U.S. equity closed-end funds, and we'd just like to highlight that there are always opportunities. Closed-end funds are not uniform. They don't move the same way across sectors, and one example, our largest position coming into 2017 was a fund trading at a 19 percent discount with a high quality US equity, primarily, portfolio marked by largest holding, Berkshire, and offering a cash distribution yield of 5 percent.

How did closed-end funds then perform in 2017? They came into 2017 highly discounted. Equities were cheap. International was cheap. The average closed-end fund returned 11 percent at NAV in 2017, which you would expect because bonds in 2017 returned mid-single digits and equities returned high teens. Closed-end funds are balanced on average, so that makes sense. But, the average closed-end fund itself returned 13.6 percent on a total return basis. Why? Because discounts narrowed by about 1.5 percentage points.

So what happened to closed-end funds is you get the underlying NAV return and you also get the return that comes from whatever happens to discounts during the period. Now, discounts can widen, but as we noted, discounts were very wide, and so they narrowed. And of course, the international equity closed-end funds led the way. They had the most extreme discounts, and so as a group, their discounts narrowed by more, about three percentage points. The U.S. dollar weakened and foreign equity markets performed well, and so the average international equity closed-end fund returned 33 percent in 2017.


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